Impact Healthcare REIT 08 July 2020
Disclaimer
Disclosure – Non-substantive Research
This is not substantive investment research or a research recommendation, as it does not constitute substantive research or analysis. With this commentary, Kepler Partners LLP does not intend to influence your investment firm's behaviour.
Impact Healthcare REIT (LON:IHR) owns a portfolio of care homes which it lets to operators on long-dated, inflation-linked leases with upwards-only rent revisions. The tenants are responsible for the maintenance of the properties during the length of the lease, and contracts give IHR the right to rescind the leases if their financial performance deteriorates below a certain level (even if rent is being paid).
The manager, Impact Health Partners, has built a portfolio with a core of high-quality assets which are supplemented by those which it believes can be improved, thereby achieving an uplift to valuations. The sector is supported by an ageing population in the UK and limited supply of care-home places. This could be supportive of capital values over the whole sector, and also means that there are opportunities for asset management in providing accommodation for those suffering diseases whose prevalence rises with age, such as dementia.
Demand for the shares was strong until the current pandemic emerged, with IHR trading on a premium for long periods of time and issuing shares to grow the portfolio. However, the discount to NAV widened substantially in March, and has since narrowed to 10%. We discuss the impact of the pandemic on tenants in the Portfolio section; so far the full picture isn’t yet clear.
IHR’s shares yield 6.6%, and the board aims to grow the payout in line with the growth in the underlying rental income, which has a floor at +2% per annum and a cap at 4%. The rent due to IHR was covered 1.8 times by tenants’ operating profits as of the end of December.
IHR’s long-dated, inflation-linked cash flows with contractual minimum uplifts of 2% would surely see the shares trading on a premium if it weren’t for the uncertainty around the impact of COVID-19 on the health of residents and the finances of tenants. With the UK economy entering into a recession and likely to see many millions of unemployed over the coming months, income that is not dependent on the UK economy should be in high demand (and of course there is the impact of Brexit at the end of the year to consider).
We are optimistic that at the current stage of the epidemic – where it is fast receding, with prevalence at very low levels – a fuller picture of the impact will soon be clearer. The manager has stated that tenant defaults cannot be ruled out, although all the information they have given around costs and occupancy levels seems relatively positive to us. Of course, there is the potential for a second wave in the winter which could depress demand for the shares once again.
Given the discount some may see an opportunity here, and in the long run it seems that demand for care homes will remain high and the potential for yield should be good. That said, the uncertainty around the impact of the coronavirus means that investors need a reasonable degree of risk appetite in the short term.
| bull | bear |
| Attractive yield backed by long-dated, inflation-linked rental income | Full impact of the pandemic on the finances of tenants is as yet unclear |
| Financial health of tenants has minimal exposure to the health of the UK economy | Potential for regulatory interference in the sector |
| Demographic trends likely to support demand for the assets in a market with limited supply | Rent smoothing means that dividends can be uncovered by cash income in the early years of contracts |
