Civitas Social Housing — Positive outcomes drive consistent returns

Throughout the pandemic, Civitas has demonstrated its ability to deliver consistent and attractive financial returns for its shareholders while continuing to deliver a strong positive social return, providing much needed private investment capital to support the delivery of care-based community housing for some of the most vulnerable in society. From IPO in November 2016 to 31 March 2021 (end-FY21) Civitas has generated an aggregate net asset value (NAV) total return of 29.6% or an annual average 6.1%. Dividends have increased each year since IPO and represent two-thirds of the total return in the period. This strong performance reflects the vital role of portfolio properties in the provision of an essential service, secured by long-term lease and care arrangements, creating good visibility of income with little direct correlation to the wider property market or economy, capable of delivering stable inflation-indexed dividend growth.

Earnings growth since IPO has been driven by acquisitions, rent increases indexed to CPI inflation and economies of scale reflected in a steadily reducing EPRA cost ratio. We expect this trend to continue and is reflected in our FY22 and FY23 forecasts. In addition to the £22.0m of committed investment announced in Q122 we assume £50m (before costs) of additional commitment as the company continues to deploy the c £85m proceeds of the M&G debt facility. This represents just a part of Civitas’s substantial pipeline of investment opportunities, amounting to over £200m, of which a significant part is under active discussion. Taking full advantage of what we believe to be an accretive further opportunity will require additional capital, both equity and debt.

The targeted 5.55p aggregate FY22 DPS represents a prospective yield of 4.8%, supporting the c 7% premium to end-FY21 net assets per share, with good prospects for inflation-linked dividend growth. Compared with its closest peers (Exhibit 16), investors in social housing and healthcare, Civitas shares trade at a similar yield to the average and lower P/NAV. With performance during the pandemic demonstrating the resilience of the sector and the business model, we consider that Civitas offers an attractive yield while also delivering a material social benefit. The latest social impact report prepared by The Good Economy estimates that Civitas’s portfolio generated a total social value of £127.0m during FY21, including £75.9m of fiscal savings for public budgets and £51.2m in respect of social impact through improved outcomes for residents.

Long, inflation-linked leases provide considerable visibility of contractual rent income, while the rents of those living in homes that meet the criteria for SSH are funded by central government and paid via local authorities directly to the housing providers that lease the properties from Civitas and manage them. SSH is an essential service and demand is not directly linked to the economy; as a result, the asset class is little correlated with the broader residential and commercial property sectors. On page 15 we identify the key sensitivities to the company outlook as:

Civitas invests across the UK in care-based community housing and healthcare facilities for the benefit of working aged adults with long-term care needs. It is externally managed by Civitas Investment Managers (CIM), whose growing team brings significant direct experience in social housing, healthcare and fund management. Civitas shares are a constituent of the FTSE EPRA NAREIT Global Real Estate Index.

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 measurable positive social return, providing much needed private investment capital to approved providers0F1 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.

Since the company’s IPO in November 2016 portfolio growth has been focused on SSH for vulnerable adults with complex care needs. A broader investment remit in place since May 2020 will see future investment additionally targeted at a wider range of lease counterparties, meeting a broader range of care-based needs, including homelessness, addiction, and NHS step-down. In all cases, Civitas acquires the properties and leases them to housing providers to manage.

There is a chronic shortage of all forms of social housing including SSH, and it is widely expected that the demand will continue to increase 1F2, driven by greater penetration of the existing population in need and the further growth of that population, primarily driven by improved post-natal care and increased life expectancy. 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. Nonetheless, recent data from Mencap point to the fact that around half of individuals with long-term care needs live with elderly parents and will increasingly be in need of alternative support; that more than 3,000 individuals with a learning disability are currently placed in inpatient units, often far away from family; and that 82% of local authorities have a shortage of suitable housing for adults with a learning disability. For investors requiring more information regarding the SSH market, our detailed initiation note can be found here.

