Civitas Social Housing — Growing portfolio, dividends and social impact

Civitas invests in specialist social housing (SSH) assets, fully let on long inflation-adjusted leases (more than 24 years) and providing strong visibility of contractual income with a low historical correlation to general economy, or residential or commercial property. Its investment objective is to provide an attractive level of income, together with the potential for capital growth. The company also delivers a strong positive social return, providing much needed private investment capital to housing associations/registered providers (RPs) so that they may provide and manage additional, care-based quality accommodation to some of the most vulnerable in society. The chronic shortage of SSH homes, increasing demand and the wide acceptance that SSH represents value for money while improving lives are all positive indicators for further growth.

Since IPO, Civitas has generated an average annualised EPRA NAV total return of 7%, after the property acquisition costs incurred in growing the portfolio. Long leases are CPI inflation adjusted, providing strong visibility of contractual income. On the assumption of flat property valuation yields, rent indexation should also support NAV growth. Based on targeted quarterly DPS payments amounting to 5.34p for the current financial year, Civitas offers a prospective yield of almost 7% while trading at 0.74x the end-FY19 EPRA NAV per share of 107.1p. Compared with a peer group of long income investors in social housing/healthcare assets, the Civitas yield is above average (peer group average 5.1%) and the P/NAV is well below average (peer group average 1.06x). A number of investor concerns, primarily regarding the strength of the housing association covenant, appear to have negatively affected the share price and are explored in detail in this note. The SSH contractual structure is complex, and we conclude that it is the quality and location of the assets, their suitable adaption to the long-term needs of the tenants, rents being at an appropriate level and the growing demand for SSH that provide the effective security to Civitas’s long-term income.

We forecast a continuation of strong income growth as FY19 acquisitions make a full year contribution and Civitas continues to gear its existing equity base towards its 35% target (end-FY19 22%). We assume £170m of additional acquisition investment in the current year at a gross yield of 5.7% before acquisition costs (5.4% after), slightly lower than the historical range of 5.5–6.5% reflecting the strength of investor demand for the asset class. Scale economies and a revised investor advisor fee base (a cost saving of c £400k pa) should further contribute to earnings growth, with the total expense ratio reducing towards 1.3%. The company targets aggregate quarterly DPS payments in the current year of 5.3p, a 4.3% increase over FY19. We forecast further growth in FY20, with the DPS well covered by diluted EPRA earnings.

The assets that Civitas invests in are fully let on long leases, with the income to pay the rents funded 100% by government via local authorities and a low historical correlation with the general economy or the wider residential or commercial property sectors. On page 18, we identify the following key sensitivities to our forecasts and the company’s outlook:

Civitas Social Housing (Civitas) is the leading listed UK social housing REIT with the investment objective of providing an attractive level of income, together with the potential for capital growth from investing in a diversified portfolio of fully developed and let social homes, particularly specialist supported housing (SSH) for vulnerable adults. The company is externally managed by Civitas Housing Advisors, whose growing team brings significant direct experience in social housing, healthcare and fund management. Civitas aims to deliver positive financial returns for investors by targeting assets that benefit from inflation-adjusted, long-term leases, with a low historical correlation to the general economy, or residential or commercial property. It also delivers a positive social return, providing much needed private investment capital to housing associations so that they may provide and manage additional, care-based quality accommodation to some of the most vulnerable in society, improving tenant life outcomes in a cost-effective manner. Social impact reports are published twice yearly by the company, the most recent in June 2019.

The company was admitted to the premium listing segment of the Official List of the London Stock Exchange in November 2016, when it raised an initial £350m in an oversubscribed IPO. Reflecting the strength of investor demand and the scale of the market opportunity available to the company, a further £302m was raised in November 2017 through the issue of C shares, converted into new ordinary shares in December 2018. In September 2018 the shares were included in the FTSE EPRA NAREIT Global Real Estate Index.

