Driven by demographics

Target Healthcare REIT 1 May 2020 Outlook
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Target Healthcare REIT

Driven by demographics

Company outlook

Real estate

1 May 2020

Price

108p

Market cap

£494m

Net debt (£m) at 31 March 2020

110.9

Net LTV at 31 March 2020

18.1%

Shares in issue

457.5m

Free float

100%

Code

THRL

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(2.3)

(3.6)

(0.4)

Rel (local)

2.1

(1.1)

6.2

52-week high/low

118.2p

106.0p

Business description

Target Healthcare REIT invests in modern, purpose-built residential care homes in the UK let on long leases to high-quality care providers. It selects assets according to local demographics and intends to pay increasing dividends underpinned by structural growth in demand for care.

Next events

Q320 DPS payment

29 May 2020

FY20 year end

30 June 2020

Analysts

Martyn King

+44 (0)20 3077 5745

Target Healthcare REIT is a research client of Edison Investment Research Limited

Target’s Q320 update shows its portfolio of high-quality, purpose-built care homes continuing to grow and perform well, with quarterly dividend payments maintained. The current pandemic presents a significant near-term challenge to the sector but does not change the underlying demographic-driven fundamentals while highlighting its critical role in supporting the NHS and the importance of long-term investment.

Year end

Revenue (£m)

Adjusted net
earnings* (£m)

Adjusted
EPS*(p)

EPRA NAV/
share (p)

DPS
(p)

P/NAV/
share (x)

Yield
(%)

06/18

28.4

15.7

5.54

105.7

6.45

1.02

6.0

06/19

34.3

20.1

5.45

107.5

6.58

1.01

6.1

06/20e

43.8

24.9

5.65

108.9

6.68

0.99

6.2

06/21e

47.6

28.6

6.25

111.9

6.68

0.97

6.2

Note: *Adjusted earnings exclude revaluation movements, non-cash income arising from the accounting treatment of lease incentives and guaranteed rent review uplifts, acquisition costs and performance fees, and include development interest under forward fund agreements.

Care home demand driven by demographics

Care home leases are long with upwards-only, RPI-linked rental growth. End-user demand is driven by demographics rather than the economy, and a growing elderly population, combined with a shortage of quality homes, suggests a strong demand in years to come. Near term, the spread of COVID-19 is increasing pressure on the NHS to free beds by utilising available care home capacity, supporting occupancy for the operators but also presenting them with additional risks and challenges. Staffing pressures and costs are increased while COVID-19 cases could temporarily reduce available beds. Modern, purpose-built homes may well assist operators in managing these risks but some will need short-term support, from landlords through rent deferrals and from other government sponsored initiatives.

Strong focus on asset quality

Reflecting a desire to provide stable and sustainable, long-duration rental income, Target puts a very strong focus on the quality and location of the assets as well as the operational capabilities and financial performance of tenants. It believes that modern, purpose-built homes with flexible layouts and high-quality residential facilities, including single-occupancy bedrooms complete with en-suite wet rooms, are more likely to provide sustainable, long-duration rental income, appealing to residents and allowing tenants to provide better and more effective care. Our forecasts assume no further accretive acquisitions but with moderate gearing, available capital and continuing pipeline of opportunities, this is possible. Rent collection is robust but should any of the operators be materially negatively affected by COVID-19, the knock-on effect to cash flows and/or earnings could limit near-term DPS compared with our forecasts. We provide a sensitivity on page 14.

Valuation: Indexed, long-term income

Visible, indexed rental growth supports long-term dividend growth. We would expect any COVID-19 dislocation to cash flows and/or the level of quarterly dividends to be temporary and our forecasts, based on contractual rents and an unchanged DPS (a yield of 6.5%), currently indicate 94% cover of DPS in FY21.

Investment summary

Target Healthcare REIT invests in modern, purpose-built residential care homes across the UK and is externally managed by Target Fund Managers, a sector specialist investment manager with an experienced team. Target aims to provide investors with attractive quarterly dividend income through a portfolio that is diversified by tenant, geography and the payment profile of the end-user care home residents. Target’s approach to care home investment is characterised by a focus on the quality of the physical asset and location, alongside a comprehensive assessment of tenant capabilities, both before and after investment. From IPO in March 2013 to the end of March 2020 (Q320), the company delivered an EPRA NAV total return (EPRA NAV growth plus dividends paid but not reinvested) of 54.0%, or an average annualised rate of 6.2%. Dividends have accounted for c 80% of this total return. During FY20 to date Target has declared three quarterly dividends of 1.67p (an aggregate 5.01p), an increase of 1.5% on the prior year. Medium-term gearing is targeted at c 25%.

Driven by demographics

Care home investment is characterised by long lease lengths (30–35 years) at inception, with annual rent uplifts (RPI-linked or fixed) providing a high degree of visibility to long-term contracted rental income. The demand for care home places is being driven by the ongoing demographic shift to an ageing population with more complex care needs rather than the economic cycle. However, despite a growing population of elderly the number of care homes is lower today than it was in the late 1990s and much of the existing stock (older, inadequate or poorly converted premises) falls below best standards. There is an undersupply of modern, well-designed and equipped homes with generous communal spaces, and Target’s focus on only such assets differentiates it in the quoted sector. 85% of the homes within the Target portfolio have been built since 2008 and all of the rooms are single occupancy. Substantially all (96%) have full en-suite wet room facilities (with plans in place to upgrade those that did not).

At 31 March 2020 (Q320) the external valuation of Target’s portfolio was £613.4m, comprising 73 homes (71 operational and two pre-let sites in development under forward funding agreements), let to 27 different tenants. The EPRA topped-up net initial yield (NIY) was 6.05%, based on annualised contractual rent on expiry of relatively short-duration lease incentives of £38.9m and the EPRA net initial yield was 5.69% based on current passing rent of £36.6m. The weighted average unexpired lease term (WAULT) was 29.2 years, with leases mostly linked to RPI and a small number with fixed rent uplifts.

Exhibit 1: Growing assets and rental income

Exhibit 2: Rents linked to inflation

Source: Target Healthcare REIT

Source: Target Healthcare REIT, Bank of England

Exhibit 1: Growing assets and rental income

Source: Target Healthcare REIT

Exhibit 2: Rents linked to inflation

Source: Target Healthcare REIT, Bank of England

COVID-19

We do not expect the COVID-19 pandemic to have a material impact on the fundamental investment case although it brings near-term challenges to tenant care home operators. Over the medium term, by highlighting the critical role that sector plays, including its support for the NHS, the pandemic may even help to crystallise long-debated reform of the care funding model and thereby help to unlock much needed investment. For that reason, in this report we focus on Target’s strategy and the longer-term investment case but begin with an update on the near-term impacts of the COVID-19 pandemic.

COVID-19 update

Increased near-term cost pressures for the operators

The current pandemic presents a significant near-term challenge to the care home sector and potentially for some of Target’s tenants, as they strive to maintain the best quality of care and protect the safety and wellbeing of their residents and staff. Staffing is a key challenge for care operators in normal times and maintaining adequate staff levels during the COVID-19 outbreak is a key concern. Staff members that show signs of infection are required to remain at home in self-isolation for two weeks while residents who are put into isolation, either through infection or upon newly entering a home, will require additional staff resources. More positively there have been indications of increasing job applications across the sector as a result of displacement from other sectors but whilst this will ease recruitment pressures it will not eliminate near-term staffing and staff-cost pressures. In addition to staff pressures there has been widespread reporting of the shortage and high cost of personal protective equipment (PPE) facing many operators. While the NHS is striving to utilise all available care home capacity for suitable elderly patients who would otherwise be forced to remain in hospital beds the operators must balance their efforts to assist with their duty to provide effective care to existing residents. Where infection and/or death does occur there is likely to be a temporary downward pressure on available beds.

Modest impact on Target portfolio to date

Target’s regular close engagement with, and support for, its 27 operator tenants has been stepped up during the pandemic. All the operators routinely have business continuity procedures and infection control protocols in place, and these were implemented well ahead of the COVID-19 guidelines for the general public using existing PPE stocks. Confirmed or suspected cases of COVID-19 are currently affecting residents occupying less than 5% of the beds in Target’s portfolio, although the company expects this to increase as the pandemic progresses. Staff absences amongst Target’s operators have increased but are currently manageable.

