In decades past, when you didn’t wait weeks to see a GP and doctors even made house calls, they mostly operated in small practices from surgeries they owned. These were often located on the ground floor of houses, perhaps with the doctor living upstairs. But as property prices rose, the requirement for expensive equipment increased and economies of scale from larger practices beckoned, this business model became impractical.
The solution was purpose-built health centres incorporating diagnostic testing, clinics and pharmacies, the idea being that this would take pressure off the hospitals and enable more treatment to be provided locally. Since the NHS, inevitably, didn’t have the resources for the capital spending required, it chose to contract with the private sector to finance, build and own premises that it would rent under long-term agreements.
The first person to see the opportunity was Harry Hyman, who set up Primary Health Properties (LSE: PHP) in 1995 and listed it the following year. PHP now owns 292 health centres, serving 3.2 million patients, and has recently expanded into Ireland. Medicx (LSE: MXF) followed ten years later and Assura (LSE: AGR) soon after.
With combined assets of over £3bn, these are substantial firms and have very similar business models. All three are risk-avoiders and have investment characteristics much closer to listed infrastructure funds than to conventional property firms. They seek to provide their investors with a steadily rising level of income (PHP has increased its dividend each year for 20 years) and thereby modest capital gains.
The properties are let on long-term leases, with more than 90% of income coming directly or indirectly from the NHS and most of the rest from pharmacies. In theory, the buildings could be redeveloped or sold when the leases expire, but it is much more likely that new leases will be signed.
Rental agreements provide for regular uplifts. In the case of PHP, these currently work out at 1% a year, but there is the potential for larger uplifts if a property is modified or extended. Expansion comes from buying new premises or through funding a developer and then buying on completion. Either way, construction risk (and reward) is avoided. Given the long-term nature of income streams and low interest rates, balance sheets include significant amounts of long-term debt. The loan-to-value ratio of PHP and Medicx is about 50%, and 34% at Assura.
As in the infrastructure funds, share prices stand at significant premiums to net asset value partly because the firms have a vested interest in keeping asset values low so that new shares can be issued at a premium. With only 20% of the PHP portfolio having a lease expiry below ten years (15% at Medicx), the rental stream, not a notional value of the property, is the key determinant of value. This rental stream enables PHP to pay a dividend, now fully covered by earnings, which provides a yield just below 5% and is rising at about 2.5% annually. At Medicx the yield is 6.7%, but this is only 64% covered by earnings, while at Assura, it is just 4.2%, owing to lower levels of debt.
Hyman is quietly bullish about the outlook for PHP and the sector. A rental yield of 5.4% covers management and debt costs, leaving 2.2% spare for shareholders on new centres. In Ireland, this margin is 4.6%, albeit with slightly higher risk. Expansion continues to add value, while the current portfolio locks in a solid return for many years to come. If only life was so easy for the poor patients struggling to see their doctor.
In the news this week…
n Fund managers have urged the Financial Conduct Authority (FCA) to drop plans to force fund groups to charge a single all-in fee to investors, say Madison Marriage and Chris Flood in the Financial Times. Vanguard, Old Mutual Global Investors and the New City Initiative (a group of 54 asset managers) have challenged the regulator on several suggested reforms aimed at raising competition in the industry and cutting costs for investors.
The all-in fee was proposed by the FCA after the watchdog found that only one in five investors are aware that trading costs come out of their returns. However, Vanguard, the second-largest fund house globally, warned that an “all-in fee” could “encourage asset managers to inflate their estimates of trading costs to protect profits”, note Marriage and Flood. Old Mutual Global Investors, meanwhile, cautioned that “a single charge… could pose an unintended conflict of interest between asset managers and investors by providing an incentive to reduce the level of trading”.
(We’re not sure why that would be bad – overtrading is bad for returns.) However, Teresa Fritz, of the Financial Services Consumer Panel, argues that it’s up to fund managers to manage costs properly. “The asset management industry has survived for too long hiding its costs… in order to give the illusion of being competitive.”