Since IPO, Civitas has invested more than £750m (before acquisition costs) and has equity resources to increase this to c £1.0bn at the company’s target leverage ratio of 35%, with ample opportunities for further growth beyond this. There is a chronic and growing shortage of accommodation across all forms of social housing, to which registered providers (RPs), in particular housing associations (HAs), are seeking to respond, increasingly supported by the private sector capital that long-term investors like Civitas can provide.

Initial investment has focused on SSH, providing suitably tailored accommodation for those requiring high levels of care and support for needs typically related to mental, physical and learning disabilities or autism, and for whom the alternative would often be care homes or long-stay hospitals. SSH properties are let by Civitas to HAs on full repairing and insuring, CPI-linked leases, with an average maturity of c 25 years, and typically the rental income received by the company is paid directly to the HAs by central government or local authorities. The company plans further growth in SSH and a broadening of the portfolio exposure to include other areas of government-sponsored housing serving tenants with needs such as homelessness, addiction, or providing NHS step-down or key worker accommodation. This may further diversify the lease base to include charitable and voluntary organisations, while geographically the company is also looking to expand its footprint from England & Wales to the other parts of the UK. The company may at some future date seek to complement its portfolio of SSH by acquiring portfolios of general needs social housing, although given the continuing opportunities in the former we believe this unlikely in the near term.

The sector is regulated by the government-sponsored Regulator of Social Housing. Regulation has played an important role in providing long-term stability to the social housing sector, and while individual registered providers have from time to time faced financial difficulties, there have been no material losses suffered by funders as a result of a registered provider default. We believe that current regulatory interventions in the fast developing SSH segment are primarily aimed at safeguarding this financial resilience and maintaining the operational standards of the sector (see page 11).

Overall management and supervision of Civitas is provided by the independent board, consisting of four non-executive directors. The chairman is Michael Wrobel who, with more than 30 years of experience in the investment industry, has held senior positions in the investment management industry, has served as a director of various investment trusts, is a pension fund trustee and a former director of the Association of Investment Companies. The other directors are Alastair Moss, Peter Baxter and Caroline Gulliver, who collectively bring extensive experience in areas such as property law, investment management, accountancy, local government, social housing and charities, and listed investment company boards. Detailed biographies can be found on the company’s website.

To provide investment advice, and manage the property portfolio and day-to-day activities of the company, the board has appointed Civitas Housing Advisors (CHA) as investment adviser. Led by CEO Paul Bridge, CHA brings together a growing, specialised team with significant experience in social housing, healthcare and fund management. With more than 20 years’ experience working at a senior level in the social housing sector, Paul Bridge is a leading industry figure. He was previously CEO of Homes for Haringey, a large registered provider, and is non-executive chairman of the Metropolitan Thames Valley housing association. During the past year CHA has continued to strengthen its team and further widen its skills base, reflecting its view that supported housing for working age adults with long-term care needs is both an important component of the social housing sector and a long-standing core part of the healthcare pathway in the UK.

We believe that CHA’s industry knowledge and relationships are important factors, not only in managing the Civitas portfolio but also in sourcing investments, particularly in less competitive off-market transactions. CHA is also actively engaged with the regulator and its housing association partners, helping the latter to develop and mature, in support of both the company’s financial and social impact goals.

The advisory fees payable to CHA are calculated quarterly, based on net assets, with a tiered structure under which the marginal advisory fee reduces with increasing net assets. This increases the potential for scale economies and increases the attractiveness of asset growth for shareholders. There are no other transaction fees or performance fees payable to CHA. Up until 26 April 2019, the ‘portfolio basis’ net asset value (explained in the financial section on page 15) was used to calculate the fees. However, at the same time as extending the initial investment advisory contract notice period that had been in place since IPO, to 30 May 2024 from 30 November 2021, the board agreed with CHA that the advisory fees would in future be based on the IFRS measure of net assets. At 31 March 2019, IFRS net assets were £666.5m, approximately 10% lower than net assets measured on a portfolio basis (£741.2m) and the manager indicates that the change represents an annual cost saving to the company of c £400k.

