Civitas Social Housing — Performing well and looking to further growth

Since IPO, Civitas has built a c £900m portfolio of primarily specialist supported social housing (SSH) properties, providing much needed homes for vulnerable young adults. The properties are fully let on long, inflation-adjusted leases and we expect the sector’s historically low correlation to the general economy, or the broader residential and commercial property sectors, to continue.

During the COVID-19 pandemic, the sector proved to be operationally resilient and the fundamental demand for specially adapted, high-quality accommodation has remained strong and even increased as local authorities look to relieve pressure on other care services. The impact of COVID-19 is mitigated by a relatively low average age of residents, less likely to suffer from the types of underlying health conditions categorised as ‘high risk’ by the NHS, and the configuration of much of the modern housing stock, around self-contained apartments and small housing clusters, which supports infection control and management. In the longer term, the chronic shortage of SSH homes is forecast to increase and compared with the alternatives of residential care or hospitals, it is widely recognised to improve life outcomes in a cost-effective manner.

In addition to the continuing strong demand from local authorities for specialised supported housing, the broadening of Civitas’s investment remit approved by shareholders in May has further increased the range and scale of the potential investment opportunities available. The revised investment policy allows the company to enter into long-term lease opportunities with a broader range of counterparties, expanding from the current focus on local authorities and housing associations to include the NHS, major charities and community interest companies. Over the coming one to two years, Civitas aims to position itself as a strategic partner with these to provide a wide range of community-based social assets to meet an expanding range of needs.

With the FY20 annual results at the end of June 2020, Civitas disclosed a pipeline of investment opportunities of c £200m including specialised supported housing investments as well as investments from across its expanded counterparty base. Not included in the c £200m were several large transactions that it had begun to discuss. With the Q221 trading update, Civitas confirmed that active discussions are continuing over the potential acquisition of a range of high-quality existing and new build properties to be acquired at completion without the need for forward financing of the development.

During the first two quarters of the current financial year to 31 March 2021 (FY21), Civitas has completed the acquisition of five properties for an aggregate investment of c £14m (before acquisition costs). The properties had all been contracted for at year end and most significantly include the high acuity, newbuild, state-of-the-art supported housing and healthcare facilities in Wales (£12.1m) as well as smaller properties in Telford and Sunderland. The company has set aside an additional £10m in respect of the Welsh facilities, payment of which is contingent upon certain financial conditions being met. Including the completed acquisitions and annual rent indexation, by the end of Q221 the run-rate of contracted rent roll had reached £50.0m, compared with £48.4m at the end of FY20.

As previously disclosed, the company continues to target £80–120m of additional debt, the upper range of which is consistent with its target gross gearing of c 35% (and a maximum 40%). Gross gearing is defined as gross debt divided by gross assets including the investment properties on a portfolio valuation basis, and it was 26.9% at end-FY20. Current borrowing facilities of £272.5m are fully drawn and free cash resources fully committed. The end-FY20 cash balance of £58.4m roughly breaks down into the c £30m liquidity reserve that Civitas prudently targets and the committed investments (including the contingent payment) that have since completed or are expected to do so before year-end.

The general economic uncertainty created by COVID-19 has slowed discussions with potential lenders regarding the additional debt facilities, with many lenders focused on managing existing exposures to borrowers that were negatively affected, but Civitas says that lending activity is beginning to move forward and that it expects to provide an update in due course.

Clearly, the scale of the investment pipeline, including the large transactions in early stage discussion, would exceed even £120m of additional borrowing, but to be consistent with meeting the gearing targets, acquisitions above this level would require additional equity funding. Given the stable, inflation-indexed nature of the existing portfolio, the benefits of scale and increased diversification (by counterparty, care need, and regulatory regime) that further growth offers, we would expect a good level of investor interest in any equity raising.

As a result of the slight delay in financing we have pushed back some our investment assumptions, deferring rental income, although given the scale of the investment pipeline we have increased our aggregate investment assumption from c £98m (all during FY21) to £115m spread over FY21 and the first half of FY22. Given the company’s comments about the large scale of certain investment opportunities, we would expect additional debt capital to be deployed fairly quickly and we assume £55m (before costs) of investment in H221 (all in Q4 and none in Q321) followed by £60m (before costs) in H221, all at an assumed net initial yield of 5.5% with costs assumed at 6.8%.

To fund the acquisitions we have assumed £100m (within the range of £80–120m the company is targeting) of borrowing from 31 December 2020 (end-Q320) at an assumed cost of c 3%, above the current weighted average cost of debt (2.47% at end-FY20 and we estimate c 2.15% recently based on the three-month Libor rate of c 0.05%) but similar to the current cost of Civitas’s fixed rate debt (c 41% of the total).

Our FY21 forecasts are reduced a little by the delayed borrowing and deployment, but there is very little change to FY22 even though the H122 acquisitions will not contribute for a full year in FY22.

Our FY21 forecasts indicate DPS substantially (c 95%) covered by EPRA earnings. On a run rate basis, the dividend has been fully covered since the beginning of FY21, but this includes the properties on which contracts had been exchanged or where investment had been legally committed; these only contribute partially to FY21. Our FY22 forecast assumed continuing DPS growth (+1.9%) and increasing cover (to 1.06x).

On the company’s basis of measuring gross gearing, we expect c 32% at end-FY22, closer to its medium-term target of c 35%, and our estimate of net loan to value (debt adjusted for cash as percentage of the IFRS balance sheet portfolio value) is c 33%.

Civitas shares offer an attractive 5.0% dividend yield with good visibility of inflation-indexed dividend growth and trade at around NAV. Since IPO in November 2016 the average discount to NAV has been around 3% (Exhibit 4) with a peak premium of c 10%, but the average is reduced by two distinct periods of temporary weakness. The first of these occurred from late-2018 to mid-2019 reflecting initial investor caution in response to increased regulatory intervention in the sector. As the issues became better understood, the share price began to move higher, only for the improvement to be punctuated by COVID-19 fears at the beginning of the lockdown. An appreciation of the critical role that the sector performs, the factors that mitigate the operational risks of COVID-19 and the robustness of rent payments have resulted in the shares recovering.

In Exhibit 5 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, investing in housing and healthcare properties. Civitas shares have outperformed the peer group average, UK property sector and FTSE All-Share Index over the past year, which we believe reflects the stable and growing income stream and a recovery from earlier investor concerns regarding regulatory intervention in the specialised housing association sector. This continuing regulatory scrutiny is aimed at improving corporate governance and/or financial viability of several lease-based specialist supported housing providers and should reinforce the sector’s ability to meet the growing needs of local authorities for additional accommodation. Despite this strong share price performance, the shares continue to offer an attractive yield, with a growing dividend that we expect to be fully covered, while continuing to trade at a small discount to NAV. Performance during the pandemic has demonstrated the resilience of the sector and the business model.