Ageing brings new opportunity

As the once alternative asset class of real estate becomes ever more mainstream, fund managers are searching for sub-sectors to find alpha generating nuggets of income. Nursing homes (also known as senior housing) may not be the first thing that comes to mind, but they are increasingly capturing investors' imagination.

As Julia Felce, head of UK property research at Schroders Investment Management, points out: "It is becoming more challenging to achieve returns over the benchmark in sectors such as residential, retail and office. As a result, we are seeing investors willing to take bigger bets and look at alternative areas within property to gain out-performance. Nursing homes have come on the radar screens in the past 12 months. Although at present they may be more suitable in the absolute return category, due to the long leases and retail price index linked leases, there is potential in future to tap into the strong expected revenue growth."

This is not the first time that fund managers have taken an interest in nursing care homes as a real estate investment. There was a big rush in the 1990s when governments started to talk about tightening their purse strings. Developers in the US and UK rubbed their hands in anticipation and embarked on new projects, but according to Jack Foster, a fund manager with US-based fund management group Franklin Templeton, the demand had not yet come through and markets soon became overbuilt.

The UK was particularly hard hit by the troubles of nursing care operators such as Nationwide Health Properties (NHP), which began to unravel about six years ago when tenants leasing the group's buildings and running them as nursing homes went into receivership. The company was eventually sold two years ago to private equity powerhouse Blackstone for £564m (€841m).

Not surprisingly, this type of incident left a bad taste in institutional investor's minds but the sector has recently come back in favour. In today's return hungry environment, nursing homes are an attractive prospect, mainly thanks to the omnipresent and loudly ticking demographic time bomb.

Europe's ageing population has caused much debate and discussion in pension fund circles, but they are expected to be a boon to this specialist slice of the real estate sector which is aiming to cater to the burgeoning number of European pensioners. As Tobias Just, a Frankfurt-based analyst of Deutsche Bank, puts it: "This is one asset class where demographics are not a burden."

The numbers speak for themselves. According to statistics from the EU, by 2050, the number of 65 to 79 year-olds is set to rise by 44% while those aged 80 or more is likely to grow by a momentous 180%. At the same time, those in the 15-24 year-old bracket are expected to have dropped by 25%, while 25 to 39 year-olds are likely to fall by 26% and 40 to 54 year-olds by 19%.

Although the trend is similar across the UK and continent, there are, of course some variations between different countries regarding the pace of growth of their respective ageing populations. DTZ, a UK-based global real estate advisory firm which conducted a recent study of five European countries, revealed that the absolute number of people over 80 years of age between 2005 and 2015 will increase by 18.6% in the Netherlands, 25.6% in France, 27.6% in Germany and 28.6% in Belgium. Spain is expected to experience the biggest increase at 43/% although this can be partly explained by the country's attraction as a retirement destination, particularly for older people hailing from northern European countries like Germany, the UK and the Netherlands.

According to Calum McKenzie, a researcher at DTZ, the UK market is the most advanced in terms of development, followed by Germany, with Spain having the most promise as developers are increasingly hoping to build homes for the various expatriate communities. The indigenous population in Spain, as well as other southern European countries, may be slower off the mark to accept nursing homes due to cultural mores. However, attitudes in the Mediterranean countries are beginning to change. In the past, family members tended to care for their older relatives, but the increased sense of individualism, as well as the loosening of family ties is likely to open the door for nursing home opportunities.

Despite their differences, the five countries as well as the UK do share one main thing in common - their respective governments will not have enough money in their coffers to care for their ageing populations. As the DTZ report notes, with expenditure on nursing care likely to rise substantially across Europe in the coming decades, private contributions will have to rise to fill the growing gap between state or state-sponsored spending on nursing care.

any countries are already trying to grapple with the problem. In the UK, for example, only people with assets of less than £11,750 can obtain full funding from their local social services department, while those with total assets of over £19,000 must typically pay the full costs out of their own pockets. In Germany, on the other hand, about half of the nursing homes are run by welfare organisations including large charitable, mainly religious organisations, while in the Netherlands and Spain, private providers are dominant.

It is no surprise, perhaps, that against this backdrop, a growing band of private equity investors, particularly in the UK, are marching into the sector. They are lured by a combination of factors - the sector's ability to generate cash, the growth opportunities offered by an ageing population, the debt markets' willingness to fund such deals as well as the prospect of further consolidation between nursing care operators.