Although it has not been used, shareholders have granted the board authority to repurchase up to 15% of the share capital in the market if they believe it to be an appropriate mechanism for correcting any imbalance between supply and demand.

The company will hold a continuation vote at the AGM following the fifth anniversary from admission, which will be in 2022, and every fifth anniversary thereafter.

Social housing1 is low-cost rented housing, and in some cases low-cost home ownership, for those who lack the financial resources to access the private market. The social housing sector is large, but a chronic shortage of affordable housing means that it remains in high demand. The current stock of social homes for rent in England is more than 4.0m units (source: Full Fact), down from around 5.0m units in the early 1980s, but still represents almost one in every five homes. Of the total, c 2.8m are provided by housing associates and the balance by local authorities, a share that has declined steadily. The housing charity Shelter estimates that well over a million families are stuck on local authority waiting lists in England alone, the majority for more than a year, and more than a quarter for more than five years. Social housing may be provided at ‘affordable rents’, typically around 80% of the open market level, or ‘social rents’, typically 50% or less of open market levels and aimed at those with the greatest need. In recent years, the overall supply of newly built social housing has been in the range of 40,000–60,000 homes per year, with the majority provided at the higher-end affordable rents. Homes built for social rent have recently fallen to very low levels (c 5,000 homes in 2017/18), despite representing the larger share of the rented stock.

The majority of social housing is termed ‘general needs’ and may be occupied by anyone who meets the allocation criteria of the local authority or housing association provider.

In the broad social housing sector, supported housing provides housing, support and care as an integrated package, on either a long-term or short-term basis, to meet a range of needs. This may be provided across a number of different housing types, including group homes, hostels, refuges, supported living complexes and sheltered housing. The aim is to allow those in need of supported housing to live as independently and inclusively as possible within their community. Estimates vary slightly, but at any one time around 700,000 people across the UK rely on supported housing, which means that around 14% of all UK social housing is represented by supported housing. The majority of those in supported housing are the elderly, but for those with certain special care needs, this may be provided within a specific type of social housing, known as specialist supported housing (SSH). SSH is specifically designed or adapted for people who require specialised services to enable them to live as independently as possible, as an alternative to a care home but with a similar level of support. Those living in SSH represent around a quarter of the c 700,000 living in supported housing, typically including those whose needs are long term or lifelong, and relating to mental, physical and learning disabilities, autism, domestic abuse, substance abuse and homelessness.

All funding for approved SSH comes from central government and is distributed via the local authorities that commission the services. SSH provision is therefore not reliant on the level of local authority funding. An important distinction of SSH is that the level of rent is set on a bespoke basis according to individual needs and is exempted from the social rent rules that normally apply to housing benefit awards. This exemption was created by legislation in 1996 and so SSH has been around for more than 20 years. In order to fall within the exempt rent legislation, SSH homes must fulfil a number of criteria including the following:

The cost of supported housing is higher than for general needs social housing, but there is broad agreement that it generates substantial cost savings in other parts of the public sector, while at the same time provides a real improvement in the quality of life of recipients. Research, including the government’s own data, shows that at a time of increasing demand for SSH, it is a cost-effective way of providing homes for people compared with the likely alternatives of residential care or long-stay hospitals.

There are many factors that contribute to the additional costs that are related to the highly specialised nature of the accommodation compared with general needs. These may include the need for 24-hour staffing, the installation and monitoring of CCTV, the need for and monitoring of enhanced fire and safety equipment, bespoke adaptions and/or construction design, higher levels of wear and tear, and the long lead time often needed to securely place tenants.

Government data (from Future of supported housing, May 2017) estimates that for working age people (ie excluding the elderly), the average rent cost in supported housing was £214 per week, ranging from an average £133 per week for people with a physical disability to an average £277 per week for women’s refuges, with average weekly rent costs for people with learning disabilities and autism sitting somewhere in between. The Minister for Local Government at the time estimated the net savings generated by supported housing at an annual £3.5bn.

