Far from the London world of luxury flats and phallic skyscrapers, doctors' surgeries occupy a sleepy corner of the British property market. Typically let on long leases to GPs, who are reimbursed by the NHS, their chief appeal for investors is that nothing much can happen. There are no development super-profits - yet at least the rent will always be paid.
But there is nothing sleepy about the three listed companies that specialise in the sector. The past month has been particularly hyperactive. On 17 May MedicX Fund (MXF) made an audacious unsolicited bid proposal for Assura Group (AGR), which fell through when it failed to receive the backing of Assura’s management. MedicX then announced the acquisition of 14 medical centres. Finally, the largest player, Primary Health Properties (PHP), last week raised £68.5m of equity.
The sector’s very sleepiness explains all this activity. In an investment environment bristling with risks, investors have seized on primary-care property as a high-yielding safe haven, bidding PHP and MedicX up to premia over their book values (as we will explain, Assura is viewed differently). For companies that have every incentive to grow - scale boosts stock-market liquidity and spreads management fees across a larger base - this has been an open invitation to issue more equity, take on more debt, and buy more property.
Care of the NHS
The safe-haven status of GP surgeries is founded on the long, government-backed leases that underpin the rents. But it also reflects the uniquely monopolistic nature of the underlying tenant, the NHS. Because there is no competition between rival medical practices, there is no speculative development and thus no risk of oversupply in a period of easy credit. At the same time, demand does not depend on the volatile process of corporate expansion and contraction. Rents are therefore not conventionally cyclical.
One might think that the NHS monopoly would be in a strong position to suppress the rents it pays to private landlords. But this is not the case. The health service is trying to shift care provision from hospitals to beefed-up GP practices, which are much cheaper and can deal with most routine ailments. Assura estimates that more than £10bn of investment is required to turn all existing surgeries into modern medical practices. The NHS depends on PHP, MedicX and Assura to fund the necessary development, and is therefore obliged to offer rents that justify the capital outlay. Market rents have tended to track development costs as a result.
This has earned the companies a reputation as inflation hedges. If commodity prices suddenly pick up, it should be mirrored in construction costs and therefore rents. Some leases are even explicitly linked to the retail-price index. With portfolios revalued in line with rental growth and debt costs fixed, landlords’ equity should balloon in an inflationary environment.
This is the safe-haven story, which PHP and MedicX have very successfully marketed to private investors. But two significant cracks in the story have emerged. No one doubts the solidity of the existing income-generating portfolios, but - except in the case of lower-yielding Assura - the scope for dividend growth now looks limited.
| Market value | Share price | Rental EPS | EPS growth | Div yield | Div cover | PE ratio | AdjustedNAV | Adj NAV growth | Premium or discount | Loan to value | |
|---|---|---|---|---|---|---|---|---|---|---|---|
| Primary Health Properties | 302 | 313 | 10.2 | -30% | 5.9% | 55% | 31 | 305 | -4% | 2% | 61% |
| MedicX Fund | 206 | 79 | 2.6 | 8% | 7.2% | 46% | 30 | 63 | -4% | 25% | 57% |
| Assura Group | 186 | 36 | 1.9 | 27% | 3.3% | 164% | 19 | 39 | 6% | -8% | 62% |
Source: company accounts | |||||||||||
Unhealthy dividends?
One problem is uncovered dividends. PHP started to pay out more than it earned in rental profits back in 2010. Because it has increased dividends in each year since, while earnings per share have progressively fallen, rental profits now cover just 55 per cent of the payout. MedicX has never paid covered dividends, having been set up in 2006 with a strategy of funding the payout partly out of capital gains. But it has fallen short even of this target, mainly as a result of share issuance. In the absence of rapid capital growth, paying uncovered dividends erodes the equity value of the companies. Book value per share has been falling at both PHP and MedicX.
Assura operates in the same sector, but a rocky history has paradoxically left it with a more conventional approach to managing its balance sheet. Having diversified away from property into medical services and pharmacies - running up big debts in the process - the company ran into endless problems during the financial crisis (the company's shares proved a highly successful Investors Chronicle sell tip in late 2010). Yet the sale of its non-property businesses, a complete clean-out of the previous board and management team and a rights issue to pay off a £69m interest-rate swap have restored order in the past 18 months. Chief executive Graham Roberts took advantage of the general chaos to rebase dividends at a very cautious level - too cautious, perhaps, but at least there is now scope for growth in both the payout and the company’s equity value.
The second problem, which all three companies face, is a slowdown in rents. The coalition government’s plan to reorganise the NHS plays to the sector's advantage by biasing the system to general practitioners - thus making the poor quality of many old surgeries more problematic. But the upheaval caused in the NHS bureaucracy has also caused a hiatus in approvals for development. Since open-market rents are driven by the development process, this has allowed the old link between rental growth and inflation to break down. Rents are now growing at 1-2 per cent a year, judging by Assura’s annual results - down from the 3-4 per cent once considered normal.
IC VIEW:
Nobody knows how long it will take for the NHS’s new commissioning bodies to get back to business. Yet the reorganisation officially came into effect on 1 April, leaving scope for a recovery in rents as pent-up demand for new developments is gradually released. Certainly, the long-term prospects of the market look sound. The profit stream on offer will not propel anyone to sudden riches, but offers more security than virtually any other on the stock exchange. Sleepy investments ensure a good night’s sleep.