Target received its March quarter rental payments in line with its typical collection pattern, although recognising the uncertainties being faced it has agreed for a limited number of tenants to stage their rental payments (in advance) through the upcoming quarter. The company says that it expects demand for the beds provided by tenant operators to remain strong, supporting cash flows despite short-term increases in staff and other costs.

More fundamentally, Target highlights that modern, purpose-built homes with larger than average bedroom size and full en-suite wet-room facilities will assist operators in the effective control of infections and implementation of isolation procedures.

Moderate gearing with good liquidity and borrowing headroom

As discussed in detail on page 13, at 31 March 2020 (end-Q320) the group had drawn £142m out of total borrowing facilities of £180m, comprising £80m of fixed-term debt (fully drawn) and £100m of variable rate revolving credit facilities (£62m drawn). In addition to the £38m of borrowing headroom the group has c £30m of current cash balances. Net loan to value at end-Q320 was 18.1%. Investment commitments, primarily relating to the two forward-funded (pre-let) development assets, was £12m.

Income sensitivity analysis

Clearly this is a fast-moving situation and the full impacts remain difficult to assess. As a starting point, Target says that aggregate rent cover in respect of the mature homes in its portfolio (that is, homes that have had the same operator for a three-year period or longer and by definition excludes newly developed homes) was 1.6x at the end of December 2019. Our dividend forecasts are driven by our expectations for adjusted earnings which in turn assume that contracted rents are received in full. Our analysis on page 14 suggests that Target would be able to maintain a good level of quarterly distributions, albeit at a lower level, even with fairly significant deferral of rental income. We do not expect Target’s recent agreements with a limited number of tenants for staged payments in advance over the coming quarters to have any material impact on cash flow and dividend paying capacity. However, should any of Target’s tenant operators be more seriously affected by the pandemic, there is a risk of a more significant cash flow impact with implications for near-term dividend payments. In the extreme case of tenant failure there would potentially be an impact on reported earnings as well as cash flow as a result of bad debts and potential delays in re-tenanting with associated costs.

It is too early to anticipate what impact the pandemic may have on property valuations across the broad property sector and for the care home sub-sector. There was no apparent impact in property valuations in Q320 with a 0.6% like-for-like increase in the portfolio value driven by RPI-linked rental growth. In part reflecting changes in the asset mix, the portfolio net initial yield was marginally lower at 6.05% compared with 6.07% at end-Q220. However, the external valuation was subject to the material uncertainty clause that has become an industry standard, with a dearth of transactions to provide evidence of market values.

Strong underlying long-term growth drivers

While the COVID-19 pandemic may have a short-term impact, demographic trends suggest that the need for elderly residential care will continue to increase for a great many years. Existing estimates by the Office of National Statistics (ONS) indicate that the number of people in the UK aged 85 or older will double by 2041, from c 1.6 million to c 3.2 million, and the COVID-19 pandemic is unlikely to change this basic direction of travel. Currently, around 15% of those aged over 85 require specialist care that can only be adequately provided in a hospital or care home. Meanwhile, the number of residential and nursing home beds in the UK has in recent years failed to keep pace with this growing need and has declined from a peak of 563,000 in 1996 to 466,000 in 2018, as obsolete homes have withdrawn from the market, often driven by the requirement for higher care standards. Much of the new care home development is focused on geographical areas with supportive demographics and which can support a high share of self-funded residents such as the South-East and South-West.

As local authorities have substantially withdrawn from the operation of residential care homes it will largely fall to the private sector, both for profit and not-for-profit, to meet this growing need. However, while the private sector is the dominant provider of care, accounting for c 90% of all beds, local authorities remain a significant provider of funding for care home residents, accounting for c 50% of the total, either in full or with some top-up from residents and their families. Given the pressures on local authority funding and increasing demand, there is a widespread recognition of the need to find a long-term funding solution for social care in the UK if the challenges and opportunities presented by an ageing population are to be met. Longer-term funding for adult social care continues to be debated publicly, along with closer co-operation between health and social care. A government Green Paper exploring the options was originally due in 2017 but has been delayed several times and there is no indication that it will be produced in short order. The prime minister had promised a new set of social care proposals this year and while this too may be delayed, the current pandemic can only highlight further the critical role that the care industry plays in providing for the care to vulnerable elderly people and relieving pressures on the hospital system.

Private care providers have experienced sustained growth

Across the industry, this combination of growing demand, shrinking supply and the shift from local authority to private sector provision continues to generate sustained, above-inflation growth in revenues and average weekly fees for the operators. LaingBuisson estimate that over the past 20 years average weekly fees to private sector operators have increased at an average c 3.7% pa (compared with average increases in RPI of 2.8%) with £16.5bn being spent on care of the elderly in care homes in 2019. Factors contributing to this rise in fees include rising staff and property costs, increasingly complex medical and care needs (including rising levels of dementia), higher standards of care required by the regulator, and growth in the private pay market driven by customer choice and the shrinking pool of those eligible for public funding.

However, despite real-term fee growth over the past five to six years, industry profitability margins have trended lower and performance is mixed across the sector. Given the pressures on local authority funding and their significant pricing power, in general there is a clear differential between the fees that they pay compared with the fees paid by self-funded residents. In many cases, the local authority fees paid are insufficient and are effectively cross-subsidised by higher-paying self-funding residents. Whilst a balance of resident funding is desirable, operators that rely heavily on local authority-funded residents may struggle more to cope with industry-wide pressures from staff costs, staff shortages and regulatory pressures to improve standards of care. This is more so if the homes that they operate are older, often converted and poorly configured. Conversely, homes at the very high end of the market and fully reliant on privately funded residents may in certain economic circumstances struggle to maintain the above average fee growth of recent years. For all operators, post Brexit immigration proposals introduced by the government in January 2020 appear to have the potential to increase staff shortages, while the April 2020 6.2% increase in the National Living Wage, the largest ever annual increase, will add to staff costs, typically around 60% of care home operating costs.

The problems facing the wider industry inevitably receive much media attention and what is often overlooked is the ability of well-managed operators, with efficiently run homes, in locations with a good demand-supply balance to meet this need effectively and sustainably.

Investment attracted by long leases and RPI-driven rent uplifts

In recent years there has been increasing competition for assets, with a range of investors attracted to the typically long lease lengths and upwards-only rent reviews. This is especially true for modern, purpose-built assets that benefit from a supportive supply-demand imbalance and it remained so up until the spread of COVID-19. In common with the wider property sector, the pandemic has to a large extent brought a near-term freeze in transaction volumes and it remains too early to assess the longer-term impact on the care home investment market

Across the market, yields vary according to a range of factors including asset quality. The valuations of modern, high-quality assets typically reflect lower yields, recognising the expectation that these assets are best placed to generate sustainable, long-term income with a lesser requirement for capital expenditure and a lesser risk of obsolescence.

At the very highest end of the market (‘super-prime’), yields in the range of 4% have been typical, representing a capital value of c £350k per bed. At the low end of the market yields have been closer to 9% with capital values of perhaps £40k per bed. Target operates in the mid-upper range of the market. We estimate an average capital value per bed at end-H120 of c £120k.

Future-proof asset selection

Targeting high-quality assets…

Target’s approach to investment in the sector reflects a desire to provide stable and sustainable, long-duration rental income with which to support the dividend policy. To this end, it puts a very strong focus on the quality of the physical asset and its location, alongside an in-depth assessment of the operational capabilities and financial performance of the tenant, both before and after investment. Target believes that modern, purpose-built homes with flexible layouts and high-quality residential facilities, including single-occupancy bedrooms complete with en-suite wet rooms, are more likely to provide sustainable, long-duration rental income. Not only do such homes provide an attractive environment for residents, they also support tenants in the provision of better and more effective care. Target only invests in these ‘future-proof’ homes and avoids homes that may require material asset management, especially older adapted properties, and homes with small bedrooms and poor en-suite facilities, lack of public and private space and narrow corridors with stairs.