Mencap commissioned research (Funding supported housing for all, April 2018), which estimated the average rent cost of SSH housing (including the service charges) at £232 per week within an overall average weekly cost of SSH (including the cost of the care package at an average £1,337 per week) at £1,569. This compared with its estimate of the average cost of registered care (residential care) at £1,760 per week or £3,500 per week for in-patient hospital care. Its findings are consistent with National Housing Federation data, which estimated the annual saving resulting from SSH for people with learning difficulties and mental disabilities at £15,500 or c £300 per week.

The ability of registered providers to charge higher rents than are available for general needs social housing continues to be an important factor in making SSH schemes viable and increasing provision. It has also enhanced the flexibility of RPs and charities to develop innovative ways of meeting the needs of those with a broader range of bespoke requirements for other forms of supportive housing and care needs. The government has considered the existing framework of funding, seeking to ensure that this is sustainable, ensures quality, provides value for money and encourages the supply of supported housing. In August 2018, a consultation process on possible alternative funding options concluded with the recognition that supported social housing is a vital service for some of the most vulnerable people in our communities and that housing benefit should remain in place for all supported housing.

SSH expected to grow further

It is widely expected that the demand for SSH will continue to increase, driven by greater penetration of the existing population in need, and the further growth of that population.

At both the national and local level it is government policy to offer SSH to more people. In part, this reflects the value for money that it provides compared with the alternatives of residential care or long-stay hospitals, a consideration that is not simply cost related, but also recognises the enhancement to quality of life that SSH can provide. More than 2,000 people with autism or a learning disability are still living in long-stay hospitals, and although the NHS is committed to halving this number progress has been slow. Despite a steady flow into community based SSH, the hospitals quickly refill due to the shortage of alternative provision relative to the demand. Mencap estimates that c 50% of people with a learning disability live with a parent or some other home carer over the age of 65. As this group of carers ages and becomes less able to perform this role, the demand for alternative housing increases. At the same time, as advances in medical care, and in particular post-natal baby care, have improved infant survival rates, the size of the population living with life-long medical and care needs is increasing, and these people are themselves living longer.

Although not directly comparable, the expectation of increasing demand for SSH is clear from available research. The Mencap-commissioned research estimated the total number of SSH units at 22,000–30,000, with an expectation that the demand will increase to 25,500–33,500 units by 2021/22 and 29,000–37,000 units by 2027/28. In a December 2015 research paper (Supported housing: Understanding need and supply), the National Housing Federation estimated a then shortfall of c 16,000 homes, with an expectation that this would increase to c 29,000 by 2019/20 and to c 47,000 by 2024/25.

As noted above, all funding for SSH housing falling within the exempt rent legislation comes from central government via the local authorities that commission the services. The local authority enters into a care contract with the chosen care provider (CP), which includes a personal care agreement for each tenant. In turn, the CP enters into a service level agreement with the RP/HA, which secures it with access to, and management of, the property. In terms of the funding disbursed by the local authority, the care costs are paid directly to the care provider, while the rent and property service charge payment are made by the local authority directly to the RP/HA (ie not to the CP or to the tenant). Typically, there are arrangements in place (and Civitas insists on this) whereby the CP will cover the cost to the RP/HA of voids (empty properties), discussed below.

Although the contractual structure shown in Exhibit 2 is somewhat complex, Civitas indicates that most local authorities favour a clear separation between the RP, CP and long-term property owner. In a situation where the CP is also the property owner, it is much more difficult for the local authority to replace them should it choose to. In part due to local authority encouragement, CPs have been divesting properties, in some cases to Civitas.