Up to 31 March 2021 (end-FY21) Civitas had deployed £803m of capital, at an average purchase yield of 5.84%, into a portfolio of 619 properties that were independently valued at £916m, reflecting a net initial yield of 5.24%. The properties were let to 16 different approved providers on long leases (a WAULT2F3 of 22.6 years), providing homes for almost 4,300 individuals, receiving an average 43 hours per week of care from 118 different care providers. Around a third of the homes acquired by Civitas have been homes brought into the sector for the first time, adding much needed new capacity, and with growth, Civitas has achieved economies of scale, reflected in a steadily declining EPRA cost ratio. We forecast the cost ratio to decline further as available capital is deployed.

Civitas has consistently delivered positive total returns3F4 each quarter since IPO. With operational and financial resilience continuing during the pandemic, rents have continued to be received in full, quarterly dividend payments have been uninterrupted, and there has been no discernible impact on portfolio valuations. This strong performance reflects the vital role of portfolio properties in the provision of an essential service; secured by long-term lease and care arrangements; providing good visibility of income with little direct correlation to the wider property market or economy; and capable of delivering stable inflation-indexed dividend growth. The impact of COVID-19 infection has been low within homes, reflecting the relatively low average age of residents (an average of 32 years), 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. Further insulating the approved provider lessees from the pandemic impact, the care provider generally takes responsibility for voids (unoccupied units) and pays for all of the personal healthcare equipment required by residents, for which it is paid by local authorities.

From IPO in November 2016 to 31 March 2021 (end-FY21) Civitas has generated an aggregate NAV total return of 29.6% or an annual average 6.1%. Dividends have increased each year since IPO and represent two-thirds of the total return in the period. The slight slowdown in FY21 total return (5.4%) primarily reflects the relative pause in portfolio growth, partly due to the pandemic but also the time taken to put in place additional long-term borrowing facilities.

Alongside the financial results Civitas published the latest, and fourth, independent social impact report on the company, prepared by the specialist social impact consultancy, The Good Economy. The report confirms that Civitas continues to be an authentic ‘impact investor’ in accordance with the International Finance Corporation (IFC) operating principles4F5 and is proactive in its approach to asset management, taking well defined steps to improve the quality of existing homes, especially in terms of improving environmental performance. It estimates that Civitas’s portfolio generated a total social value of £127.0m during FY21, including £75.9m of fiscal savings for public budgets and £51.2m in respect of social impact through improved outcomes for residents, and that Civitas generates £3.51 of social value is created for every £1 of annual investment.

The fiscal savings arise from the lower cost associated with SSH compared with the alternatives of residential care or long-stay hospitals. Mencap-commissioned research (Funding supported housing for all, April 2018), estimated the average rent cost of SSH accommodation (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.

As part of its broader environment, social, and governance (ESG) focus, Civitas has set the goal of becoming carbon neutral across its portfolio by 2030, although the timing of this being achieved partly depends on developments in the availability of government grants. The company recently entered into a national framework agreement with E.ON, one of the UK’s leading energy providers, to undertake environmental enhancements aimed at improving energy efficiency and reducing carbon emissions across the portfolio. The initial focus will be on 55 properties within the portfolio that have lower EPC ratings, building on successful pilot projects that Civitas and E.ON have already undertaken, including the installation of solar panels and air source heat pumps.

Overall management and supervision of Civitas is provided by the independent board, consisting of five 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, Caroline Gulliver and Alison Hadden, 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.

The external investment adviser is CIM, an impact investor focused on community-based assets that can deliver sustainable returns and positive social outcomes. CIM is led by its founder directors and brings to Civitas a growing, specialised team with significant experience and a proven track record in social housing, healthcare and fund management. In our view, CIM’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. During the past year CIM has recruited additional experienced staff to provide a detailed control framework for the Civitas portfolio and to provide additional oversight and direction of third-party property management providers. It is also investing in new web-based asset management and billing systems.

Advisery fees are calculated quarterly, based on net assets, with a tiered structure under which the marginal advisery 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.

Exhibit 5 provides a summary of the Civitas portfolio at end-FY21 and shows its development since IPO. Civitas only invests in completed properties and does not engage in development or the forward funding of developments. Properties have mostly been acquired from selected developers and from care providers, including many with which Civitas has built strategic relationships.