Across the UK sector, 75% of homes currently registered were built prior to 2000, many being conversions of existing properties during the period of expansion from the mid-1980s to the mid-1990s. Data sourced from LaingBuisson suggests that rooms with full en-suite wet room facilities represent a minority (only around one-fifth) of the care home stock, with the vast majority of en-suite facilities representing WC and hand wash basins only. In contrast, 85% of the homes in the Target portfolio at the end of FY19 had been built in the previous 10 years and 96.3% of the rooms had full en-suite wet room facilities (with plans in place to upgrade those that did not).

Exhibit 3: UK care beds by room type

Source: Target Healthcare REIT

…operated by good-quality tenants

The quality of rental income depends not only on lease length and how rent levels are reviewed, but also on the sustainable performance of the tenants. Prospective tenants’ operational ability, care ethos and finances are scrutinised before acquisitions are made and Target maintains an ongoing dialogue with its tenants after investing that goes well beyond the classic landlord role. When necessary, assets are subject to more focused management, which usually involves supporting the tenant towards improved performance and may occasionally lead to the company promoting a change in the operator of the asset. During FY19, Target was engaged with the outgoing operator and carefully selected new operator in the re-tenanting of an existing home.

Across the portfolio, Target estimates that approximately two-thirds of the income of the operator tenants includes at least some element of private fees, and that in turn purely private fees represent approximately two-thirds of this and mixed private/public fees (‘top-ups’) the balance. Fees received from purely public sources (local authorities and the NHS) represent approximately one-third of operator income. This mix is reflected in higher than average fees per resident received by the operator tenants; in the quarter ended 30 June 2019, Target estimates £858 per week per resident compared with £718 for all UK care homes.

When invested, Target is an engaged landlord and invests considerable resource in its ongoing property management role. The purpose of this is to add value to the rental covenant and help ensure that this endures over the long period of the lease. Target maintains an ongoing dialogue with its tenants, receives and reviews management accounts for each home on a regular basis, and each home is visited at least every six months. During the current pandemic the established reporting channels for key operating and financial metrics remain in place but physical home inspections have been replaced by remote monitoring.

As part of Target’s own engagement and monitoring process, it also considers the results of the assessments carried out by the industry regulators (in the case of England, the Care Quality Commission or CQC with similar rating systems operated in Wales and Scotland). Care is needed in interpreting this data as while providing useful insights into operator performance the inspection timetable can often lead to delays in ratings adjusting to material changes, such as a new operator, new standards of practice, or a change in the home manager.

Growing and increasingly diversified portfolio

As at 31 March 2019 (end-Q320), Target’s portfolio was valued at £613.4m, comprising 73 properties, of which 71 were operational and two were pre-let sites being developed under forward-funding agreements, let to 27 different tenants. With an annualised contracted passing rent of £38.9m (£36.6m of annualised cash passing rent after adjusting for short-term lease incentives) the portfolio valuation reflected an EPRA topped-up net initial yield of 6.05%. The WAULT of 29.2 years remained very high, the product of 30- to 35-year leases at inception and the low average age of the portfolio. All leases are fully repairing and insuring, and upwards-only, with the majority RPI-linked, subject to caps and collars, although some have fixed annual uplifts. The long WAULT and inflation-linked leases provide considerable visibility of long-term income growth.

Exhibit 4: Portfolio summary

Mar-20

Dec-19

Jun-19

Jun-18

Jun-17

Q320

H120

FY19

FY18

FY17

Properties

73

71

63

55

45

Beds

5073

4901

4,094

3,552

3,096

Tenants

27

28

24

21

16

Contracted passing rent (£m)

38.9

37.6

32.2

26.0

20.3

Portfolio value (£m)

613.4

589.9

500.9

385.5

266.2

WAULT

29.2 years

29.2 years

29.1 years

28.5 years

29.5 years

EPRA Topped-up net initial yield

6.05%

6.07%

6.26%

6.44%

6.75%

Source: Target Healthcare REIT data

Target has continued to diversify its tenant base, the majority of which are mid-sized care home operators managing more than five homes. As a result of this growth and diversification, the share of rent roll attributable to Target’s largest tenant, Ideal Care Homes, has reduced to c 12%. The reduction in the number of tenants from 28 at end-FY19 to 27 currently reflects the re-tenanting of six homes operated by Orchard Care Homes to two existing tenant operators (see below).

The company says that the majority of the portfolio continues to perform well, which is reflected in the fact that, of the 55 assets owned at the beginning of FY19, all but four increased in value during the year with two remaining the same and two reducing. Target quotes rent cover for the mature homes (that is, homes that have had the same operator for a three-year period or more and by definition excludes newly developed homes). Newly constructed homes typically require 18–36 months to build occupancy and rent cover. At 31 December 2020 (end-H120), rent cover for mature homes was 1.6x, a similar level to the FY17-19 average (end-FY19: 1.7x).

Significant year-to-date investment activity

During the first nine months of FY20, the portfolio valuation increased to £613.4m from £500.9m at end-FY19. Target has completed acquisitions totalling a commitment of c £110m (including transaction costs) and has completed two pre-let developments. As a result, the proceeds of Target’s last equity fund-raising in September 2019, when it raised £80m (gross) in an oversubscribed issue of 72.4m shares, have been quickly deployed. The company has also drawn on available debt facilities of which more remains available. The (FY20) year-to-date investment comprises:

Two care homes in Ripon, Yorkshire, and Stourport, West Midlands, for c £18.6m (including transaction costs), adding an aggregate 137 new beds, announced on 23 August 2019 (Q120). Both homes are fully operational, modern and well-equipped, with full en-suite wet room facilities. The homes are both let to a subsidiary of Maria Mallaband Care Group, a new tenant to the group.

A substantial package of acquisitions with an aggregate consideration of £81.3m (including transaction costs) announced on 8 November 2019 and comprising:

A portfolio of five purpose-built operational care homes in Yorkshire, adding an aggregate 362 beds, completed in Q220. Four of the homes have a long and successful trading history and the fifth reached practical completion and opened in July 2019. All the rooms have en-suite facilities and, although unusually for the group, c 20% are currently without full en-suite wet room provision, this will be retro-fitted and has been priced into the contract. The portfolio is leased to a subsidiary of the national operator and existing tenant Bondcare.

Two additional newly constructed and well-equipped care homes, also in Yorkshire, adding 172 beds with full en-suite wet room facilities. Completion of this transaction was announced on 20 January 2020 following the receipt of CQC registration for the homes, which are leased to existing tenant Burlington Care.

A total of 31 retirement living apartments in Cirencester, Gloucestershire, completed in Q220. The apartments are adjacent to an existing Target care home and are managed by the same tenant, Aura Care Living.

An 80-bed operational care home in Dorset, completed in Q220. The home was constructed in 2017 and provides en-suite wet room facilities. It is let to a subsidiary of Encore Care Homes, a new tenant to the group.

The Q220 completion of a forward purchase agreement entered into in September 2018 for a newly constructed 73-bed home in Newton, Wales, let to Sandstone Care, which at the time was a new tenant to the group (but is now operating four Target homes, see below).

A development site with a forward-funding agreement in Rudheath, Cheshire, for £9.7m (including transaction costs), acquired in Q320. The completed care home is pre-let to an existing tenant of the group, L&M Healthcare. Planning consent was received in October 2019 with the development phase expected to take 16 months.

The completion of existing pre-let forward funding developments in Preston, Lancashire, during Q120 and Birkdale, Merseyside, during Q220. The Preston home added 74 newly operational beds and is let to L&M Healthcare. The Birkdale home added 55 new operational beds and is let to Athena Healthcare, an existing tenant of the group.

Specific acquisition yields have not been disclosed, but Target has indicated that these are consistent with previous similar transactions.

As a result of Target’s active management of the portfolio, including continuous monitoring of the performance of each asset at both a tenant and property level, in July 2019 (Q120) two homes were sold. The homes were relatively small (amounting to less than 3% of portfolio value) and the company says that while both were acquired as long-term investments, the initial investment case had changed and the opportunity for disposal at more than 5% above the carried value would optimise the portfolio performance and free resources for reinvestment.