Property investors such as Civitas are not contracted directly with either the local authority or the CP. Instead, they lease the properties to, and receive the rent from, the RP/HA, usually on long leases (in Civitas’s case, c 25 years at inception). There has been quite a lot of discussion about the difference between the length of the typical lease agreement between the RP/HA and the property owner and the typically shorter length of the service level agreements between the CP and the RP/HA (commonly five years). The concern is that a change of CP may see the RP/HA lose tenants and rents to meet their longer-term lease obligations. Civitas believes that this is a very unlikely scenario but one for which it has been working to provide contractual safeguards, better matching the duration of service level agreements with leases. It notes that:

Managing voids

The Civitas properties are fully let to HAs and so voids do not directly affect rental income. For the HAs, tenant voids do occur despite the shortage of supply of home spaces. There are a number of reasons for this, including the fact that it may take up to a year to fill a newly opening home for clinical reasons, transfers from long-stay hospitals are complex and subject to delays, setting up individual care packages can take time, and introducing a compatible new tenant into a vacancy in an existing home needs to be handled with care. The level of voids can vary quite markedly depending on the clinical need and tends to be longest for people with learning disabilities. In most cases, the voids experienced by the housing associations are covered by the care provider, although this may not be the case if it arises through poor management (eg if the property is unavailable because the housing association has failed to maintain a valid gas safety certificate). We discuss below how Civitas works closely with its housing association partners to support their development and the spread of best practice. Minimising uncovered voids is good for the HAs and hence good for Civitas. Management says that it is currently receiving rents from housing association lessees in respect of void properties on 6% of the total portfolio.

The Civitas portfolio has grown strongly and steadily since IPO, with £758m (before acquisition costs) having been committed as at 31 March 2019. The properties have been acquired from HAs, CPs, developers or private owners at yields ranging from 5.5–6.5%. Civitas only invests in completed properties and does not engage in development or the forward funding of developments. Civitas says that developers are often encouraged to approach it with completed properties by local authorities that are keen to have evergreen social impact funds invested in them. It also notes that CPs welcome the certainty that a well-resourced investor brings to the process. Civitas has established strategic relationships with some of the largest CPs, which often have a strong influence over where tenants are placed, given that the care element of SSH costs represents c 85% of the total (ie rent and service costs a more modest c 15%).

Assets are selected through a rigorous process aimed at building a portfolio that will sustainably deliver on its investment objectives over the long term, and it is worth noting that the company has reviewed and rejected potential acquisitions with a value of more than £400m since IPO. The most common reasons for a property being rejected is that the level of rents (relative to the care provided) is above the median level that Civitas targets, because of the condition of the property or because the property does not meet the company’s social impact hurdles.

Reflecting increases in asset values since acquisition, the balance sheet portfolio value at end March 2019 was £820m, with a contracted annualised rent roll of £45.7m and a long weighted average unexpired lease length of more than 24 years. The portfolio comprised 591 individual properties, fully let to 15 different registered providers that manage SSH homes for more than 4,000 tenants on behalf of 157 different local authorities, around half of the total in England and Wales. The UK market for SSH is very fragmented and although Civitas is the leader in terms of portfolio size, management estimates that its 4,000 plus tenants still only represent around 2.4% of the market total. This provides Civitas with ample scope to increase market penetration, as well as growing with the market. The average age of a tenant in a Civitas-owned property is 32, which suggests they may be living in those properties for many decades to come.

The portfolio is geographically diversified around major conurbations, with around one-third of the properties being purpose built or repurposed and two-thirds being well located community properties which have been adapted on a bespoke basis for long-term use by residents. The list of HAs with which Civitas has chosen to work has steadily increased, providing further diversification. The aim has been to establish a registered management counterparty in each area and to have several others in reserve to provide for contingencies.

The five main areas within social housing targeted by Civitas are:

In practice, many residents have been diagnosed with more than one care need, reflected in the size of the multi-diagnosis category in Exhibit 7.

Key factors in sustainability

In building a sustainable portfolio, Civitas highlights three core features:

Sector regulation has historically provided stability

The Regulator of Social Housing (RSH) regulates registered providers of social housing (RPs) to promote a viable, efficient and well-governed social housing sector able to deliver homes that meet a range of needs. Civitas’s housing association tenants are regulated by the RSH but Civitas is not, although it interacts with the RSH on a regular basis. Regulation has played an important role in providing long-term stability to the social housing sector, and while individual registered providers have from time to time faced financial difficulties, there have been no material losses suffered by funders as a result of a registered provider default.

