An engaged landlord

Originally published in Caring Times

Ben Penaliggon has spent more than 30 years working in the real estate investment space, joining Octopus Healthcare four years ago.

 

“Having looked at several different specialist real estate sectors, I chose healthcare,” he said. “It seemed that here was a sector where everybody wakes up on the first of January each year, and they know for sure that there is a shortfall of quality accommodation in certain parts of the market. That is not the case throughout the real estate sector, in fact it’s quite the reverse in other subsectors, like retail for example, so I thought that made a very interesting proposition for the investment community.”

The two major strings to Octopus Healthcare’s bow are the elderly care home side, for which Ben is responsible, and retirement communities, headed-up by Kevin Beirne.
“Our involvement with the elderly care home sector goes back to 2010 and over that time Octopus Healthcare has launched two funds,” said Ben. “One of the first major projects for us after the formation of Octopus Healthcare was to take the more mature of those two funds and move it from being a fixed-life to a perpetual-life fund, so it’s there for the ultra-long term; it can take capital in on a quarterly basis, and there is a mechanism to enable investors (typically institutions and pension funds investing for the long-term) to exit if they need to.

“In our estimation, whereas a number of other real estate subsectors had specialist, unlisted, long-term funds, this was lacking in healthcare. We wanted the healthcare sector to have similar access to long term and high quality private capital.“We now have a base of blue-chip institutional investors seeking long term exposure to the healthcare sector – a market which is not easy to access because of the shortage of quality stock in the sector. We formed the perpetual life vehicle, Octopus Healthcare Fund, in August 2017 and since then we have had a lot of interest from both existing and new institutional investors in the fund. We’ve raised £320m in capital since converting the fund, which has been at the high end of expectations.

In part, this reflects the increasing interest of ‘alternative’ real estate investments to investors, with healthcare of course being a part of this universe.” I asked Ben to explain what kind of
investors are attracted to Octopus Healthcare funds. “Octopus Healthcare Fund is seeking to offer investors diversified exposure to the UK healthcare real estate sector, primarily to elderly care homes, in an unlisted vehicle, and a return driven heavily by the income, which in most cases is index-linked and therefore highly attractive. “Our investors tend to be pension funds, domestic and international, which has been the case throughout the two funds we have launched, and it’s interesting that we are seeing good demand from both those cohorts.

At the moment, roughly threequarters of our fund is comprised of UK investors, with a quarter from overseas, but I think the overseas component will increase. We have seen very good demand for our fund from European investors, but also demand from further afield. “The key dynamic we’ve seen over the last few years is the rising institutional demand for the healthcare sector. As part of our recent institutional investor report (Understanding the opportunity for institutional investors), we polled international investors with a combined $6.8trn under management and found that there was increasing appetite from investors to allocate more to healthcare infrastructure over the next five years.

“One of their barriers was having the specialist knowledge, and the resourcing of it, but another key finding was that those investors were looking to increase their involvement with healthcare, up from 6.1% to 9.5% and that’s a big shift – investors are looking for diversification and the dynamics of the healthcare sector are not lost on them. They are certainly aware of the challenges but I think they can see some clear advantages. Lease structures are another key part of the attraction. So, yes, there are some big pluses for investors but there are also challenges to be navigated, so
that means investors will likely either want to have either a specialist internal resource or to use a specialist manager, and that is how we can help.”

The Octopus Healthcare funds focus on leased product, with typically 30-35-year lease terms – significantly longer than in other real estate sectors where they are, in some cases, shrinking. There is typically indexation around rental increases and a lease may take different forms depending on the nature of the business Octopus Healthcare has partnered with.
“We spend a lot of time finessing the various financial covenants that we use,” said Ben. “This can be very helpful for operators because the extent to which we can de-risk a situation means we can lower our cost of capital which benefits the operator.”

The fact that the Octopus Healthcare Fund is performing a social good, in helping to build the UK’s healthcare infrastructure, is an an increasingly important consideration for
many investors, Ben told me. Even in the last six months we have noticed investors asking increasingly about environmental, social and governance (ESG) issues – it is an increasing focus and making a contribution to social infrastructure is a great thing.”