Prudent approach to continuing investment pipeline

As the severity of the pandemic emerged, towards the end of Q320 Target prudently postponed the completion of the acquisition of two homes. The position remains under review and there is an ongoing dialogue with the vendors. Additionally, the company continues to analyse and perform due diligence on a number of near-term investment opportunities and a wider pipeline of opportunities at a less advanced stage, but the timing of any further acquisitions will be considered carefully against both the market outlook and the group’s available funds.

Successful re-tenanting

In addition to long lease terms, successfully chosen assets contribute significantly to income security. This is best demonstrated when tenants inevitably run into problems. As part of its ongoing asset management, during FY19 Target re-tenanted one of its homes to remove an underperforming tenant. The process was completed with no interruption to residents and resulted in an increase in property value.

In September 2019, Target was informed by Orchard Care Homes that as part of its own business restructuring it intended to exit the six homes it leased from the group. By February 2020, these had been split into two regional sub-portfolios and successfully re-tenanted to two of Target’s existing operators. Burlington Care now operates the three homes that were located in Yorkshire and Sandstone Care operates the three homes located in the North West. Target continued to receive the contracted rental income throughout the re-tenanting process and, while new rental incentives have been offered in relation to some of the properties, these are offset by Orchard's rent deposits that will be retained by the group. On an aggregate basis there has been no material change in the contracted rental income the group will receive from these properties once the rental incentives expire and the valuation at end-Q320 resulted in a small uplift across the homes.

Management and governance

Independent board and specialist external manager

Target Healthcare REIT is overseen by an independent board of directors and is externally managed, under a management contract, by Target Fund Managers. Target Fund Managers was founded in 2010 by Kenneth MacKenzie, its chief executive, and is a sector specialist manager investing exclusively in the elderly healthcare property sector. The investment team has experience in all aspects of the healthcare property sector including operating, owning, investing in, developing and building healthcare businesses and healthcare property assets. We provide biographies of the key members of the investment team on page 17.

Target Fund Managers manages three investment funds with aggregate assets under management of c £700m, of which Target Healthcare REIT represents the largest share. The other funds are the Kames Target Healthcare Property Unit Trust, with a similar investment remit to Target Healthcare REIT, but whose investment period is now over, and a specialist fund providing flexible, bespoke funding solutions to finance a wide range of transactions in the elderly healthcare sector.

A revised investment management fee schedule, in place from 1 July 2018, abolished performance fees and introduced a tiered base fee structure with reducing rates at higher NAV levels, allowing shareholders to benefit from the increasing economies of scale that a larger portfolio provides. The marginal investment management fee will reduce from 1.05% to 0.95% as average NAV increases above £500m (end-Q320: £494.2m). A continuing improvement in underlying cost ratios in FY19, reflecting the growing scale of the business, is obscured by the impact of change in management fee arrangements on the reported ratios. As reported, the total expense ratio (TER) and the adjusted EPRA cost ratio increased to 1.52% (FY18: 1.48%) and 22.4% (FY18: 20.8%). However, had the FY18 cost ratio not been adjusted for now discontinued performance fees, the FY18 TER would have been 1.66% and the EPRA cost ratio 23.3%.

Exhibit 5: Management fee structure

Average net assets

Fee margin

First £500m

1.05%

£500m to £750m

0.95%

£750m to £1,000m

0.85%

£1,000m to £1,500m

0.75%

£1,500m+

0.65%

Source: Target Healthcare REIT. Note: Rates effective 1 July 2018.

The board recently agreed an amendment to the notice period provision for the investment management agreement. The first date that notice may be served is one year from the date of the change and the minimum notice period was extended from one to two years. This amounts to an effective initial term of three years, providing welcome continuity and certainty to the arrangement during this more challenging period.

The independent non-executive chairman of the board is Malcolm Naish, a chartered surveyor with more than 40 years’ experience of working in the real estate industry. Before becoming chairman of Target in 2013, Mr Naish was director of real estate at Scottish Widows Investment Partnership (SWIP) until 2012. At SWIP, he had responsibility for a portfolio of commercial property assets spanning the UK, continental Europe and North America, and for SWIP’s real estate investment management business. In addition to Target, Mr Naish is a director of GCP Student Living and Ground Rents Income Fund. The other independent directors of the company bring broad experience in the real estate, healthcare, and the fund management and administration sectors. They are Professor June Andrews OBE, a former trade union leader, NHS manager and senior civil servant and world-renowned dementia expert, Gordon Coull, a former partner at Ernst & Young LLP specialising in investment trusts and property, and Thomas Hutchison III, who has more than 40 years of experience focused in the lodging, hospitality, real estate development, seniors’ housing and financial services industries.

A shareholder EGM in July 2019 approved changes to the group’s corporate structure, establishing a new England-incorporated parent company (Target Healthcare REIT) at the head of the group. The main driver for moving the group’s ultimate parent company to a UK domicile from Jersey was to align the group with its existing UK tax jurisdiction, maintain and enhance its important relationships with UK local authorities and health services, and help reduce administrative costs and regulatory complexities. Importantly, there was no change to the way the group is run, its investment strategy or its dividend policy. Following the change in corporate structure, Hilary Jones and Craig Stewart retired from the board, but the board expects to nominate one new director during 2020 as part of its succession planning.

The company has an indefinite life, but shareholders are invited to vote on continuation at five-yearly intervals. The last vote was held in November 2017 and the next vote is expected in 2022.

Financials

Recent trading

Results for the period-ending 31 December 2019 (H120) showed the effects of continuing strong portfolio growth. Compared with H119, rental revenues increased by 28%, benefiting from acquisitions, development completions and RPI-linked rental uplifts. Adjusted earnings increased 21% to £11.5m with adjusted EPS at 2.72p. DPS increased 1.5% to 3.34p although dividend cover (75%) was held back during deployment of the £80m equity issuance in the period. EPRA NAV per share increased by 0.6% to 108.1p driven primarily by revaluation gains and NAV total return (adding back but not reinvesting DPS paid) was 3.7%.

Exhibit 6: Summary of H120 financial performance

£m unless stated otherwise

H120

H119

H120/H119

IFRS

Adjusted

Adj. EPRA earnings*

IFRS

Adjusted

Adj. EPRA earnings*

Adj. EPRA earnings*

Rent revenue

17.0

17.0

13.3

13.3

27.8%

Income from guaranteed rent reviews & lease incentives

3.9

(3.9)

0.0

2.9

(2.9)

0.0

Development interest under forward fund agreements

0.0

0.6

0.6

0.0

0.8

0.8

Total income

20.8

(3.3)

17.6

16.2

(2.1)

14.1

24.9%

Base investment management fee

(2.5)

(2.5)

(2.4)

(2.4)

5.4%

Other expenses

(1.5)

(1.5)

(0.8)

(0.8)

99.1%

Operating profit before property gains/(losses)

16.8

(3.3)

13.5

13.0

(2.1)

10.9

23.9%

Revaluation of investment properties

(0.3)

0.3

0.0

3.3

(3.3)

0.0

Realised gains on investment properties

0.6

(0.6)

0.0

Revaluation gain on properties held for sale

1.5

(1.5)

0.0

0.0

0.0

0.0

Operating profit

18.6

(5.1)

13.5

16.4

(5.5)

10.9

23.9%

Net finance cost

(2.0)

(2.0)

(1.4)

(1.4)

27.8%

Tax

0.0

0.0

0.0

0.0

Net earnings

16.6

(5.1)

11.5

14.9

(5.5)

9.5

Other data:

H120

H119

H120/H119

IFRS EPS (p)

3.91

4.24

-7.7%

Adjusted EPS (p)

2.72

2.69

1.4%

EPRA EPS (p)*

3.50

3.29

6.3%

DPS declared (p)

3.34

3.29

1.5%

Dividend cover

0.75

0.80

NAV per share, IFRS & EPRA (p)

108.1

106.9

1.2%

Investment properties

589.9

463.9

27.2%

Gross LTV

22.9%

15.3%

Source: Target Healthcare REIT data. Note: *Adjusted EPRA earnings includes development interest under forward fund agreements.

Q320 showed continuing progress

During Q320 rental income continued to benefit from index-linked increases and acquisitions. The average uplift on completed rent reviews was 2.6%, generating like for like growth in contracted rents of 0.4% during the quarter, the main driver of 0.6% like for like growth in the property valuation. EPRA NAV per share reduced very slightly during the quarter, to 108.0p, as a result of one-off debt refinancing costs (see below), equivalent to 0.3p per share. Including dividends paid, EPRA NAV total return was 1.5%, taking the aggregate return for the first nine months of 2020 to 5.1%. An unchanged Q320 interim dividend of 1.67p per share was declared for payment on 29 May 2020 to shareholders on the register at 11 May 2020.

Revised forecasting assumptions

Our forecasts have been updated for the recent developments detailed above, including all the announced transactions and equity raising. We have not assumed any further investment commitments in the light of the current market uncertainties, although the company has available funding and continues to review potential acquisitions from an active pipeline of opportunities. We would expect acquisitions to have a positive impact on our forecasts. Our key forecasting assumptions include:

Anticipated completion of the Burscough forward-funded development at end-FY20 and the recently acquired Rudheath development at end-FY21 (too late to contribute to income in the forecast period).

Annual RPI rental uplifts of 2.5% pa (reduced slightly from an assumed 3.0% previously in line with recent experience).

The assumed RPI rent uplifts and development completions lift contracted annualised rent roll from the £38.9m reported at end-Q220 to £39.8m at end-FY20 and £41.4m at end-FY21. We forecast rental income growth of c 28% in FY20 and 9% in FY21.

Investment management fees are calculated as per the fee schedule shown in Exhibit 5, increasing with average net assets. For FY20 we forecast other expenses at a similar level to FY19, benefiting from the non-repeat of corporate restructuring costs (£0.7m) but also including an assumed £1.0m pf provisions against rent receivables (of which £0.5m in H120, non-COVID-19 related).

To be consistent with our rental growth assumptions and without forecasting any specific valuation yield shift, we continue to assume gross revaluation gains in line with RPI-linked rent uplifts (ie an unchanged NIY). In FY20 this is partly offset by acquisition costs written off. The gross revaluation gains are equivalent to 3.6p per share in FY20 and 3.4p per share in FY21. The impact of COVID-19 is difficult to anticipate at this stage. We estimate that a 0.1% decrease or increase in the topped-up NIY would increase or decrease NAV per share by c 5p per share.

Exhibit 7: Income statement revaluation movement

£m

FY19

FY20e

FY21e

Gross revaluation movement

17.4

15.0

15.6

Acquisition costs written off

(2.6)

(4.2)

0.0

Movement in lease incentives

(2.3)

(0.7)

0.0

Net revaluation movement

12.5

10.1

15.6

Movement in fixed or guaranteed rent reviews

(6.4)

(7.7)

(7.7)

Gains/(losses) on revaluation of investment properties as per income statement

6.2

2.4

7.8

Acquisition costs as % of purchase value

2.6%

3.8%

0.0%

Gross revaluation as % of opening portfolio value

4.5%

3.3%

2.5%

Gross revaluation gain per share (p)

4.5

3.3

3.4

Source: Target Healthcare REIT data, Edison Investment Research

As we discuss below we have assumed no additional borrowing from Q320 onwards and as a result net finance expense is forecast at a broadly similar rate to H120.

Including c £0.8m of development interest in respect of forward-funding developments, we forecast FY20 growth in adjusted earnings of 34% to £26.9m and 6% growth to £28.6m in FY21. Including the impact of the additional 72.4m shares issued in September 2019 (c 19% of the prior number of shares outstanding), we forecast adjusted EPS of 5.7p in FY20 (FY19: 5.5p) and 6.3p in FY21.

Robust balance sheet position with conservative gearing

Target ended Q320 with a robust balance sheet position, strengthened by the September 2019 oversubscribed £80m equity issue, and conservative leverage.

Including the new £50m term loan facility with ReAssure agreed in early January 2020 and the repayment of an existing £40m term loan with First Commercial Bank (FCB), Target now has £180m of committed banking facilities comprising £80m of term loan facilities and £100m of more flexible revolving credit facilities. At the end of Q320 Target had drawn £142m of its debt facilities, leaving £38m undrawn. End-Q320 cash was £31.1m and outstanding commitments amounted to £12m, primarily in respect of the two development assets. The end-Q320 loan to value ratio was 23.1% gross and 18.1% net of cash. As at 21 April 2020 the cash balance was £29m.

Exhibit 8: Summary of debt portfolio

Lender

Facility type

Facility

Maturity

Margin

RBS

Term loan & revolving credit facility

£50m**

September 2021*

Libor + 1.5%

HSBC

Revolving credit facility

£80m

January 2022***

Libor + 1.7%

ReAssure

Term loan

£50m

January 2032

Fixed 3.28%

Source: Target Healthcare REIT data. Note: *RBS facility includes the option of two one-year extensions subject to RBS approval. **The RBS facility comprises a £30m term loan and £20m revolving credit facility. ***HSBC facility includes option of one-year extension subject to HSBC approval.

The new facility with ReAssure is for a term of 12 years at a fixed cost of 3.28% pa and after repayment of the FCB loan (due in August 2022 with a cost including hedging of 3.08%) provided £10m of additional debt funding capacity, while extending the duration of the debt facilities. In March Target exercised its option, with the consent of HSBC, to extend the term of this facility by one year to January 2022. With the refinancing, the interest rate swap used to hedge the FCB facility was closed out leaving swaps covering £30m of the otherwise floating rate RBS facilities in place. The above financing activity lengthened the weighted average expiry of Target’s debt from less than 2 years to 4.5 years at end-Q320 with an average cost of drawn debt, inclusive of arrangement fee amortisation, of 2.99%. Our forecasts assume no need for further debt drawing during the forecast period with net LTV ending FY21 at 18.3%.

Estimate revisions

Our revised estimates are shown in Exhibit 9. Compared with our previous forecasts, net rental income is higher, reflecting the equity raising and further investment since our last estimates were published. Adjusted net earnings are also higher, primarily for the same reason, but adjusted EPS based on the increased number of shares in issue is lower. The reduction in forecast adjusted EPS compared with our last published forecast primarily reflects:

Although our forecast net rental income is higher, we now expect a higher share to represent IFRS adjustments to cash rental receipts in respect of fixed rent uplifts and lease incentive smoothing. The non-cash IFRS adjustments are excluded from adjusted earnings (but are included in EPRA earnings).

Lower assumed RPI uplifts (2.5% pa versus 3.0% pa).

The reduction in our assumption for further acquisition activity results in lower gearing (end-FY20 net LTV: 18.0% versus 26.4% previously) as a result of the September 2019 equity raise and reduced investment assumption.

We now assume an unchanged DPS reflecting the reduction in forecast adjusted earnings and current market uncertainty, but expect FY21 DPS to be substantially (94%) covered by adjusted earnings.

Exhibit 9: Estimate revisions

Net rental income (£m)

Adj. net earnings* (£m)

Adjusted EPS* (p)

EPRA NAV/share (p)

DPS (p)

Old

New

Chg (%)

Old

New

Chg (%)

Old

New

Chg (%)

Old

New

Chg (%)

Old

New

Chg (%)

06/20e

43.0

43.8

2.0

26.1

24.9

-4.8

6.78

5.6

-16.7

111.0

108.9

(1.9)

6.71

6.68

-0.5

06/21e

44.9

47.6

6.0

27.2

28.6

5.3

7.05

6.3

-11.4

115.9

111.9

(3.5)

6.84

6.68

-2.4

Source: Edison Investment Research. Note: *Adjusted earnings exclude revaluation movements, non-cash income arising from the accounting treatment of lease incentives and guaranteed rent review uplifts, and acquisition costs, and include development interest under forward funding agreements.

Income sensitivity

Our dividend forecasts are driven by our expectations for adjusted earnings that in turn assume contracted rents are received in full and our analysis suggests Target would be able to maintain a good level of quarterly distributions, albeit at a lower level, even with fairly significant deferral of rental income. At present, we do not expect Target’s agreements with a limited number of tenants for staged payments in advance over the coming quarters to have any material impact on cash flow and dividend paying capacity. However, should any of Target’s tenant operators be more seriously affected by the pandemic, there is a risk of a more significant cash flow impact with implications for near-term dividend payments. In the extreme case of tenant failure, there would potentially be an impact on reported earnings as well as cash flow as a result of bad debts and potential delays in re-tenanting with associated costs.

