Primary care provides an attractive commercial property opportunity.
Commercial property has endured the mother of all slumps, falling over 40% in the last two years.
Will it recover soon? Well, values have been increasing, so much so that some of the bombed out investment trusts stand on premiums to net assets. I think this is just a false dawn caused by the average investor, desperate for income, chasing any investment dog wagging a high-yield tail.
The reality is that rents are still falling, voids (tenant empty periods) are increasing and the amount of new speculative office space coming on to the market shows no signs of slowing. Add to that miserable unemployment and growth forecasts and I reckon commercial property is going nowhere for a year or so.
But there is one sub sector that looks appealing -- Primary Healthcare Property. And the good news is there are two easily accessible UK investments available.
A growing and strategically important role
Primary care is the range of health services that play such an important role in local communities -- doctors (GPs), pharmacists, midwives and even dentists. Primary care providers are the first point of contact for a patient.
Importantly, given the likely cuts in government expenditure, there is a definite trend away form secondary care and toward primary care. Apart from anything else it's (rightly or wrongly) seen as more cost effective and therefore likely to remain an important part of government strategy -- whichever party is in power.
When I was a lad the delivery of primary care was driven from the doctor's surgery, often no more than a converted room in his house. Now, delivery is more likely to be from purpose-built healthcare centres increasingly providing a 'one stop shop' for patients. And this is where the investment opportunity lies; specialist companies that source, design, build, maintain and lease appropriate properties.
The investment case
The drivers of commercial property value destruction are notably absent from this sector. First, the trend toward shorter leases, providing opportunities for tenants to renegotiate rents. Typically in the healthcare sector leases are twenty years or longer, and rents are linked to inflation and, ultimately, government backed.
Second, void periods. Many commercial property landlords are exposed to the economic cycle. When recession hits, voids (tenant empty periods) can be as much as 20% or more and that soon eats into income yield. Even in the public sector departments such as HMRC have been known to reduce staff and consolidate sites when economic circumstances demand. In the primary healthcare sector voids are virtually unknown, and rental income is achieved on every square foot of developed property.
Healthcare properties will inevitably share some of the valuation issues faced by other property companies as they are obliged to obtain regular independent valuations. However, for the income investor this is less important than the almost guaranteed inflation-linked income.
Even for the total return investor this asset class is uniquely easy to value. Because of the long leases and predictable cash flows, all you need to do is apply the discount rate you are happy with to arrive at your own valuation.
Two players to ponder
There are two quoted companies operating primarily as landlords of primary healthcare facilities (rather than construction or equipment and related services). They are MedicX (LSE: MXF) and Primary Healthcare Properties (LSE: PHP).
Primary Healthcare Properties is the oldest company in this sector having floated in 1996 and paid an increasing dividend ever since. The company had a successful share placing in October and released a positive interim management statement on 18 November, stating that they achieved rent increases of 3.2% per annum at the latest reviews.
As a real estate investment trust, it has to pay out 90% of its income and the forecast dividend for 2010 is a fairly predictable 17.5p which, on a current share price of 290p, is a yield of 6%.
MedicX only floated in 2006 -- not the best time for a property fund. It too raised extra funds via a placing and open offer during this year. Its last reported rental growth was 2.8% per annum. On 25 November it issued a statement giving notice that the final quarterly dividend will be paid on 31 December, which makes a total distribution for the year to September of 5.33p. That's a yield of 6.7% on the current price of 79p.
At its last interim results, MedicX expected conservative annual dividend increases of 2.5% per annum. It reports final results this Tuesday. Any confirmation of good trading could lead to the shares being re-rated.
Both companies are small caps weighing in at £179 million and £79 million respectively, but unlike most small companies are almost completely unexposed to economic risk. Both companies are committed to growth, so you should expect debt to increase and possible rights issues.
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