Acquisition activity during the past year was relatively low compared with previous years, in part due to the pandemic but primarily reflecting the time taken to arrange additional debt financing. During FY21, six properties were acquired, providing 79 homes, for an aggregate cost of c £15m (before acquisition costs). This included two high-acuity, purpose-built facilities in Wales.

As Civitas has begun to deploy the proceeds from the c £85m M&G debt facility, since end-FY21, a further 29 properties have been acquired for an aggregate £22.0m (before costs), all specially adapted to provide long-term support for a further c 100 individuals with disabilities, learning difficulties and mental health care needs.

Alongside acquisitions, investment has also continued in the existing portfolio with the aim of ensuring that properties continue to meet the needs of tenants. In some cases, changing resident needs dictate changes to a property, often involving minor works carried out by the tenant. Under certain circumstances Civitas funds the works, enhancing the longevity and sustainability of the portfolio. During FY21 capital expenditure funded by Civitas amounted to c £4.0m (FY20: c £1.8m) including property improvement works, renovations and scheduled post-completion works. We expect capex to continue at a broadly similar rate, including energy efficiency measures linked to the E.ON arrangement. The latter is likely to be spread over several years with much of the gross capex, but not all, funded by government grant programmes; Civitas anticipates its own contribution to the energy efficiency capex to be well below £1m pa.

To date, Civitas has been primarily focused on SSH and similar specialist housing that falls into five main categories:

Civitas has a focus on homes that are suitably adapted to support the provision of medium to high acuity care, evidenced by the average 43 hours per week of care received by residents within its homes. The investment adviser indicates that around two-thirds of the portfolio supports mid-acuity SSH and similar specialised housing and one-third supports the provision of high acuity residential care.

In addition to the continuing strong demand from local authorities for Civitas’s traditional core activity, the broadening of Civitas’s investment remit approved by shareholders in May 2020 has further increased the range and scale of the potential investment opportunities available to the company. This will enable Civitas to diversify into working with a broader range of counterparties and with new client groups, 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 with similar dynamics to SSH5F6, to meet an expanding range of needs. The near-term focus is on meeting the substantial demand for suitable housing for those who have suffered homelessness, combined with additional support aimed at preventing them from returning to homelessness.

The concept of ‘advanced homeless provision’ goes beyond simply providing temporary housing and involves integrating a significant level of care and support aimed at breaking the cycle of homelessness.

Civitas is already providing accommodation to several local authorities in London which have identified the need for adapted specialist housing for homelessness provision, provided in properties that are suitably designed to provide a significant level of care and support.

All funding for accommodation that meets the strict requirements for SSH6F7 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. Civitas works with more than half of all local authorities in the UK.

Landlords (like Civitas) are not usually contracted directly with the local authority. Rather, local authorities contract with care providers, which is responsible for the provision of care to residents. The care provider in turn enters into a service level agreement with the approved provider that manages the property leased from the property owners (eg Civitas). Civitas’s portfolio is fully let on long-term leases (average WAULT of 22.6 years) to a diversified group of 16 approved providers, which in turn work with 116 care providers. Historically, the service level agreements between the care providers and the approved providers have been much shorter than the property lease agreements. Technically, this mismatch could represent a risk to approved providers should a care provider not renew a service level agreement, although in practice it is highly unlikely that either local authority or care provider would wish to relocate a resident from a carefully selected long-term home. Although this is only a technical risk, Civitas has sponsored the adoption of 25-year ‘back-to-back’ agreements between care providers and approved providers, to match long-term leases, and more than one-third of the portfolio is now on this basis. Government funding for SSH is disbursed via the local authorities, with care costs paid directly to the care provider, while rents and property service charge payments are made directly to the approved provider (not the resident). While the properties are fully let by Civitas to the approved providers, the latter may have unoccupied accommodation from time to time, often reflecting: the fact that it may take up to a year to fill a newly opening home for clinical reasons; the complexity of transfers from long-stay hospitals; delays in setting up individual care packages; that introducing a compatible new tenant into a vacancy in an existing home needs to be handled with care. The cost to approved provider’s that vacancy/voids represent are in most cases allowed for within the care contract and are covered by the care provider. Civitas says that voids within the homes that it owns are limited and the latest impact report produced by The Good Economy indicates that the level is consistent with the overall sector.