In Exhibit 10 we illustrate the potential near-term sensitivity of DPS and DPS cover from rent deferral. For simplicity, we have assumed any rents deferred to be a deduction from forecast income and adjusted EPRA earnings, although in most cases this is likely to be a cash flow impact (the timing of collections, in most cases temporary) rather than an income impact (the amount of rent to be collected over time). We have modelled the sensitivity based on our FY21 forecasts, which include a full contribution from recent acquisitions. A 10% reduction in our forecast FY21 rental income reduces dividend cover from the forecast 94% to 81%. From an alternative perspective, if targeting 100% dividend cover, the implied FY21 DPS would be 6.29p rather than our forecast 6.68p, or 5.38p with a 10% reduction in rental income.

Depending on the nature and expected duration of any shortfall in near-term income Target may decide to use existing financial resources to support distributions.

Exhibit 10: Illustrative impact of rent deferral on near-term DPS and DPS cover

Rental income vs forecast:

Implied dividend cover (x)

Implied DPS at full cover (p)

FY21 forecast/

0.94

6.25

-1%

0.92

6.16

-3%

0.90

5.99

-5%

0.87

5.82

-10%

0.81

5.38

-15%

0.74

4.94

-20%

0.67

4.51

-25%

0.61

4.07

Source: Edison Investment Research

Valuation

Annualised DPS has increased in each year since IPO in 2013 and, based on the Q320 DPS of 1.67p, the annualised rate of DPS is 6.68p, representing a prospective yield of 6.2%. The P/NAV is 1.0x.

Exhibit 11 shows the NAV total return history since IPO. The cumulative total return (adjusted for dividends paid but not assuming reinvestment of dividends) from IPO in March 2013 to the end of Q320 was 54.0% or an average annualised rate of 6.2%. Dividends accounted for c 80% of the total. In the absence of acquisition costs, our FY21 forecasts imply a return of 8.9% with RPI-linked rent uplifts contributing to earnings and capital growth (with an assumed unchanged yield) and supported by modest gearing. The key risks to this forecast return are a negative near-term impact on earnings (not simply on the timing of rent receipts) from COVID-19 or a widening of market valuation yields.

Exhibit 11: NAV total return history (no reinvestment of dividends paid)

FY14*

FY15

FY16

FY17

FY18

FY19

9M20

Cumulative to end-Q320

Opening NAV per share (p)

98.0**

94.7

97.9

100.6

101.9

105.7

107.5

98.0

Closing NAV per share (p)

94.7

97.9

100.6

101.9

105.7

107.5

108.0

108.0

DPS paid (p)

6.5

6.1

6.2

6.3

6.4

6.5

5.0

42.9

NAV TR %

3.3%

9.7%

9.0%

7.5%

10.1%

7.8%

5.1%

54.0%

Compound annual average return

6.2%

Source: Target Healthcare REIT data, Edison Investment Research. Note: Company published total returns are on a dividend reinvested basis and are higher. *22 January 2013 to 30 June 2014. **Adjusted for IPO costs.

Within the broad commercial property universe, Target is part of a group of companies that is differentiated by its focus on stable long-term income growth derived from long-lease exposures across a range of property types, including healthcare property, social housing, ‘big box’ distribution centres, supermarkets and leisure assets. Care home property investment yields are higher than for other healthcare assets and the leases at inception are longer.

Exhibit 12: Last published WAULT for selected long income REITs

Company

Years

As at:

Target

29.2

Mar-20

Triple Point Social Housing

25.7

Dec-19

Civitas

23.8

Dec-19

LXI

22.0

Sep-19

Secure Income

21.0

Dec-19

Impact Healthcare

19.7

Dec-19

Supermarket Income

18.0

Dec-19

Tritax Big Box

14.1

Dec-19

Assura

13.6

Sep-19

Primary Health properties

12.8

Dec-19

Source: Company data

Although all the companies listed in Exhibit 12 (above) are focused on generating long-term income and have WAULTs that are above the average of the broad property sector, there are considerable differences between the different asset classes in which they invest, lease terms and the tenant covenants that support the long-term contractual income. These differences are reflected in valuation and performance differences (Exhibit 13). Target’s very long WAULT and predominantly RPI-linked rent growth provides investors with considerable visibility over a growing stream of contracted rental income and offers considerable protection against inflation. Compared with the peer group average, Target shares trade with a similar P/NAV but have a noticeably higher yield.

Exhibit 13: Summary of long-lease REITS

Price (p)

Market cap (£m)

P/NAV (x)

Yield (%)

Share price performance

1 month

3 months

12 months

From 12M high

Assura

77

2038

1.43

3.6

-8%

-1%

29%

-12%

Civitas Social Housing

99

612

0.92

5.3

2%

-1%

13%

-4%

Impact Healthcare

93

298

0.87

6.6

2%

-14%

-14%

-19%

Lxi

102

534

0.86

5.6

-6%

-25%

-17%

-27%

Primary Health Properties

154

1879

1.43

3.7

-4%

-2%

18%

-8%

Secure Income

276

894

0.66

6.1

-14%

-41%

-33%

-42%

Supermarket Income

107

506

1.10

5.4

-3%

-1%

4%

-3%

Triple Point Social Housing

97

342

0.92

5.2

7%

-2%

3%

-9%

Tritax Big Box

121

2060

0.80

5.7

8%

-14%

-19%

-26%

Average

1.00

5.2

-2%

-11%

-2%

-17%

Target Healthcare

108

492

1.00

6.2

1%

-10%

-8%

-14%

UK property index

1,467

4.0

5%

-23%

-15%

-26%

FTSE All-Share Index

3,283

4.9

6%

-19%

-19%

-23%

Source: Historical company data, Refinitiv. Note: *Based on last published EPRA NAV per share. **Based on trailing 12-month DPS declared. Refinitiv price data at 30 April 2020.

Among the companies shown in Exhibit 13, over the past 12 months the strongest share price performance has been delivered by the primary care asset investors (Assura and PHP) and, in our view, the strength of tenant covenant has contributed significantly to this (the vast majority of rents are backed directly or indirectly by government). Compared with care homes, the average lease length is shorter, and although upwards-only, a significant share of the leases are subject to open-market review rather than being indexed to inflation. For the social housing investors (Civitas, Triple Point), rental income is also funded by government via local authorities, although payment is made to the housing association tenants who then pay the investor landlords. Lease terms for the other companies are predominantly index-linked, with tenant exposures being mostly corporate, across a range of sectors – industrial, supermarkets and care home operators where a significant differentiating factor is the strength of the corporate lease covenant.

Sensitivities

The visibility of Target’s contractual income and dividend paying capacity is provided by long leases and RPI-linked rent increases. We see the key sensitivities as relating to the following:

The failure of any of the tenants could negatively affect the collection of contractual income. Target seeks to mitigate this risk through a rigorous investment process, ongoing oversight of all its homes and operators, and the increasing diversity of its tenant base. Were any operator or home to fail, a focus on investing in high-quality homes situated in areas with supporting demography should make the home attractive to another operator. This approach was borne out by the successful re-tenanting of all six homes previously let to Orchard Care Homes.

Key operational and financial risks to the tenant operators include: their ability to maintain high standards of care and compliance with stringent and evolving regulatory oversight; upward pressure of staff costs and local shortages, especially for trained nursing staff; and budgetary pressures on the local authorities that fund c 50% of UK care home beds. High-specification, modern, purpose-built accommodation provides advantages to operators in terms of care quality and may be more likely to attract self-funded residents for whom industry fees are on average materially higher than for local authority-funded residents. Such properties may also assist operators in delivering better quality care and attracting and retaining staff. The COVID-19 pandemic increases the risks and challenges facing operators in the near term, the impact and duration of which is for now difficult to assess.

Average care home fees have risen at a faster rate than RPI in recent years, particularly fees for self-funded residents. In many cases these fees will be met by a draw-down of home equity and/or other savings. Any sustained reduction in asset values could have a negative impact on the growth of privately funded fees.

Strong investor interest in care home assets has seen valuations increase and the yields available on investment tighten, particularly for good-quality, modern, purpose-built assets. Favourable funding conditions have maintained a positive investment spread and, to the extent that further portfolio growth is accompanied by expansion of the equity base above £500m, the reduction in the marginal rate of investment management fees should be beneficial.

RPI-linked rent increases protect against inflation, providing inflation does not rise too much. Target’s RPI-linked leases are subject to caps and collars, and we would expect the blended cap to be around 4% with a floor at c 2%. Should inflation increase significantly, above c 4%, the cap to rental increases could cause income growth to lag the growth in expenses and funding costs. We would nevertheless expect such conditions to generate more significant challenges to the mainstream commercial property market where occupancy is also likely to be more volatile.

Of Target’s £180m of committed term loan and revolving credit facilities, £80m is fixed/hedged and £100m is floating rate. Assuming no change in the differential between Libor and RPI, the impact on the variable funding costs arising from any increase in Libor should be matched by increases in rental income, provided RPI does not rise above the cap on rent increases.

Exhibit 14: Financial summary

Year to 30 June (£000s)

2014

2015

2016

2017

2018

2019

2020e

2021e

INCOME STATEMENT

Rent revenue

3,817

9,898

12,677

17,760

22,029

27,923

36,097

39,883

Movement in lease incentive/fixed rent review adjustment

1,547

3,760

4,136

5,127

6,334

6,354

7,710

7,710

Rental income

5,364

13,658

16,813

22,887

28,363

34,277

43,807

47,593

Other income

0

66

61

671

3

0

10

0

Total revenue

5,364

13,724

16,874

23,558

28,366

34,277

43,817

47,593

Gains/(losses) on revaluation

(2,233)

(1,013)

(573)

1,585

6,434

6,155

3,876

7,843

Realised gains/(losses) on disposal

0

0

0

0

0

0

642

0

Total income

3,131

12,711

16,301

25,143

34,800

40,432

48,335

55,437

Management fee

(648)

(1,524)

(2,654)

(3,758)

(3,734)

(4,702)

(5,261)

(5,522)

Other expenses

(780)

(880)

(992)

(1,236)

(1,458)

(2,742)

(2,783)

(1,523)

Total expenditure

(1,428)

(2,404)

(3,646)

(4,994)

(5,192)

(7,444)

(8,044)

(7,045)

Profit before finance and tax

1,703

10,307

12,655

20,149

29,608

32,988

40,291

48,391

Net finance cost

190

(716)

(929)

(808)

(2,010)

(3,104)

(4,496)

(4,240)

Profit before taxation

1,893

9,591

11,726

19,341

27,598

29,884

35,796

44,151

Tax

(4)

(39)

(24)

(219)

11

0

3

0

Profit for the year

1,889

9,552

11,702

19,122

27,609

29,884

35,799

44,151

Average number of shares in issue (m)

105.2

119.2

171.7

252.2

282.5

368.8

440.4

457.5

IFRS earnings

1,889

9,552

11,702

19,122

27,609

29,884

35,799

44,151

Adjust for valuation changes

2,233

839

(425)

(2,211)

(6,434)

(6,155)

(3,013)

(7,843)

Other EPRA adjustments

0

174

998

420

1

729

(1,458)

0

EPRA earnings

4,122

10,565

12,275

17,331

21,176

24,458

31,328

36,308

Adjust for fixed/guaranteed rent reviews

(1,547)

(3,760)

(4,136)

(5,127)

(6,334)

(6,354)

(7,710)

(7,710)

Adjust for development interest under forward fund agreements

261

2011

849

0

Adjust for performance fee

150

466

871

997

550

0

0

0

Adjust for debt early repayment fee

0

0

0

0

0

0

400

0

Group adjusted earnings

2,725

7,271

9,010

13,201

15,653

20,115

24,866

28,598

IFRS EPS (p)

1.80

8.02

6.81

7.58

9.77

8.10

8.13

9.65

Adjusted EPS (p)

2.59

6.10

5.25

5.23

5.54

5.45

5.65

6.25

EPRA EPS (p)

3.92

8.87

7.15

6.87

7.50

6.63

7.11

7.94

Dividend per share (declared)

6.00

6.12

6.18

6.28

6.45

6.58

6.68

6.68

Dividend cover

1.08

0.83

0.82

0.82

0.81

0.94

BALANCE SHEET

Investment properties

81,422

138,164

200,720

266,219

362,918

469,596

572,995

586,992

Other non-current assets

0

2,530

3,742

3,988

27,139

37,573

45,504

53,509

Non-current assets

81,422

140,694

204,462

270,207

390,057

507,169

618,498

640,501

Cash and equivalents

17,125

29,159

65,107

10,410

41,400

26,946

31,783

25,111

Other current assets

6,524

6,457

13,222

25,629

3,365

4,264

9,957

9,957

Current assets

23,649

35,616

78,329

36,039

44,765

31,210

41,740

35,068

Bank loan

(11,764)

(30,865)

(20,449)

(39,331)

(64,182)

(106,420)

(140,684)

(141,484)

Other non-current liabilities

0

(2,530)

(4,058)

(3,997)

(4,673)

(7,068)

(7,940)

(8,316)

Non-current liabilities

(11,764)

(33,395)

(24,507)

(43,328)

(68,855)

(113,488)

(148,624)

(149,800)

Trade and other payables

(3,089)

(3,623)

(5,002)

(5,981)

(7,360)

(11,802)

(13,788)

(14,352)

Current Liabilities

(3,089)

(3,623)

(5,002)

(5,981)

(7,360)

(11,802)

(13,788)

(14,352)

Net assets

90,218

139,292

253,282

256,937

358,607

413,089

497,826

511,417

Adjust for derivative financial liability

0

0

316

9

115

707

290

290

EPRA net assets

90,218

139,292

253,598

256,946

358,722

413,796

498,116

511,707

Period end shares (m)

95.2

142.3

252.2

252.2

339.2

385.1

457.5

457.5

IFRS NAV per ordinary share

94.7

97.9

100.4

101.9

105.7

107.3

108.8

111.8

EPRA NAV per share

94.7

97.9

100.6

101.9

105.7

107.5

108.9

111.9

CASH FLOW

Cash flow from operations

3,172

8,081

8,906

4,394

23,627

20,476

31,199

33,483

Net interest paid

161

(514)

(681)

(615)

(1,366)

(2,313)

(3,130)

(3,440)

Tax paid

0

(47)

(164)

(543)

(122)

1

(73)

0

Net cash flow from operating activities

3,333

7,520

8,061

3,236

22,139

18,164

27,997

30,043

Purchase of investment properties

(51,894)

(57,581)

(61,924)

(63,250)

(89,981)

(99,615)

(120,104)

(6,154)

Disposal of investment properties

0

0

0

0

0

0

14,402

0

Net cash flow from investing activities

(51,894)

(57,581)

(61,924)

(63,250)

(89,981)

(99,615)

(105,702)

(6,154)

Issue of ordinary share capital (net of expenses)

44,520

46,644

97,501

0

91,729

48,925

78,176

0

(Repayment)/drawdown of loans

8,646

22,525

(12,808)

20,906

26,000

42,000

34,000

0

Dividends paid

(4,364)

(7,074)

(9,681)

(15,589)

(17,353)

(23,628)

(29,117)

(30,560)

Other

0

0

14,799

0

(1,544)

(300)

(117)

0

Net cash flow from financing activities

48,802

62,095

89,811

5,317

98,832

66,997

82,942

(30,560)

Net change in cash and equivalents

241

12,034

35,948

(54,697)

30,990

(14,454)

5,237

(6,671)

Opening cash and equivalents

16,884

17,125

29,159

65,107

10,410

41,400

26,946

32,183

Closing cash and equivalents

17,125

29,159

65,107

10,410

41,400

26,946

32,183

25,511

Balance sheet debt

(11,764)

(30,865)

(20,449)

(39,331)

(64,182)

(106,420)

(140,684)

(141,484)

Unamortised loan arrangement costs

(497)

(645)

(551)

(669)

(1,818)

(1,580)

(1,316)

(516)

