The two listed real-estate investment trusts (Reits) that own care homes, Impact Healthcare (LSE: IHR), with £360m of assets, and Target Healthcare (LSE: THRL) with £520m, have come through the Covid-19 crisis well. The stocks have fallen by 6% in six months. The former trades on a 4% discount to net asset value (NAV) and the latter a 5% premium. They both yield over 6%. The result is attractive but not too-good-to-be-true valuations.
The cost of care for the elderly has become a burning political issue. In 2019, £16.5bn was spent providing for around 450,000 elderly residents of 12,000 care homes. About 3.2 million people in Britain are over 80 and that number is expected to grow steadily over the next 20 years. Demand for beds in care homes is rising. Accountancy group Grant Thornton projects long-term growth of about 1.8% per annum, which, with existing homes full, requires new capacity.
Learning the lessons of the 1990s
Capacity reached 550,000 in 1997 after a decade of strong growth largely as the result of the construction of purpose-built, single-storey, specialist homes by listed private-sector companies. The new Blair government, however, disliked the idea that investors and entrepreneurs, such as Duncan Bannatyne, were prospering at public expense, since most of the places were filled by local authorities and the NHS. So they squeezed the providers by limiting the reimbursement from the Treasury, while other government measures raised staff costs. Capacity fell by 20% over the next decade, which ought to make the private sector wary of being asked to help solve the crisis in elderly care all over again.Fortunately, Impact and Target are not getting carried away. The business model of both is to own the homes but rent them to specialist operators. The number of beds owned by Impact has more than doubled to 5,600 in three years and the number of properties has nearly doubled to 104. But expansion has been funded by equity, not debt. Eleven tenants provide a contracted rent of nearly £30m, resulting in a return on capital of 8.8%. All of the rent due in the year to date has been received.
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Just six homes had some residents testing positive for Covid-19, and all were free of it by the end of July. Occupancy levels dropped by 8% between March and the end of June but have now started to recover. Tenants’ costs rose sharply as a result of the increased expense of agency staffing, protective equipment and cleaning, but are now coming down. With an average increase in weekly fees of 12.5% in the year to April, the tenants can comfortably afford their steadily increasing rents. Only a handful of Target’s 71 homes have been affected by Covid-19, with the infection rate falling from a peak of 3.2% of its 4,925 beds to under 0.3%. About 96% of its rents for the second quarter have been received. Despite this, like-for-like rental income increased 0.4% in the last quarter, allowing a marginal increase in NAV even after paying a quarterly dividend. Meanwhile, £43.6m of rental income, expected to increase by 8.7% this year, provides a return on capital very similar to Impact. Target has net debt of around 20% of gross assets, so an equity issue to fund further expansion is likely.
Target looks more expensive but this may reflect the quality of its portfolio: larger than Impact’s and all purpose-built. With fees rising faster than costs, the dividends of both look likely to increase steadily. Both shares look attractive for yield and capital growth but the potential for political interference, well-meaning or not, should not be ignored.
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