Tel: 01937 222107

Looking to Sell Looking to Buy

HPC Market Review - January 2012

After a year which has seen a great deal of activity focused on the social care sector, it is likely that 2012 will throw up challenges of its own, in addition to suffering from symptoms of a ‘hangover’ from 2011.

After a year which has seen a great deal of activity focused on the social care sector, it is likely that 2012 will throw up challenges of its own, in addition to suffering from symptoms of a ‘hangover’ from 2011.

The cost of care is likely to figure high on the agenda this year. We have already seen some local authorities impose fee cuts on care home operators for the remainder of the current financial year and there will almost certainly be robust negotiations regarding fee levels between operators and commissioners over the coming months. In November 2011, the High Court ruled that Sefton Council had broken the law by not paying due regard to the cost of care when it froze care home fees. In December, the High Court ordered Pembrokeshire Council to review, for a second time, the amount it pays private care homes, despite the fact the council had already increased fees for each resident from £390 to £464 per week. Giving the ruling, Mr Justice Beatson said that the council did not follow the agreed funding model, nor did it give appropriate consideration to a number of factors when calculating the revised figure. Following these rulings, it seems likely that many care associations will follow suit and challenge any onerous decision on fee levels which cannot be supported by councils demonstrating they have followed due process in calculating fee rates.

In an attempt to prevent such actions, president of ADASS (The Association of Directors of Adult Social Services) Peter Hay, called for a ‘truce’ between providers and commissioners and suggested direct negotiations on fee levels without resorting to legal action. Whether or not this happens effectively remains to be seen, however, what is certain is that there will be a lot of discussion about fee levels over the coming months, with or without the lawyers.

Looking back at the biggest story of 2011, we do not believe that we have yet seen the end of activity in relation to the former Southern Cross estate. Whilst the sector’s ability to get its own house in order so swiftly has been admirable, it is apparent that some transfers of former Southern Cross homes have been little more than a ‘quick fix’, with homes now being operated under rolling management agreements, rather than having had new leases granted or existing leases assigned under revised terms. Whilst these arrangements have enabled the sector to avoid the nightmare scenario of mass home closure, they provide no security of tenure for the operators. What they have achieved is to allow interested parties to buy more time. It seems likely that both landlords and operators will now use that time to properly assess their estates, a process which may yet have consequences for some older and under-performing homes. There are also questions being raised in some quarters over the robustness of some of the new operators and their ability to sustain operations in the longer term. Indeed, some of the operators who have taken over the Southern Cross estate have themselves, very recently, been through a financial restructuring process or are in ongoing discussions with their current funders. It is true that much of the scaremongering in 2011 regarding wholesale closure was due to inaccurate or misleading reporting in the press, however this was, nonetheless, unsettling for staff, relatives and most importantly the residents themselves. It is to be hoped that none of these parties find themselves in an ‘out of the frying pan - into the fire’ situation during 2012.

The financing of the broader sector remains a thorny issue. There is no question that the high profile collapse of Southern Cross, together with the BBC’s Panorama expose on Winterbourne View created an extremely negative view of the sector which has permeated into the decision making processes of investors and lenders alike. The ongoing turmoil in the Eurozone has created an atmosphere of uncertainty which has not been conducive to freeing up the finance market. These factors, coupled with a requirement for the banks to recapitalise their balance sheets, do mean that securing debt financing for any business is as problematic as it has been for many years. With the Government’s austerity measures impacting on public spending, revenues in the social care sector have been affected and all of these factors combined create a new landscape in which long-term care providers must attempt to move forward.

This has forced operators and developers to look at new funding models and to consider structures which they would not previously have entertained. In spite of the collapse of Southern Cross, 2011 proved to be a fertile year for property investors buying into the long-term care sector sale and lease back model. The model in itself is not fundamentally flawed and remains a good option for operators seeking to expand in a market where debt funding is hard to come by. Where the sector must be very wary however, is in allowing the sale and lease back model to be used to prop up businesses which are fundamentally flawed. It seems that there are cases where the selling of freehold property is used as a mechanism to deliver cash into the operating business. Where the business is not independently sustainable without the delivery of this additional income, then the model is not viable and history tells us it will not succeed in the long-term.

To avoid such cases, it is important that investors are buying assets at realistic valuations which accurately reflect the revenue and trading performance of the business. At correct values, the model should be sustainable and provide the landlord with sufficient cover, provided occupancy rates are not significantly impacted. If however such investments were to be sold at figures higher than the true valuation, then the care home will be over-rented and the model will not be sustainable. The temptation, as we have seen historically, will be for the operator to continue to sell more assets in order to deliver revenue to the business over and above that which the basic fee income provides. In such situations however, it is only a matter of time before the operator finds itself ‘laying the track down in front of the train’ and locked in to a cycle where it cannot, in essence, do anything other than continue to expand.

As in all adverse markets there are opportunities. The core estate of care homes in the UK continues to age and many are fast approaching obsolescence. It seems very likely that with the ongoing pressure on local authority fees, many marginal care homes will be forced to close. We are also approaching the ‘maturity wall’ for many businesses which raised high levels of debt in the mid 2000’s in order to expand. Much of that will now be coming up for re-financing and it is quite possible that we will continue to see more companies tipped into administration during 2012.

Hard as it may be to believe, later in 2012 we will see the 5th anniversary of the queues outside Northern Rock which heralded the start of the credit crunch. Whilst there has been new development in the care sector during that period, the lack of availability of funding means that this has been at nothing like the pace required in order, not only to meet future demographic challenges but also to replace much of the ageing stock. There must be good opportunities for new and ambitious operators to develop new facilities in that environment and we are already seeing some innovative and ground-breaking designs which may shape the future of social care provision in the UK.

HPC continues to be involved in advising some of the country’s largest care home groups, providing a broad range of consultancy, research and transactional services. Our view is that a new market requires a new approach to the traditional role of the property consultant and we are pleased to be at the vanguard of this change. We hope we will have the opportunity of working with you in 2012.

January 2012