Buying opportunities and threats in the UK care home industry

Not all sectors receive the same level of interest from business buyers, and the care home industry in particular has always had more than its fair share of interest. But will its popularity amongst business buyers wane in the face of the introduction of the living wage? And how will the sector’s more aggressive consolidators weather the fallout from Brexit?

An ever-popular sector
Care homes have consistently ranked among the most viewed businesses at the Business Sale Report. Buyers are often care home managers who are interested in making a purchase, keen to capitalise on the experience they’ve built up working for someone else, or business people who see an opportunity in an expandable business.

What’s keeping care homes in such demand? To start with, there’s no doubt that in the caring industries, passion for the work is a big motivator; a lot of buyers genuinely want to make a difference for their residents or patients.

But it would be naive to think that profit potential isn’t at least as strong a factor. Although profitability in the sector is under downward pressure - Knight Frank research revealed that EBITDARM as a percentage of income stood at 27.1 per cent in 2014/15 - it remains an attractive figure compared to the Office for National Statistics’ data showing average profitability for all UK private non-financial corporations in the third quarter of 2015 stood at just 12.9 per cent.

The threats
Care homes may be a profitable business model in general, but recent changes are increasing the pressure on companies. Staffing costs are one of the most concerning for many.

Staff costs for care homes have been on an upwards trend for the past five years. In 2014/15, they rose from 57.6 per cent to account for 61.9 per cent of total income.

The new National Living Wage (NLW) increases mean that this upwards trajectory is only likely to increase. NLW meant an increase in minimum wage for people over the age of 25 in April 2016, increasing hourly pay from £6.70 to the NLW rate of £7.20. The government aims to increase this to £9 by 2020.

For an industry with such a heavy reliance on low- cost labour, many care homes will find themselves under real pressure with these changes. According to some reports, such as that of Chai Patel, chief executive of HC-One, one of Britain’s largest care home providers, up to half of care homes in their current guise will be financially unsustainable as a result.

Other changes behind the scenes have brought different pressures to the industry. Cash-strapped local authorities have changed the requirements for patients to qualify for residential care homes, while national health rules mean that not all health problems will be covered by the NHS and support for elderly heading to care homes is means-tested. While patient-facing on the face of it, these funding problems will inevitably impact the care homes and the number of people they care for, as well as the health problems they focus on.

Then of course there is the concern that the recent vote for the UK to leave the European Union could further limit access to the staff and carers that the industry depends on. There are currently some 130,000 EU health and care workers in the UK; replacing their roles or adjusting to new employment visas and regulations will bring new challenges to the sector, especially as the older population accounts for an increasingly large percentage of the country.

The opportunities
So the care home industry has more than its fair share of challenges. But while the media will, typically, focus in on the negative angle of recent government-level decisions, buyers can look deeper and weigh up the situation for themselves.

Firstly, they will be aware that the demography of the UK is changing. The UK has a rapidly ageing population, predicted to worsen post-Brexit if immigration slows as expected. There is rising longevity, with people living longer through improvements in health, diet and preventative care.

This means that there will be rising demand for care home services for the elderly.

The challenges mentioned above are hitting some of the larger scale operators as their sheer scale makes it harder for them to make dynamic adjustments in response to ever-changing legislation. The aforementioned HC-One, for example, has put up almost a quarter of its care home portfolio for sale in a bid to pay down its debts. Four Seasons, meanwhile, is selling some £60 million worth of homes amid serious financial woes.

For smaller scale buyers, these disposals, which come with more than a hint of financial distress, could offer the chance to buy into an up-and-running care home. By keeping to scale and stepping in with a new approach, there is no reason why new buyers couldn’t find the solutions to old challenges thanks to their fresh perspective.

Scalability is also particularly interesting in this sector and buyers may find that by scaling things down a notch in comparison to the big operators they can actually increase their profit margins. Knight Frank data shows the optimal size of a care home, in terms of overall profitability, is in the 80-99 size bed category. Average EBITDARM per bed in this 80-99 bed care home category stands at £11,303, which is 19 per cent above the all index average and 34 per cent higher than the weakest performing under 40-bed category. Contrary to expectations, margins don’t increase when you exceed the 99-bed stage - hence the opportunity in downscaling or realigning larger operations.

Knight Frank found that when a care home exceeds 100 beds, there are the economies of scale expected, but these are offset by comparatively weak occupancy and fee levels, meaning that EBITDARM per bed in this care home category averages at £8,850 – or seven per cent below the all- index average.

Figures like these highlight the importance of understanding regulations, staff costs, and the usual due diligence in any business purchase; the answers aren’t always what you might expect when it comes to successful turnaround strategies. In the case of care homes, changes in use, design, target market and type of care could well prove more profitable than simple expansion.

We will see smaller, more nimble and marketing-savvy operators manage care homes more efficiently, creating quality experiences for customers in aesthetically-pleasing environments. Customers’ families and friends will be included as part of the customer outreach, with the aim of turning them into advocates - central to word-of-mouth marketing efforts.

The successful operators will scrutinise costs and look to make savings wherever possible, without compromising standards of care.

These operators will not only spring domestically, but from overseas. Foreign investor demand for healthcare assets in the UK continues to increase and we will see this trend accelerate with the recent drop in sterling.

All things considered, the middle ground in the sector remains upbeat and optimistic about the future. Paul Salmon, managing director of Care Sector Property/Business Agents Bishops says he does not think there will be a long term effect on the attractiveness for buyers in the wake of the EU referendum result or the new National Living Wage.

When the dust has settled down, says Paul, following the surprise result of the referendum and the appointment of a new Prime Minister, confidence will return to the marketplace. The care sector has survived a long period of tightening and changing regulations and this situation is no exception.

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