Working with a spread of approved providers, across a broad range of local authorities and regions, facilitates occasional lease reassignments (or transfers of properties from one approved provider to another). This may be to optimise the efficiency of care provided (eg transferring the management of a property to an alternative provider with a stronger presence in an alternative location), but also provides an additional opportunity to manage tenant exposures, where good quality assets in strong locations are the key to successful lease reassignment. There were no lease reassignments in FY21 although in FY20 a significant number of the assets leased to Westmoreland Housing Association were reassigned to Auckland Home Solutions, supporting Westmoreland’s significant stock rationalisation programme as it seeks to meet the requirements of the Regulator of Social Housing (RSH). In 2018, properties leased by Civitas to First Priority Housing Association were successfully reassigned to alternative providers within a few weeks when the latter became financially distressed. The reassignments were on similar terms, with no material financial impact on Civitas and no impact on the care provided to residents.

Auckland was the founder member of The Social Housing Family CIC, a not-for-profit community interest company (CIC) that was sponsored by Civitas. Although independent of Civitas and governed by an independent board, the CIC is intended to benefit Civitas and the sector by pooling skills and experience and promoting best-practice amongst its members. Since joining the CIC Auckland has enhanced its board, management and processes. Qualitas Housing, also a Civitas lessee, has become a second member of the CIC and Civitas expects other providers to join soon.

The social housing sector has traditionally had a low financial risk profile, in part due to the ongoing monitoring presence of the RSH and the fact that much of the rent is funded by central government through housing benefit and latterly, universal credit. Civitas’s lessees are regulated by the RSH, but Civitas is not, although it interacts with the RSH on a regular basis. The RSH seeks to identify potential issues in the sector and is active in resolving these. Historically, in a small number of cases where a registered provider7F8 has faced financial or other challenges, the regulator has stepped in to facilitate a solution, preventing any general loss of confidence across the sector. This may involve a strengthening of corporate governance, assisting with moving properties to a different provider that may be better placed to manage them (as was the case with First Priority), or a financial merger.

For some SSH providers, the pace of growth has outstripped the development of their management and governance structures as well as their capital resources, resulting in greater regulatory attention, and leading to several providers being issued with regulatory notices and judgements8F9. For those deemed non-compliant by the RSH there are clear signs of progress being made in terms of governance, management and financial strength, although there is more work to be done. Following a pause in regulatory action during the lockdown, allowing providers to focus on operational issues, regulatory engagement with the lease-based providers has recommenced. As one of the leading private sector investors in the supported housing sector, working with some of the fastest-growing providers, nine9F10 Civitas lessees are the subjects of regulatory judgements or notices. Civitas, through CIM, has supported these providers in addressing the specific concerns of the RSH. More generally, it has taken steps to address regulatory concerns about the long-term risk planning of providers by introducing caps and collars on rent indexation (typically of between 1% and 4%) and ‘force majeure’ clauses, setting out appropriate steps in the unlikely event of a formal change in government policy and funding.

While the nine lessees subject to regulatory judgements and notices collectively account for around two-thirds of Civitas rents it is important to stress that there has been no impact on rent collection or negative impact on the external valuations of the properties owned by Civitas. We expect this to remain the case. In our view, regulatory interventions in the SSH segment of social housing 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. There may be cases where some approved providers are unable to satisfy the RSH and over time we would expect concentration amongst the providers (perhaps through mergers and other amalgamations), leading to a smaller number of stronger providers. As has been demonstrated, quality properties, in the right locations, adequately adapted, and supporting an appropriate level of care are attractive to alternative providers in their efforts to meet the strong and growing need for accommodation.

Despite the pandemic, there were no surprises in the FY21 results. Although acquisition activity was modest in the year, rental income increased, costs were well-controlled, and 100% collection of rents supported good growth in underlying operational cash flow of almost 10%.

In particular, we note that:

The FY21 results were very close to the estimate that we published in May 2021 (Exhibit 11) and our updated FY22 forecasts are modestly reduced in aggregate. We have also introduced an FY23 estimate.