Although exempt social housing has been around for 25 years, over the last few years private capital has played an increasingly important role in supporting the much-needed growth and sustainable development of the SSH sector, filling the gap created by the limited availability for all forms of social housing. The capital has been provided by a range of funds and other investors in SSH assets, which are then made available to housing associations on long leases, typically indexed to CPI. Given its greater complexity and granularity, and the continuing strong demand for general needs social housing, SSH has not generally been the focus of the longer established HAs and sector growth has been led by 40–50 more specialist HAs that have been established in the past 10 years or so. These have typically utilised lease-based structures to provide the capital for growth and, in many cases being newer and smaller associations, inevitably have relatively thin capital bases and less sophisticated management and governance structures.

In early 2018, one of these newer entities and a significant lessee of Civitas properties, First Priority Housing Association, became financially distressed. Its leases, including those with Civitas, were reassigned on similar terms to other providers within a few weeks, with no material loss incurred by capital providers (see comments in financial section). However, in the aftermath the regulator has been engaging with other specialist SSH HAs with similar lease-based business models to establish whether the issues at First Priority are replicated elsewhere. As a result of this work, the regulator has raised a number of concerns and has published regulatory judgements and notices in some specific cases, primarily in relation to corporate governance and/or financial viability (see Appendix for description of the regulatory process).

Exhibit 8 provides a summary of the five regulatory judgements and notices to date in respect of Civitas lessees. In aggregate these account for 40-50% of the Civitas portfolio.

More specifically, the four key concerns raised by the regulator are:

We believe that current regulatory interventions in the fast developing SSH segment are primarily aimed at identifying, assessing and making clear the risks so that these may be adequately managed as a means to safeguarding this financial resilience and maintaining the operational standards of the sector. Significantly, in a recent seminar hosted by Civitas, the regulator recognised the important role played by private capital in supporting the much-needed growth and sustainable development, and commented that he saw no inherent issues with the lease-based model. It is important to note that Civitas continues to operate as normal with its HA partners that are subject to regulatory notices and judgements, and that there have been no material impacts on its ability to collect rents due, but is engaging with them to help effect any changes that may be necessary to allay the regulator’s concerns.

Civitas is highly experienced in the social housing sector and fully understands the challenges that its specialist SSH HA partners face as they seek to grow and respond to the SSH shortage. It engages frequently with them, helping them to develop and mature, in support of both its financial and social impact goals. Civitas also has regular engagement with the RSH and is sponsoring industry-wide initiatives to support continued growth while managing risks. Alongside the voluntary seminars for the housing association partners, the more formal hands-on monitoring of the portfolio involves quarterly meetings with each partner. These are led by senior members of the Civitas team, who visit the HA on the ground, meeting the managers, board and also the care providers, inspecting properties and reviewing performance against KPIs. As a result of this active engagement, Civitas has provided support in areas such as recruiting new board members to strengthen corporate governance, compliance with health and safety requirements, and asset management. Attracting new independent members to strengthen and broaden the boards of smaller housing associations is no easy task, but one where Civitas can make a real difference to addressing regulatory corporate governance concerns. At a general level, Civitas is looking at ways that the lease structure may evolve to provide more tangible evidence of the sustainability of the SSH model. This includes:

Civitas has recently sponsored the formation of a new community interest company as the first unitary overarching body that can represent SSH, bringing together its multiple facets spanning health, social policy, housing policy and welfare. It is also working with Learning Disability England to establish a new trade body that will promote the benefits of SSH including the cost savings to the public sector and social benefits that it delivers, and will seek to build on these through the sharing of skills and knowledge and the spread of best practice across the sector.

In this section we first discuss the progress reflected in the FY19 results, before outlining our forward-looking financial forecasts in detail.

FY19 results reflect strong portfolio expansion

The FY19 results reflect the continuing growth in the company’s asset and income base. During the year, £286m (before acquisition costs) was committed to acquisitions, including investment of the C share proceeds, with conversion taking place at the end of November 2018 and leading to the creation of 272.5m new ordinary shares.

