The Subplot | Nice little earner, Manchester offices
Welcome to The Subplot, your regular slice of commentary on the North West business and property market from Place North West.
- Nice little earner: why smart investors are looking at healthcare property
- Not over yet: Manchester offices have a way to go to return to normality
TELL ME WHERE IT HURTS
NW property gets healthy
Israeli bank Leumi UK is the latest to start hunting for opportunities in the North West health property sector, Subplot can reveal. Low-stake, high-yield, low risk, and likely to expand thanks to volume housebuilding, what’s not to like?
The market for building, funding and investing in GP surgeries and health centres in the region is about to expand, keeping pace with housebuilding. But with the existing supply of fundable schemes tight (and likely to stay that way), as well as facing some planning problems and new interest from family offices and overseas investors, it’s a tricky, competitive and attractive niche scene. Yields are tumbling below 4% thanks to super-strong rental covenants backed by the NHS. This is what you need to know.
The basic dynamic here is that building 200,000+ homes in the North West means demand for a lot more health centres. Meanwhile, a steady drumbeat of demand is provided by existing GP partnerships which have not got the funds, or the time, to bring their surgeries up to modern standards. They account for about two-thirds of the total. That’s why investors like Leumi are on patrol and why consultants like Cushman & Wakefield are making new appointments. The market is dominated by North West names such as Assura plc, PHP and Eric Wright Group, so it’s already a sophisticated scene.
The appeal of 25-year index-linked rents backed by the government is not hard to understand. “Healthcare is a non-discretionary, needs-based purchase which consequently provides relatively stable income against which borrowing can be structured. The demographic drivers are compelling, with the UK population ageing and the prevalence of dementia and mental health conditions sadly increasing,” Leumi UK property finance manager Guy Brocklehurst tells Subplot.
A good hedge
“We anticipate investors will increasingly look to healthcare assets as a way of offsetting more volatile income from other asset classes which may be impacted by the new working paradigm and wider economic uncertainty,” says Brocklehurst. Leumi UK is “very open to financing high-quality opportunities within the North West”.
Small but beautiful
New arrivals join a small but busy market. Thomas Pearson, real estate partner at law firm JMW, with clients including Assura and care home operators, says it’s a tick-tock kind of business, gently moving under its own steam. Covid-19 made relatively little difference. “Some individual investors were scared off from bidding,” he says, but otherwise things carried on as usual.
And usual is…
…fairly slow, to be honest, thanks to the complexities of surgery development. The issues include relationships between GP partnerships, local clinical commissioning groups, the district valuer, banks, and investors, then come the problems of site finding and construction. It means volumes are low. Maybe 20-30 a year in the North West in a good year, only a dozen or so in a thin one. As of the end of June 2021, Assura is currently on site with 17 UK developments worth £99m, included a new-build in Timperley, another on site in Kelsall, Cheshire, and an opportunity in Blackburn. Deal sizes vary – an Eric Wright health centre in Ashton-in-Makerfield was around 10,000 sq ft with a £5m capital value, and that’s the mid-to-upper end of a scale that goes up to £12m (where pension funds tend to be the buyers) and down to £1m – £2m. Portfolio sales are not uncommon.
It would be an exaggeration to say investors are piling in. But there are more of them. Where a deal might have three or four main bidders, it now has five or six. “Health centres are safe income and the pandemic has emphasised that, but the shift in yields goes back over the last five years. We’re now seeing some sub-4% yields but I doubt it will compress much further because the gap with the cost of capital is now about as narrow as it can get,” says Adam Lowe, the recent mover from Assura to Cushman & Wakefield in Manchester.
Dollars and dinars
Overseas money, as the Leumi example shows, is now more prominent in the North West. “The appeal is growing to institutional money, overseas investors and high-net-worth individuals from the Fast East and US. What they see is the drivers behind the market, such as an ageing population and more treatable medical conditions, so there will be more need for health centres. They expect incremental growth,” says Lowe. Assura says that in the year to March 2021 it added £300m-worth of new health centres at an average yield of 4.4%, which is keen by anyone’s standards.
What investors like is that while this is a market with growth potential, it isn’t going to grow too fast. Supply constraints are powerful. Frank Convery, health property principal at Avison Young, explains: “We’re always in competition with residential for sites, or with roadside users, and the potential sites we can use are limited because surgeries are very location-sensitive. If you are not in the heart of the patient list area, then you have problems, so our location choices are restricted.” Section 106 agreements on large housing schemes have also caused problems. Often, the problem is that the section 106 agreement entirely ignores the need for a health centre. Sometimes the problem is that it mandates one, despite a new surgery having just been completed nearby.
Simon Oborn, head of property at Assura, explains: “There is huge logic and opportunity in better alignment of local healthcare infrastructure requirements with masterplanning for new homes and growing communities. But for a long time, we have been raising our concerns about the disconnect and inconsistency which can exist between planning functions of local government and the NHS. This means that primary care infrastructure requirements to support new development can be overlooked.” Adds Cushwake’s Lowe: “We need more understanding on when surgeries are required.”
Behind the planning problems, the maths can also be a constraint. The rent the NHS is willing to pay never quite covers the construction cost (bridging loans from NatWest and Lloyds were always necessary). Now rising construction costs have made the sums even tighter. Rents on new-build hover around £220/sq m, and construction costs from £2,700/sq m to £3,000/sq m.
The key is patience. Wayne Ashton, head of partnerships at Eric Wright’s healthcare division, says: “It’s a slower growth market – you really do have to work with your partners to get the operating model right for everyone involved.” Investors and developers have their eyes fixed on a near-time growth prospect. As demand for healthcare rises and town centres search for alternative uses, the guess is that retail and maybe office premises could be ideal for repurposing as urban health centres. Convenient, well located, accessible – they feel like the future to some observers. “There could be real opportunities to repurpose retail, creating health centres more integrated into communities. That could open the door to new developments, meaning more health stock comes forward,” says CBRE senior director for operational real estate Shaun Skidmore.
Conclusion: A niche that will grow into a specialism, definitely one to watch.
DRIVING THE WEEK
It’s not over yet
Is there something soft in central Manchester’s office market? Three data dumps – on Manchester take-up, Birmingham take-up and rent collection rates in both cities – suggest a slow recovery for the post-lockdown market.
It’s still early days, the summer could change everything, and who knows what we will all be doing and saying this time next year… but data emerging over the last few days shows just how far Manchester’s office market has come, and how far it has still to go, in efforts to reverse the pandemic-inspired collapse.
Our friends in the Midlands
Comparing Manchester with Birmingham is mostly a waste of time, so treat with caution. Even so it can help expose trends. Data extracted from Re-Leased, which have got quite good at spotting trends, suggests Manchester’s office occupiers are a shade less resilient than Birmingham’s. Over the pandemic as a whole, they come out looking a bit wobbly compared to the capital or Birmingham. Dynamic economies like Manchester’s (and London’s) will always generate more office occupiers who have thinner resources and less resilience, than largely stable economies that don’t grow so fast (like Birmingham’s). But the rental payment data reveals a continuing issue which doesn’t exist in Birmingham. Investors, who are now focussing more keenly on tenant reliability, will take note.
Three weeks on from the June quarter rent collection day, Re-Leased said its analysis of London office rents due for the June quarter this year showed just 52% had been collected at day 21, the lowest figure at this point in the quarter since the beginning of the Covid-19 pandemic. Manchester did a little better, with rent collection rising from 59% to 69% at the same point in the last quarter. But the outstanding success was Birmingham where rents paid surpassed pre-pandemic levels at 89% for the June quarter this year.
These figures slightly exaggerate how well Manchester did during the pandemic. In the last four quarters, Manchester was either the worst for rent collection or very nearly the worst (2% difference, in Q3 2020). Manchester landlords are consistently offering more credits to their tenants. In earlier quarters this has amounted to as much as 13%. In the latest it is smaller, 1.9%, but still twice what it is in either London or Birmingham.
Out of townies
The market looks a little soft in a second way. You can see this if you compare the city centre to out-of-town markets. The latest data shows South Manchester and Salford Quays looking considerably more dynamic. They are not operating at something resembling pre-pandemic levels. Instead of being about 50% down, like the city centre markets, South Manchester is down by about a quarter, and Salford Quays by a sixth. The trend away from South Manchester before the pandemic has reversed.
You can skip the maths
Here’s the working out: office take-up in central Manchester in H1 was 454,00 sq ft according to the Manchester Office Agents Forum, while in H1 2019 it was 805,000 sq ft. Back in the first half of 2019, the trend was away from out-of-town offices. In H1 2019, take-up in South Manchester was 277,00 sq ft, a 23% drop on the same period in 2018. Today, in the first half of 2021, the trend is the other way with take-up climbing from 93,000 sq ft in Q1 to 118,000 sq ft in Q2, a combined total of 210,000 sq ft. Salford Quays/Old Trafford tends to be more volatile, but its H1 2021 total of 103,000 sq ft compares well with the 2019 H1 total of 122,000 sq ft.
There’s no suggestion of looming disaster, and indeed the data shows Manchester riding an improving trend line. For instance, office take-up in central Manchester in Q2 2021 was 220,000 sq ft, and H1 was 454,000 sq ft and in the smaller Birmingham market, the equivalent figures totalled 204,000 sq ft and 253,000 sq ft. That suggests Manchester was out of the traps much faster (after a 2020 performance that was appreciably stronger than Birmingham’s), and then held its pace.
Conclusion: You could call that strong and stable. Manchester rent collection is improving while landlord forgiveness is not being stretched anything like as much as it was. No big drama. Even so, breaths will be held as we await the Q3 data.
The Subplot is brought to you in association with Cratus and Bruntwood Works.