The slight reduction in our FY22 forecast is driven by the weighted impact of a lower level of new investment commitment than previously assumed, partly offset by a higher annualised rent roll than we had allowed for at the end of FY21 (£50.8m versus £50.4m).

In addition to the £22.0m of committed investment announced in Q122 we now assume £50m (before costs) of additional commitment (£72m in FY22 in total compared with £100m previously). This is consistent with full utilisation of existing debt capital, the maintenance of a c £30m cash buffer and 35% gross gearing (gross debt as a percent of IFRS gross assets). Our previous assumption for capital commitment had explicitly assumed either a lower cash float or additional borrowing. Based on the strong pipeline of investment opportunities we have no doubt that capital commitments will continue well beyond our assumptions, funded by a balance of new equity and debt capital resources, including utilisation of the strong investment-grade credit rating that Civitas received in March 2021 (see next section).

Our investment assumptions also allow for £4.5m pa of capex directed at existing properties, a similar level to FY21. Otherwise, our forecasts assume:

Civitas raised initial equity of £350m in its oversubscribed IPO in November 2016 and raised an additional £302m in November 2017 through the issue of C shares that converted into new ordinary shares in December 2018. As at 31 March 2021 (end-FY21), group equity was c £674m and fully drawn debt facilities amounted to £357m. Gross loan to value (LTV)11F12 was 34.5% compared with the company’s medium-term target of c 35% (with a maximum of 40%). Debt included the drawdown of the recently arranged £84.5m M&G facility, the proceeds of which were available for deployment12F13. We estimate that including our assumed further investment commitment outlined above, the company will have fully deployed its existing equity and debt capital resources by later in FY22. Given the strong pipeline of investment opportunities, we expect Civitas to seek additional equity and debt capital over time. The company plans to leverage its investment grade credit rating13F14 and access the sterling bond market. This would be complementary to any increase in equity capital and should provide access to attractively priced longer-term debt.

The debt portfolio has a weighted average cost of 2.4% with a weighted average maturity of four years14F15, enhanced by the seven-year M&G facility agreed in February 2021. The M&G facility is priced at margin over Libor of 2.75% above a fixed Libor swap rate of 0.39% (an effective 3.137% above Libor). The upward movement in long-term rates during the period when the M&G loan was being finalised slightly increased the overall margin on the facility, but Civitas was nevertheless pleased to further diversify its sources of finance by adding a good quality insurance lender.

All LTV covenants were comfortably met over the past year and the weighted average interest cover across the facilities was c 550%.

Based on the targeted 5.55p aggregate FY22 DPS, the prospective yield is 4.8%, supporting the c 7% premium to end-FY21 EPRA NTA per share.

Since IPO in November 2016 the average discount to NTA has been around 3% (Exhibit 14) but this includes two 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 contributed to a recovery in the share price.

In Exhibit 16 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. Over the past 12 months the group has shown a weaker share price development than the broader UK property sector and UK market as stocks and sectors that were hardest hit early in the pandemic have been rebounding. For comparative purposes, the valuation data in the table is based on trailing DPS and NAV data. On this basis Civitas is trading with a yield and that is similar to the average, and with a lower P/NAV. With performance during the pandemic demonstrating the resilience of the sector and the business model, we consider that Civitas offers an attractive yield while also delivering a material social benefit.

SSH assets, the core of the existing portfolio, are let on long inflation-indexed leases and the rents of those individuals living in homes that meet the criteria for SSH fully funded by central government. This is paid via local authorities directly to the approved providers that lease the homes from Civitas. The company indicates that the lease terms applicable to its planned broader investment in care-based social housing are likely to be similar in nature. The SSH sector provides an essential service to some of the most vulnerable members of society, receives widespread political support for the improved tenant outcomes and value for money that it provides, and benefits from a strict regulatory regime that contributes towards long-term stability. The sector has demonstrated operational resilience throughout the pandemic to date. As a result of these factors, the sector has a low correlation with the general economy or the wider residential or commercial property sectors.

We see the key sensitivities as: