_CoStar Q&A with Julian Evans, Head of Healthcare at Knight Frank

Care homes have been a key focus of Covid-19 – how are they coping?

There has been a lot of scare mongering in the press, particularly tabloids, regarding infection control. In my view this is completely irresponsible as operators have been fantastic in the way that they have handled the pandemic, and especially so given the lack of PPE and government guidance at the start of the pandemic and the way it has been handled throughout.

On the operational side, the pandemic has sadly accelerated deaths of many care home patients given the average age of a care home patient is 81 and the average length of stay in 18 months. However, the curve has flattened now, and we are gradually seeing an increase in new admissions which had previously dropped, meaning that barring a second wave, the occupancy market is stabilising.

How has the Coronavirus pandemic impacted the healthcare property sector?

I would say the reality is we downed tools on £4.5 billion of valuations when we went into lockdown and we had a sales book of around £1.4bn that went on hold. But that has quickly picked up again in the last two to three weeks – if things are not changing on weekly basis they are changing on a daily basis and it’s been phenomenal how quickly the momentum has recently increased.

We have been talking to a UK private equity firm that is considering scaling up existing operations and having calls with UK institutional investors who want to make their first foray into the sector because they need to redress their exposure to retail or other asset-backed sectors like hotels, hospitality and leisure that have been badly impacted by the crisis. They have to spread their risk, and a sector with an ageing population and a structural under-provision of services is a pretty compelling investment case.

What has investment so far been like into the sector and which areas of the sector are particularly strong?

The healthcare property sector saw over £1.7bn investment in 2019 and has consistently been above £1.2bn for the past three years as investors look to diversify their investment portfolios.

Specialist companies that focus on mental health such as the Priory Group have been performing well despite the pandemic. As you can imagine the longer-term effects of a pandemic like Coronavirus has had a huge impact on the mental health market which will mean that it will become more important than ever post-COVID-19.

If you consider the uptick in rising unemployment and furloughing, all this has meant increased enquiries to specialists such as the Priory Group and I actually think we will unfortunately begin to see the effects of this over the next six to twelve months as people are regrettably made redundant.

Do you predict that there will be a lot of investment activity in the near term?

If you consider where the debt and bond markets are going and look at leased assets on long leases to a tenant that has been through COVID and managed it well, and if you are a fund manager at a large institution and you have too much exposure to retail, why wouldn’t you reposition to increase market share into healthcare? I think that has already started to happen so you will see competitive tension around that sort of product.

The M&A market has been relatively quiet for the past two years, having said that, it is a highly fragmented sector. If you are a family-run provider with say five to ten care homes, you’ve got Brexit looming and we have just been through the pandemic so I suspect by Q4 this year or Q1 next year we’ll see a lot of owner operators preparing for an exit because they are pretty brow beaten with life and we will see a spike of mandates coming to the market next year.

If they are leased assets, I think we can see yield compression and for going concerns like the Priory Group it will hold firm in value, possibly at a premium.

Those that are in multi-family or any asset backed sector are looking to diversify risk and are increasingly looking at senior living, we have over half a billion of live sales in the UK and we have had credible bids from overseas funds so there are definitely new entrants.

Many of the calls we have been having with potential investors have been from Asia-Pac, Malaysia, the US and Australia, with institutional capital that that wants to enter the UK. It is going to be very hard work over the next three to six months but hopefully by Q3 of this year I think this pent-up demand and flight to quality will come together.

What’s your outlook for the healthcare property sector after the Covid-19 pandemic?

It sounds cliché to say it, but it is going to be real flight to quality, as with any sector, primary product will survive and thrive, and secondary and tertiary products will fall away. That is no different in healthcare. With tertiary assets, a little bit like retail, the pandemic is just going to accelerate the closure of poor businesses which means that good operators, those who have critical mass, have good working capital and can survive an economic recession, will continue to remain successful.

The structural fundamentals within healthcare haven’t changed, the reality is that most of us will be considering care home facilities at some point for our parents, so the demand for this type of asset is strong. The problem is that at the moment the vast majority of care home facilities are not fit for purpose. Our predictions are that by 2040 there will be a shortfall of 300,000 market standard beds so we desperately need inward investment as demand will continue to outstrip supply, and we will then face a crisis in care home bed provision.

All in all, once the situation resolves around the Covid-19 pandemic, we will see a number of changes around how operators fare and we expect that with the scarcity of stock and a continuing ageing population driving demand, the investment appetite for care home developments will remain strong. We anticipate that investment into the sector will be robust, from a broad church of domestic and overseas investors seeking defensive healthcare assets to diversify their portfolios.