In the past five years, the industry has witnessed several heavy hitting private equity players entering the fray such as Blackstone, Duke Street Capital, Sovereign Capital, Bridgepoint Capital and Electra Partners. One of the most noteworthy deals this year has been Royal Bank of Scotland's estimated £1bn purchase of a portfolio of about 294 nursing homes across the UK from Southern Cross, the country's largest operator, which had been owned by Blackstone. In the summer, Southern Cross made its debut on the London Stock Exchange.

Aatif Hassan, an investment manager at August Equity, a UK-based private equity firm which focuses on health care investments, notes: "There is a huge investment appetite for nursing care homes. Although some analysts believe the sector is overpriced, I think it is in line with other real estate sectors. The predictability of earnings and the leverage that banks are willing to offer provide comfort but I also think we will see increasing opportunities in the sector as the range of nursing care facilities expands from senior housing to more acute care facilities."

rivate equity firms, however, are only one segment of the investing community who are interested in this niche area of the real estate market. Increasingly, traditional fund management groups are either planning to jump on the bandwagon or increase their exposure. ING Real Estate Investment Management is planning to launch a UK-focused health care fund which will include nursing homes as well as hospitals, clinics and doctors' surgeries.

Jonathan Knight, fund manager of the new ING REIM fund, cites demographics as well as a fragmented operator market in the UK as the main reasons for entering the nursing care arena. "The top five operators only account for a 6-7% slice of the UK sector while the majority are medium-sized operators looking to carve out market share. What we are seeing is operators selling their assets into the market to realise latent value as well as further consolidation. Also, the industry in the UK offers annual RPI linked returns, improving covenants and longer than usual leases. The average leases on UK property, according to Investment Property Databank figures, range from under 10 to 25 years in the nursing home sector."

Morley Fund Management who was one of the pioneers, spotting the potential long before its competitors, also believes the fundamentals remain robust. Neil Gardiner, fund manager of Morley Fund Management's The Quercus Healthcare Fund, notes: "We entered this market in 1998 and at the time we were looking at different opportunities in the sub-sectors of real estate such as hotels as well as health care facilities. Eight years later, the main attractions of the health care sector continue to be strong performance, a steady stream of income generating returns plus it acts as a good risk diversifier in the portfolio."

Today, the Quercus Fund has €500m of assets under management and nursing care homes account for roughly 61% of its portfolio. Quintain Estates and Development is in charge of sourcing property while Morley manages the fund itself. Last year, the fund churned out a healthy return of 32.3% while its three-year average return for the period ending 6 September 2006 was 29.7%. The 12-month figure to 6 September 2006 was 39.3%.

Although the UK is the favourite stomping ground, the nursing home market in Germany is beginning to heat up. Rainer Thaler, who was appointed managing director of GE Real Estate in Germany last year, believes that Germany shares some of the same advantages of the UK - a fragmented market, long leases, strong growth and steady cash flow. "Not too long ago, there were few players willing to invest in this market. Today, we are seeing about 10 firms who have recently come in looking for opportunities. Although the yields are coming down as a result of this broader investor interest, prices are holding up as there is more capital than product."

Looking ahead, the challenge, as with any real estate investment, is finding the right property. Nursing homes, however, require a different checklist than the more conventional office or retail opportunity. According to Just of Deutsche Bank, location is important, but so too is the track record of the operator and whether the firm has proven its mettle in dealing with social legislation and policy. He also advises investors to aim for long leases plus occupancy rates of at least 80%.

Gerry Ferguson, fund manager of the Scottish Widows Investment Property, which currently holds three nursing homes, which currently holds three nursing homes, says, "It is important to realise that the criteria for investing in nursing homes are different to that of more traditional property such as commercial or retail. For one thing, it is similar to hotels where the alternative use could be limited. Also, there needs to be a high degree of due diligence around the operator, their ability to comply with all the legislation and whether the individual homes are commercially viable based on the level of rent they are paying."

As Knight of ING REIM puts it, "If the basic care is not right, then it will not work. Complying with the regulation is only one part. Operators need to understand the logistics and meet the tenants' needs. If they do not show this human side, then the home will quickly be de-populated and unlike an office building, where if a big company leaves, there will be another to take its place, this will not be the case if inappropriate care is delivered."