As a property expert, with extensive experience in the care sector for the last 10-15 years, I am asked regularly for my views on the impact the events at Southern Cross are having on the market.
Firstly, it should be noted that Southern Cross have only a small share of the market which comprises mainly small and regional operators. Insofar as I can see, all of the other occupiers have been faced with the same issues affecting the sector, however, many are still sustaining good occupancy levels and fee income.
Many people are not aware that Southern Cross were a relatively modest corporate company but grew to be the largest care home operator in the UK within 2-3 years.
They were without doubt the most aggressive buyer in the market place 5-6 years ago and a number of care home operators cashed in, selling their businesses to Southern Cross at premium prices. Conversely, there were few operators who offered very attractive prices for businesses and I spent many a time trying to explain why they couldn't match the buying power of Southern Cross.
In my opinion, the main reason why, was due to the Southern Cross method of funding, i.e. sale and leaseback. This is not a new method of funding and is one which can work well in the right circumstances, and is quite common when the property market is booming. Indeed, major companies such as Boots and Tesco have undertaken a sale and leaseback strategy to assist their acquisition plans in the past.
The problem arises where landlords do not understand the businesses they are investing in and set rentals levels which businesses simply cannot sustain.
The Southern Cross situation has been witnessed previously with other licensed property based businesses. The pub and hotel operator London and Edinburgh/ Swallow Hotels folded in 2007. They had effectively grown via sale and leaseback acquisition, with geared rents based not on whether the businesses could realistically afford them, but at levels simply to maximise the value of the property.
Many of Southern Cross landlords have failed to recognise the nature of the businesses they have been investing in, whereby they believed that having a covenant such as Southern Cross on a lengthy lease with annual rental uplifts, outweighed the importance of having the rent set in line with sustainable trading performance.
To illustrate this point, certain landlords and Southern Cross, were prepared to agree rentals in a number of care homes on the principle that double bedrooms were sustainable in the long term. However, even 5-6 years ago, it was common knowledge within the sector that double rooms were a thing of the past with both the regulation body and market dictating the need for large single bedrooms only. It is therefore not surprising to me that it is these homes which have been the cause of much of the concern for the company and the landlords in recent months.
Furthermore, a good number of the landlords were mainstream property investors who didn't appreciate that the care home market was very fragmented, highly regulated with only a handful of blue chip companies, something which was not prevalent in other commercial property investments such as the retail market for example.
So where are we at with Southern Cross? Believe it or not, some of the best homes in the UK are still in Southern Cross's control and these are the homes which will continue to trade in their or another operators hands.
In my opinion, there really is no way back for the landlords of the homes I mentioned earlier. They either have to revisit the rentals again or agree with Southern Cross to offload the homes at considerably reduced prices.
Indeed, a number of landlords are scouting the market at present trying to find suitable tenants. However, in many cases, they are still failing to grasp the concept that the rentals need to be geared to the trading performance of the home over the long term. Again, many are focusing on the size of the operator instead of the likely future of the business, management and the operator during the term of the lease.
Unless these fundamental issues are tackled on an individual property by property basis, then we will see this problem arising again in the next few years with Southern Cross or perhaps with another operator altogether.
The sentiment in the market is varied. As I mentioned previously, Southern Cross have only a small share of the market and the majority of operators actually own their properties outright. Many of these operators are in fact trading well and are not facing the increased burden of onerous rental payments which can severely impact on their bottom line if not set at realistic and sustainable levels.
If anything, the leasing approach which was starting to evolve over the last few years, mainly due to lack of traditional bank funding, is now being looked at more cautiously by operators at the present time. This is unfortunate. In my view, leasing remains a good way to grow a care home business if the rent is set correctly. In the current climate, operators can acquire a leasehold business without having to find and secure capital for the goodwill and fixtures & fittings. I consider this to be a fantastic opportunity.
The last 12 months has seen small and major investment funds being established to invest in the care sector. Despite the news about Southern Cross, investors still view it as a growth sector and fairly robust. However, the shrewd investors in the market now understand the business model, regulation issues and growth prospects for fee income as opposed to simply assessing the size of the operator when it comes to acquiring care home investments.
Going forward, in my view, the predominant issue facing the sector is not the news about Southern Cross but a supply issue; there is a severe lack of quality product in the market place at present, partly due to limited development finance being available in recent times.