Net cash/(debt)

4,864

(2,351)

44,107

(29,590)

(24,600)

(81,054)

(109,817)

(116,489)

Gross LTV

15.1%

22.8%

10.5%

14.2%

17.1%

21.6%

23.2%

22.4%

Net LTV

0.0%

1.7%

0.0%

10.5%

6.4%

16.2%

18.0%

18.4%

Source: Target Healthcare REIT data, Edison Investment Research forecasts

Contact details

Revenue by geography

Target Fund Managers
Laurel House
Laurel Hill Business Park
Laurelhill
Stirling

FK7 9JQ
+44 (0)1786 845 912
Email: info@targetfundmanagers.com

Contact details

Target Fund Managers
Laurel House
Laurel Hill Business Park
Laurelhill
Stirling

FK7 9JQ
+44 (0)1786 845 912
Email: info@targetfundmanagers.com

Revenue by geography

Leadership team

Non-executive chairman: Malcolm Naish

Chief executive, Target Fund Managers: Kenneth MacKenzie

Malcolm Naish is a qualified surveyor with more than 40 years’ experience of working in the real estate industry. Before becoming chairman in 2013, he was a director of real estate at Scottish Widows Investment Partnership (SWIP), with responsibility for a portfolio of commercial property assets spanning the UK, continental Europe and North America, and for SWIP’s real estate investment management business. In previous roles, he was director and head of DTZ Investment Management, was a founding partner of Jones Lang Wootton Fund Management, and UK managing director of LaSalle Investment Management. In 2002, he co-founded Fountain Capital Partners, a pan-European real estate investment manager and adviser. He chaired the Scottish Property Federation for 2010/2011. He is also a director of GCP Student Living and Ground Rents Income Fund.

Kenneth MacKenzie, a chartered accountant with 40 years of business leadership experience, is founder and chief executive of Target Fund Managers As part of this role, he leads the creation and management of Target Fund Managers’ client funds and also oversees fund-raising and investor liaison for Target Healthcare REIT. In 2005, he led the acquisition of Independent Living Services, Scotland’s largest domiciliary-care provider, later engineering its sale to a private equity investor. He had previously negotiated the proposed acquisition of a large UK independent-living business in a joint-venture with the US care-home operator, Sunrise Senior Living. Before becoming involved in the healthcare sector, he owned businesses in fields as diverse as publishing, IT, shipping and accountancy.

Finance director, Target Fund Managers: Gordon Bland

Head of investment, Target Fund Managers: John Flannelly

Gordon Bland is finance director of Target Fund Managers, where his responsibilities extend to advising on strategic planning, formulating business plans, financial modelling, budget analysis, regulatory control, managing relationships with debt partners and ensuring the provision of financial reporting to stakeholder groups. He is a chartered accountant with extensive experience of financial reporting within the asset management industry and, prior to joining Target, he worked at PricewaterhouseCoopers for almost 10 years. That included two years at its Toronto office, where he served asset management and financial-services clients in the UK, Canada and Australia. His clients included SWIP, Scottish Widows, Lloyds Banking Group, Gartmore, Baillie Gifford and Schroders.

John Flannelly has been head of investment at Target Fund Managers since its inception in 2010. He is a chartered accountant with 20 years’ experience, including 12 years spent in real-estate investment management. He has primary responsibility for investment activity across the Target Fund Managers business, with involvement in the appraisal of hundreds of care-homes for its client funds. His career began with Arthur Andersen, where he worked on audits, financial due diligence and corporate finance projects. He later moved to the Bank of Scotland to structure MBO finance packages, and then into real-estate investment management. Immediately prior to joining Target Advisers, he was investment director for an institutional investor, where he held board positions at a UK top-10 care-home operator and a care-home development business.

Head of healthcare, Target Fund Managers: Andrew Brown

Head of asset management, Target Fund Managers: Scott Steven

Andrew Brown has been Target Fund Managers’ head of healthcare since the business began in 2010, where his primary responsibilities include inspecting properties owned by client funds as well as prospective acquisitions during due diligence. The team that he leads performs Target Fund Managers’ in-house demographic and market analysis. Andrew grew up in the care business and he and his family developed one of the largest continuing care retirement communities in the UK, Auchlochan Trust. He is also an investor in Trinity Care. He has played the role of developer, builder and operator of care homes, all of which has produced a community of approximately 350 care beds, almost 100 retirement properties and over 300 staff. These facilities included both residential care homes and nursing homes and Andrew was directly responsible for operations.

Scott Steven joined Target Fund Managers in 2017 and became head of asset management in 2018. His experience spans a variety of asset management, corporate finance, and banking roles, initially with Bank of Scotland where he qualified as a chartered banker. During 15 years with the bank, he worked in the private equity and pan-European property investment businesses. Latterly, under the Lloyds Banking Group umbrella, he led a team with responsibility for managing and restructuring substantial corporate real estate assets.

Principal shareholders

(%)

Premier Fund Managers

7.0

Investec Wealth & Investment

6.1

Bank of Montreal

5.9

CCLA Investment Management

4.7

Rathbone Brothers

4.5

Premier Fund Managers

7.0

Companies named in this report

Assura (AGR), Civitas Social Housing (CSH), Impact Healthcare (IHR), Primary Health Properties (PHP), Secure Income REIT (SIR), Supermarket Income REIT (SUPR), Triple Point Social Housing (SOHO), Tritax Big Box (BBOX)


General disclaimer and copyright

This report has been commissioned by Target Healthcare REIT and prepared and issued by Edison, in consideration of a fee payable by Target Healthcare REIT. Edison Investment Research standard fees are £49,500 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2020 Edison Investment Research Limited (Edison).

Australia

Edison Investment Research Pty Ltd (Edison AU) is the Australian subsidiary of Edison. Edison AU is a Corporate Authorised Representative (1252501) of Crown Wealth Group Pty Ltd who holds an Australian Financial Services Licence (Number: 494274). This research is issued in Australia by Edison AU and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. Any advice given by Edison AU is general advice only and does not take into account your personal circumstances, needs or objectives. You should, before acting on this advice, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If our advice relates to the acquisition, or possible acquisition, of a particular financial product you should read any relevant Product Disclosure Statement or like instrument.

New Zealand

The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

United Kingdom

This document is prepared and provided by Edison for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "FPO") (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document.

This Communication is being supplied to you solely for your information and may not be reproduced by, further distributed to or published in whole or in part by, any other person.

United States

. Edison relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. This report is a bona fide publication of general and regular circulation offering impersonal investment-related advice, not tailored to a specific investment portfolio or the needs of current and/or prospective subscribers. As such, Edison does not offer or provide personal advice and the research provided is for informational purposes only. No mention of a particular security in this report constitutes a recommendation to buy, sell or hold that or any security, or that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1,185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1,185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

General disclaimer and copyright

This report has been commissioned by Target Healthcare REIT and prepared and issued by Edison, in consideration of a fee payable by Target Healthcare REIT. Edison Investment Research standard fees are £49,500 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2020 Edison Investment Research Limited (Edison).

Australia

Edison Investment Research Pty Ltd (Edison AU) is the Australian subsidiary of Edison. Edison AU is a Corporate Authorised Representative (1252501) of Crown Wealth Group Pty Ltd who holds an Australian Financial Services Licence (Number: 494274). This research is issued in Australia by Edison AU and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. Any advice given by Edison AU is general advice only and does not take into account your personal circumstances, needs or objectives. You should, before acting on this advice, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If our advice relates to the acquisition, or possible acquisition, of a particular financial product you should read any relevant Product Disclosure Statement or like instrument.

New Zealand

The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

United Kingdom

This document is prepared and provided by Edison for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "FPO") (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document.

This Communication is being supplied to you solely for your information and may not be reproduced by, further distributed to or published in whole or in part by, any other person.

United States

. Edison relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. This report is a bona fide publication of general and regular circulation offering impersonal investment-related advice, not tailored to a specific investment portfolio or the needs of current and/or prospective subscribers. As such, Edison does not offer or provide personal advice and the research provided is for informational purposes only. No mention of a particular security in this report constitutes a recommendation to buy, sell or hold that or any security, or that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1,185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1,185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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