The key financial highlights were:

The IFRS financial statements include an independent property valuation, undertaken by JLL, with each property valued on an individual basis, of £826.9m as at end-FY19, reflecting a net initial yield (NIY) of 5.27%. Also undertaken independently by JLL, Civitas provides an independently assessed ‘portfolio valuation’ of £901.6m, which assumes that each of the property-owning special purpose vehicles (SPVs) are sold as a portfolio to a third-party buyer on an arms-length basis. It is intended to provide shareholders with an indication of the enhanced value of the properties to acquirers of larger portfolios and the £74.7m, or 9%, uplift against the IFRS valuation reflects the assumption of lower buyers’ costs for the SPVs (with stamp duty being charged at 0.5% compared with 5.0% for the individual properties) and a lower NIY of 5.0%. The gap between the IFRS valuation and the valuation on a portfolio basis widened during FY19, reflecting portfolio growth and also the positive impact of that growth on the portfolio basis yield. The portfolio basis valuation feeds directly into a portfolio basis net asset value, which at 31 March 2019 was £741.2m compared with £666.5m on an IFRS basis. The company’s 35% gearing target is defined as gross debt as a percentage of the portfolio basis property valuation (before straight-line and lease incentive adjustments), although for sector comparative purposes we use IFRS portfolio value.

We expect further strong growth in income-earning property assets as Civitas further gears up its existing equity resources and given the scale of the opportunity. Our analysis confirms the company’s guidance that it expects dividends to be more than fully covered on a fully invested basis. Our key forecasting assumptions are:

With the full year results release, Civitas has updated on its acquisition pipeline which provides comfort that our assumed acquisitions are achievable. Properties with an aggregate value of c £50m are under negotiation and a further pipeline of c £210m in advanced stages of due diligence.

Civitas has existing debt facilities of £212.5m, of which £208.4m was drawn at end-FY19. The facilities comprise a £52.5m 10-year fixed rate facility and two floating rate revolving credit facilities of a shorter-term nature. Based on a three-month Libor rate of 0.84% at 31 March 2019, we estimate the average cost of the facilities at 2.5% with a weighted average unexpired term of a little over five years. All covenants on the facilities were comfortably met during the year.

In order to grow the portfolio further and achieve its target rate of gearing, Civitas is currently negotiating additional borrowing facilities amounting to £170m and expects this to also increase the overall term of its debt. We have allowed for this in our forecasts, assuming it is fully drawn by the end of FY20 and that it carries interest at 2.6%.

Based on targeted quarterly DPS payments amounting to 5.34p for the current year, Civitas offers a yield of almost 7.0% while trading at 0.74x the end-FY19 EPRA NAV per share of 107.1p.

We calculate an EPRA NAV total return since the 18 November 2017 IPO to 31 March 2019 of 17.4%, or an average annualised 7% pa. As we expect the company to hold its investment properties for the long term, we believe it more relevant to focus on the IFRS data for this purpose. Our forecasts for FY20 and FY21 imply an average annualised return of 6.8% pa over the period, with FY20 held back slightly by assumed property acquisition costs on the £170m of assumed investment in the year, before increasing to 8.1% in FY21, with a forecast CPI rental income uplift of 1.8% feeding through to capital values on the assumption of an unchanged property yield.

In Exhibit 12 we show a share price performance and valuation comparison with a group of companies that we would consider to be the closest peers to Civitas. The group includes Triple Point Social Housing and Residential Secure Income, which invests in affordable shared ownership, retirement and local authority housing (but not specialist supported housing), primary healthcare investors, PHP and Assura, and care home investors, Target Healthcare and Impact Healthcare. The peers are all focused on stable, growing, income returns, with the potential for capital appreciation, from investment in properties let on long leases to tenants whose income is provided, to differing degrees, by government funding. However, the peer group remains quite differentiated in terms of lease terms, which will naturally influence valuation levels. UK primary healthcare leases benefit from the security of being directly or indirectly backed by government, although the majority of rents are subject to open market rent reviews rather than being indexed to inflation. For the care home investors, the lease counterparties are the care home operators, and rents are generally linked to RPI.

The regulatory intervention in the SSH market has clearly affected the Civitas share price performance and hence the valuation of the company. The prospective yield of 6.8%, with DPS well covered as capital resources are fully deployed, is the highest in the group, and P/NAV is the lowest. If investors become more confident about the robustness of the Civitas income stream, the potential for a re-rating is significant.

We believe the issues raised by the regulator in the light of the First Priority failure have had a significant impact on the performance of Civitas shares, and the other investors in the social housing sector. Given the importance of long-term income visibility, this is understandable. The complex nature of the SSH contractual structure is also a factor contributing to investor uncertainty. We believe that it is the quality and location of the assets, their suitable adaption to the long-term needs of the tenants, rents being at an appropriate level and the growing demand for SSH that provide the effective security to Civitas’s long-term income.

As noted above, the specialist supported housing assets in which Civitas invests, fully let on long leases, with the income to pay the rents funded 100% by government via local authorities, have a low historical correlation with the general economy or the wider residential or commercial property sectors.

We see the key sensitivities as:

The Regulator of Social Housing (RSH) regulates registered providers of social housing (RP) to promote a viable, efficient and well-governed social housing sector able to deliver homes that meet a range of needs. RSH is an executive non-departmental public body, sponsored by the Ministry of Housing, Communities & Local Government. Civitas’s housing association tenants are regulated by the RSH but Civitas is not, although it interacts with the RSH on a regular basis.

In summary, the objectives of the RSH are to:

The RSH sets out the regulatory standards and it is the responsibility of the RPs to ensure that these are met, and for being open and honest with the RSH about how they are meeting objectives. The RSH primarily looks to the RPs to identify any problems and take the necessary action to resolve these. Where this is the case and the RSH concludes that the RP can satisfactorily respond to the problems, it will work with the provider to help it deliver the necessary corrective actions. Where an RP is unable or unwilling to respond positively, the RSH may use its regulatory enforcement and general powers. Where the RSH has very serious concerns about the financial strength of an RP, or where tenants are at risk, it has a range of intervention powers to protect the interests of those tenants and maintain the social housing assets in the regulated sector. The regulator may also facilitate discussions between a failing RP and a financially stronger RP which may be able to help, although any decision to offer or receive financial support is a matter for the boards of the respective RPs.

The RSH is risk-based in its regulatory approach, using its sector risk analysis and assessments of RPs with 1,000 or more social housing units to identify those judged to be more complex and which consequently have an increased level of risk exposures. RPs with fewer than 1,000 social housing units are subject to a lower level of regulatory engagement, and many of the SSH providers fall into this category. A sector risk profile is published annually and it can help registered providers to manage risks effectively. With the last published sector risk profile in October 2018, the RSH said that it would publish an addendum report on SSH in due course, in view of the growth of the SSH subsector and the earlier First Priority failure. This report was published in April 2019.

The regulatory judgements and notices that are published by the RSH represent its official view of an RP’s compliance with the governance and the viability requirements in the Governance and Financial Viability Standard. Regulatory notices are issued in response to an event of regulatory importance (for example, where it is found to have breached a consumer standard that has or may cause serious harm) that it needs to make public. Although regulatory judgements are not published for RPs with less than 1,000 units, the RSH may publish a regulatory notice if there is evidence that such a provider is in breach of an economic standard, or it finds serious detriment as a result of a breach of a consumer standard. Where the RSH is investigating a matter and it considers that the investigation might result in a provider (currently judged to be compliant) being reassessed as non-compliant in relation to the economic standards, the RSH will add it to its ‘gradings under review’ list. The purpose of the list is to alert stakeholders to the possibility that the provider may be moving towards non-compliance with a standard, in line with its obligations to be transparent. Once the investigation concludes, it publishes a new or updated regulatory judgement for the provider and removes it from the ‘gradings under review’ list.