Care to invest in primary care?
This article appeared in Property Forecast, November 2006 and was written by Steven Hardisty and John Trevethan of Pinsent Masons.
The changing face of investment in primary care
Private investment in primary healthcare real estate is by no means a new concept. Prior to the introduction of LIFT (Local Improvement Finance Trust) schemes, the majority of GP premises were owned by the private sector, namely owner occupier GPs.
The owner occupied model of GP surgeries has undergone a major transformation in recent years. The key driver behind this sea change has been the NHS's desire for primary care providers to take greater levels of initial responsibility to relieve the pressures on hospitals. This objective is best satisfied if GPs work in multifunctional teams possibly to include some or all of nurses, dentists, pharmacists, therapists, opticians, mid-wives and social care staff. The result is a primary care "one stop shop". Existing facilities cannot easily be adapted to this "one stop shop" approach and so a demand has arisen for bespoke facilities delivering patients with modern integrated high quality, fit for purpose accommodation. The multi-occupier nature of these buildings combined with the high development costs take investment in primary care out of the reach of GPs.
LIFT was introduced on the back of the success of PFI (Private Finance Initiative) in utilising the skills and capital of the private sector to deliver high quality secondary care developments in the form of new hospitals. LIFT provided a cost effective infrastructure for the delivery of primary care schemes below the cost threshold for PFI projects, which typically require values in excess of £25 million to justify the high setup and professional advisor costs. LIFT achieves this by allowing Local Health Authorities to select a private sector partner to whom they can offer first refusal on any new projects for a period up to 25 years.
So has LIFT and its unique partnering arrangement brought an end to traditional private sector investment in primary care? Quite simply: no. Third Party Developer schemes (or commonly known as "3PD" schemes) have continued to be constructed up and down the country by specialist primary care developers.
The introduction of LIFT has though had its effects on the 3PD sector, with many GPs and Local Health Authorities seeking to incorporate many of the tenant friendly provisions that LIFT leases (known as "Lease Plus Agreements") offer GPs. Gone are the days where a developer could expect an institutional rack rented lease in exchange for a new GP surgery.
So what are the distinctive features of primary healthcare 3PD Schemes as opposed to other sectors?
- Site acquisition
Delivery of primary healthcare is very much site specific and sourcing an appropriate development site and obtaining planning consent can be one of the most challenging hurdles. As with traditional property development, the investor will typically have tenants contractually tied to the new scheme before committing to any site acquisition. However, an additional twist to primary care investment is that developers will often be requested to assist with the disposal of the redundant GP premises post occupation of the new scheme. This can take various forms from simply advising on disposal options, to the extreme of underwriting disposal values. This is often of fundamental concern to GPs with many practices suffering from negative equity.
- Familiarity with language and documentation
The Development Agreement and Lease in a 3PD scheme will look quite familiar to the investor. The income producing asset, the Lease itself will look remarkably similar to leases of other commercial developments and at 50 pages more or less take the same time to read! This is in stark contrast to the numerous documents required for a LIFT scheme which are not only packed with new language but will use several reams of paper.
- Income Stream: The quality of the covenant
3PD schemes are always initiated and procured by GPs (as opposed to the Local Health Authority) and this usually means that the GPs will take around 50 to 60% of the space in the Building with the remainder being taken by a Local Health Authority, NHS Trust, or Local Authority. The individual GPs and other tenants normally enter into side-by-side leases directly with the developer.
The GP lease covenant will therefore look very different to the typical commercial covenant, which will have no doubt provided 3 years' worth of audited accounts and a rent deposit or guarantor! In terms of covenant strength and the ability to pay the rent, a key point to note is that GPs' rent is reimbursed by the Local Health Authority.
- Repair and Insurance
The basic building block of property investment in the UK is the Full Repairing and Insuring Lease (FRI Lease) under which the tenant is responsible for the whole of the repairing obligation and all insurance premiums.
It is now common place for 3PD investors to be required to offer a tenant an Internal Repairing Lease (IR Lease) whereby the landlord retains responsibility for structural and external repairs without reimbursement. The tenant's only responsibility is for repairing the inside of the let premises and contributing towards the maintenance of any common parts via a traditional service charge.
Such is the change within the sector that the boundaries of the IR Lease are now even being tested, with developers commonly being requested to assume liability for high cost items such as lifts, air conditioning and boiler plant. It is also not uncommon for landlord's to be asked to bear the cost of insurance premiums for the development.
Developers will seek to limit exposure from FRI leases by utilising build design and materials that minimise external repair and maintenance. This, combined with a comprehensive warranty package from the construction team, can limit liability during the early years of any scheme.
- Lease Term and Break Rights
The lease length in a 3PD scheme is often more attractive that that which an investor might achieve in other property sectors.
Typically GPs are required to lease new surgeries built by commercial landlords for a term of 20 years. This is significantly longer than the terms that most investors would achieve in the commercial office or retail markets which by general consensus are now down in the 10 to 15 year range at best.
This is often justified on the grounds of the extent of the initial capital investment i.e. the bespoke nature of the buildings. Surgeries are purpose-built and can be difficult to let for other purposes. Given the choice between a longer term and higher rents over a shorter period of time most GPs will usually opt for the longer term.
However, that said, the changing face of healthcare delivery has made many GPs nervous at committing to long leases. Developers can often be faced with requests for rolling break clauses in the event that the level of rent reimbursed from the Local Health Authority falls below the passing rent. Such requests will not be entertained by pure development investors. GPs have traditionally been able to obtain comfort from the Local Health Authority that they will take an assignment of the lease in the event that the GPs find themselves unable to assign their interest. However, Local Health Authorities are now showing a reluctance to assume such a responsibility.
- Rental and Rent Review
Generally speaking GP surgery rents for third party developments are calculated as per other sectors on the prevailing market rental level. Prior to any scheme being given the green light the developer will have first agreed the rental level with the Local Health Authority.
The rent review mechanics are somewhat different to that of traditional commercial leases. The complication of rent reimbursement means that any proposed new rent will require the approval of the Local Health Authority. One significant distinction which would scare most commercial landlords is that rent review provisions can provide for the review of rent both upwards and downwards. The only saving grace being that rent cannot fall below the starting rent. Typically rent reviews take place on a three yearly basis. Landlords are given comfort in the event that rent reimbursement ceases to exist by providing for the introduction of an upwards only open market review.
Despite the arrival of LIFT as an alternative, 3PD schemes continue to thrive. The introduction of LIFT has very much changed the face of investment in primary healthcare with many of the LIFT friendly concepts finding their way into 3PD developments. Investment in the primary healthcare sector is not for the faint hearted.
For further information email steven.hardisty@pinsentmasons.com or john.trevethan@pinsentmasons.com
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