Retirement living

Octopus Healthcare is developing a fund to specialise in retirement living which Ben says is a sector which is of increasing interest to investors. “It is in an earlier stage of its evolution,”
he said. “We are seeing models where care homes and retirement communities are located on the same site, as well as models where retirement communities are integrated with the local urban or rural community. It’s definitely not a one size fits all and that flexibility makes it exciting for property developers. Octopus Healthcare is very active in this market as well as care
homes, which allows us to bring together our specialist skills in real estate, investing and healthcare.

Specialist care

“We allocate a minimum of 75% of the fund to elderly care homes – that is the main plank of the fund. At the moment we don’t haveany exposure to specialist care, but we’ve
reserved a tranche of the fund for specialist care with a fairly broad purview because we believe the healthcare picture in the UK is going to continue to iterate over time. There is a need in many sectors to repurpose what is often ageing or obsolete real estate, we think private capital can be part of that solution, and we want the fund to be part of
that moving picture.”

Asset acquisition

Octopus Healthcare acquires assets in three ways; through the acquisition of existing facilities, forward funding and forward commitments. This way the fund is not
exposed to development risk. “We have an in-house development team because of the need to be able to ‘make your own’ in this sector,” said Ben. “This brings us proprietary deal-flow, which is great. It informs our investment process and it also allows us, when we are talking to potential tenants, to be more than a ‘chequebook’; we can offer a holistic solution to their expansion aspirations and be part of their journey as they grow their business. However, we also work closely with numerous third-party developers and developer/operators as well. “We always ensure we have an operator on board before we commit; we don’t take leasing risk. As a real estate fund we are not involved in the acquisition of operating groups as such, but we are always looking for operators that we can partner with and for whom we can help provide a real estate solution.

We have always had the mantra of investing in modern, purpose-built, futureproofed product, and homes which are pivoted towards the private-pay market.
“We are very conscious of the nature of the real estate we’re investing in and, having satisfied ourselves that it meets our criteria and is of high quality, we’re happy to have a diversified portfolio in terms of the covenant strength of the operators that we lease to. That means we have a real mix of different tenants, some of the larger groups, but we are equally happy to work with the smaller
groups in building their portfolio.” Octopus Healthcare prefers to work with groups on a repeat basis; the one-off deal isn’t particularly attractive. “We think that’s better for both sides,” said Ben. “We see ourselves very much as an engaged landlord, aligned with our tenant partners in wanting the best possible performance of and delivery of care within the homes we own.

“We pay a great deal of attention to the maintenance of the real estate – we have a building survey conducted on all the assets in our estate every year, and we share that with our tenants to make sure everyone knows what needs to be done. “Another aspect of our being an engaged landlord is that in our standard lease we have a requirement of receiving quarterly management accounts for all our homes and we analyse that data very carefully. It is very helpful to us as a landlord to have a finger on the pulse – these are operating businesses, they ebb and flow, but if there are issues
we’re forewarned, we can be there early and hopefully be part of the solution.” Clinical oversight Perhaps unusually, Octopus Healthcare have a clinical team, a doctor and two nurses, whose role is to interact with tenant operators very much at the clinical level to ensure they have the right values, governance and infrastructure to deliver the best possible care.

“Once a deal has been done, that team is constantly touring the estate to meet with the clinical teams in the homes to make sure we understand how those businesses are doing and how the care is being delivered,” said Ben. “Twice a year we look to hold an all-day seminar here in London, examining the clinical side of the businesses – it’s really well attended, with workshops and external
speakers. As a landlord we are looking to facilitate best practice throughout the portfolio, to the benefit of everybody. “So, if we have multiple homes with a tenant operator, they can take much better advantage of that than if we just had a single home with them.

An Octopus Healthcare tenant tends to be an operator of multiple homes, having a management team with a demonstrable track record and values, infrastructure and governance which are aligned with ours. We deal with some of the really big players in the sector and also with smaller groups which are growing. Across the two funds we have 21 tenants with 48 care homes overall, roughly half a billion in assets so, in itself, it is a really interesting data-set on what’s going on out there.