New development – matching capital to undersupply – By Andrew Surgenor CBRE
There are c.8,200 elderly care homes in the UK with c. 337,000 beds, yet the majority have fewer than 40 beds and tend to be conversions. Around 43% of beds are purpose built but the last period of significant new build growth dates back 20-30 years. The pace of new development recently has been slow and has not kept up with the rate of closures. Since 2000 the average net increase has been -2,979 beds a year. Only 6% of purpose built care homes have been constructed in the last 5 years.
This translates to a statistical undersupply of up to 92,000 single ensuite beds without factoring in the growth in the elderly population and the natural attrition of older homes exiting the market. Assuming a new build average of 65 beds, that is around 1,415 buildings requiring over 2,100 acres of land. With a typical cost of c.£150,000 per bed for land and construction this will require a capital investment of over £13.8bn. With 100-150 new homes being built a year, there is a 13 year development pipeline which is the major attraction for debt and equity investors.
FITTING THE PRODUCTS TO THE NEEDS
This all assumes that the care bed undersupply can only be met by building care homes. This is not the case as the current and emerging generation of elderly now have greater choice over how and where they will live and be cared for and trillions of equity in housing to be able to afford it in large parts of the UK. The options range from remaining at home with a care package, to assisted living and retirement villages, to care homes depending on their care needs. There is also increasing flexibility around how this can be paid for with emerging rental models in retirement living, shared ownership and more traditional ‘for sale’ assisted living.
IDENTIFYING THE PROVISION GAP
There remains a significant and widening gap between demand and provision and a major time lag in addressing the imbalance. Whatever the setting, those 92,000 people require a real estate solution and an accelerated pace of development.
Operators are looking to identify areas of undersupply, match demand to the right product and find the appropriate funding solutions to deliver the development. Demographic analysis tools, such as CBRE Pulse, can indicate where a new home could fit into the local market, the fee point it could secure and the depth of wealth that could afford this. With the high cost of land and rising construction pricing, the minimum fee to support new development exceeds £850-£900 per week and in high value areas is over £1,200.
FITTING THE CAPITAL AND ATTRACTIVENESS OF RETURNS
Where the capital fits largely depends on the type of development and the operator’s objective. A common challenge for the owner operator is a lack of equity and limited development experience, which adds risk and cost.
Securing bank debt requires a compelling business plan but returns are attractive, particularly where significant equity is injected. For illustration, a 60 bed home costing say £11.2m to build and trade up may be priced at £14m once mature, reflecting a 23% return on cost and 40% return on equity and start up costs assuming initial 60% leverage.
On refinance, the equity created is rolled into the next deal enabling continued growth. Where existing assets are extended or replaced, returns are enhanced because the land is owned and acts as collateral.
The timeline from identifying a site through development to mature trade can be 3-5 years which is a long time for capital to be tied in and helps explain why the pace of development has been slow. Capital from the UK and overseas has identified this time lag and the attraction of long-term income from new development and is investing to speed up the delivery process and build scale. It is enabling many regional and corporate operators to focus on their core skill of delivery of care and leave the development risk to the capital providers. The structure for this is increasingly via forward funding which gives certainty to the operator on delivery of a high quality facility without planning or development risk and no capital outlay other than trade up shortfalls. It appeals to the investor who will have certainty of income without direct operational risk. Further, depending on end value and tenant covenant, it de-risks leveraging and is attractive to banks. Structuring in this way enhances profit on cost and return on equity significantly.
NUMBERS ARE COMPELLING
The attractive returns open to specialists able to minimise delivery risk and match long dated income to low cost capital are fuelling the pick up in pace for new development in care homes, assisted living and retirement schemes. With healthcare now mainstream and able to compete well against residential, the capital and opportunity are aligning to speed up delivery of high quality care environments to the benefit of our elderly population.