By Oliver Harris
Friday 7th November 2014
The global financial crisis created a paradigm shift in the perception of risk. The unprecedented collapse of most traditional asset classes prompted investors to look further afield for truly alternative forms of investment, immune from the short term impact of market movements. Additionally, the subsequent low interest rate environment of today has resulted in a major quest for income – driving the prices of many yielding assets well above fair value.
As institutions seek to address these issues, their nets have been cast far and wide. The care home sector, a relatively unknown but growing space, remains the preserve of a few but is being increasingly recognised for its low correlation to other assets, low volatility characteristics, as well as high and sustainable levels of income.
Benefitting from demographics
The care home sector’s emergence as an alternative form of investment is underpinned by attractive and undisputable demographic trends, such as longevity and an ageing population. The provision of residential care is not subject to market forces and the payers for such services are not directly affected by short-term sentiment.
The macro demographics are irrefutable. The number of people in the UK aged 85 and over was 1.6 million in 2013, and this is set to double over the next 20 years. From 2012 to 2032, the populations of 65 to 84 year olds and the over 85s are set to increase by 39% and 106% respectively. Based on government actuary projections, the number of people living in residential care in the UK will increase to 1.25 million in 2056, compared to 419,000 in 2009. It is difficult to find a more invariable and global tailwind than the aging population.
At the very time when the requirement for residential care provision is being driven upward by demographic change, the total capacity in residential care homes has actually declined over the last decade. For example, mental health capacity has shrunk by 24.8% over the period. The supply/demand imbalance offers unrealised investment opportunities and significantly underpins the asset class, helping it to exhibit low correlations to both traditional and alternative assets.
High and sustainable income
The sweet spot for investing in care is with the operating companies, which are both the providers of the care and the owners of the real estate. The leading operators are creating profit levels in the region of 25%-28% for care provision, with gross fees being linked to RPI. In addition, the requirements to provide the capital and have the appropriate specialist regulatory experience have created high barriers to entry in the sector. This supports such high return levels.
Such a solid level of return – linked to RPI – helps to provide a high and inflation proofed income stream for investors, which is currently producing a running yield in the region of 8%. In the current low interest rate environment, high and predictable income levels are a rare commodity. It is especially favourable when compared to other alternative assets, the majority of which produce no income at all.
Uncorrelated returns
The valuation of care homes is driven by the net fees generated by each bed, rather than property market dynamics, thus insulating returns from a property market, bond market or stock market correction. However, there remains a real estate value underpin to any portfolio, which acts as embedded risk support.
Consequently, the return stream from the care home sector looks very different to any equity, bond or alternative asset and more closely resembles an inflation-linked, high yielding liability – such as a pension or endowment.
Conclusion
The ageing population and the increasing requirement for residential care provides a degree of predictability not afforded to other asset classes. Care sector dynamics are unlike any other form of investment – demonstrating that alternatives can not only provide uncorrelated returns, but can also provide a high and sustainable level of income. The sector is being increasingly recognised as a credible diversifier and investment solution in the continued quest for truly alternative assets and income.
Oliver Harris is managing partner at Montreux Capital Management
