NOVEMBER 2023

Demographics Is Destiny - Why We Invest in Target Healthcare REIT

My mother seems to have a deep-rooted fear that I will one day place her in a cheap care home. I try to explain to her that there are no cheap care homes, but this comment never has the settling effect I hope for.

This month we had one of our regular six-monthly updates from the management team of Target Healthcare, a UK listed Real Estate investment Trust (REIT) with a market value of circa £500m. Target owns over a 100 UK care homes, that were all built in the last 10 years or so. 98% of their rooms are ensuite and every home is purpose built (not converted from a residential house).

Target Healthcare does not operate the care homes. There are 32 different underlying care operators who rent the homes from Target and provide day to day care for the residents. However, importantly to us, the management team of Target have run care homes in the past and conduct their own inspections on the home and the care provided. This is so embedded into the company that the care operators can be removed from the lease if care is below standard (regardless of whether the Operator has been paying their rent).

We have been fielding a lot of questions from clients on Real Estate recently and as ever the news media is doing a good job at covering only part of the issue. When we are considering Real Estate investments, we are seeking supply and demand imbalances. For example, we do not have any exposure to Retail property today or in the past 10 years. It has been clear to us that internet shopping would reduce footfall in shops over time and in turn shops would close. The supply of empty shops would rise and then prices would fall. When we look at UK care homes, we see the exact opposite scenario. The UK has an ageing population and limited land bank. New development land has gone to home building in the past 10 years as it has been more profitable. At the same time health and safety regulations and underlying market demand have rendered older care homes (typically converted Victorian houses) obsolete. This leaves the UK with an increasing demand for good quality care homes and a shortage of them at the same time. Regardless of interest rates or economic conditions these factors (especially the ageing population) will drive demand for the properties held by Target Healthcare.

The management team are well aware of inevitability of these trends. They have done their best to insulate the fund from external risks.  For example, the company has debt of only 25% of its portfolio value, compare this to the average loan to value for UK residential property at 69% in 2022*.  Should we be worrying about interest rates rising? Well, the company is paying circa 4% on its loans and they have fixed this cost for the next 6 years. So, on a day-to-day basis they are currently unaffected by the increase in UK interest rates. What about inflation, will that make the rental income less valuable over time? Again, Target have planned ahead, they have long leases (25 years) which capture all or part of inflation each year. For example if inflation is in the 2-4% range they will capture all of this each year, if it is above 4% they will be capped at 4%. We hope not to face a prolonged period where inflation is above 4% but even if it is, we will still have growing rents.

Despite all this preparation by the management team the shares have had a torrid time over the past 18 months, with investors applying the generic view of “interest rates are up, property is bad”. Having fallen significantly the REIT is trading at approximately 30%** below its independently valued property. It is now paying a healthy 7.8% yield to investors**. This appears very simplistic to us. My father provided legal work for a number of UK property developers during the late 70s, 80s and 90s. Growing up, my house was full of their wild tales and daring do’s , they were huge risk takers who made money despite interest rates being up to 3 times the rates we see today. They did this by identifying supply and demand imbalances (and likely some other more dubious methods). But their returns were not based on hoping for interest rates to fall. Target is a conservative company by comparison to these historical characters, but the imbalances we see make it attractive to us over the long term. In fact, I own some in my mother’s portfolios (and my own) to help hedge future care costs.

If you want to discuss your commercial property exposure with your investment manager, please do contact your usual CAM representative.

*Sources Statista.com

** At the time of writing, source Bloomberg