AUTHOR: Ed Brown
Social care businesses have been rocked by big changes in the financial markets. Ed Brown looks at what it will take for businesses in the sector to succeed in ‘23.
Looking back over the last year, 2022 gave us turmoil, drama and uncertainty, often reflected in the financial world.
Interest rates and energy prices are just two of the big stories that have affected the social care sector. In this blog, we’ll be looking at what has shaped the industry in the last 12 months, and discuss what 2023 will bring for business owners, operators and would-be buyers.
Occupancy levels have recovered strongly since the pandemic. At Swoop, most of the homes we are assessing for acquisition funding have reached 90 percent occupancy in recent months. Arguably this could be why these businesses are on the market in the first place, with vendors trying to maximise their return whilst occupancy is high. Even so, it feels as though there’s been a return to more normalised trading following the lows of the pandemic. Lenders were broadly comfortable with dips in occupancy during the pandemic, but we are seeing requests for more information around historic occupancy (looking back at the last two or three years in some cases) to give confidence that recent strengthening occupancy isn’t out of context with previous performance.
The team at Swoop is seeing much greater emphasis on debt service calculations with an ever-increasing number of sensitivity tests, particularly around utility bills, food, and wages. Smaller homes that generate less than £100k EBITDA are increasingly under pressure from the underwriter’s forecasting methods. £100k can quickly evaporate when an underwriter is tripling utility costs, doubling food bills, and increasing wage costs by 10 or 15 percent. This is part of a gradual trend we’ve seen over the last few years and it’s likely that this will continue throughout 2023 with the National Living Wage set to increase from 1 April. To counter rising costs, we’ve seen operators increasing their fees during the year with further increases scheduled for 2023; this isn’t exclusive to private fee payers with some local authorities also agreeing to higher fees in order to retain beds in their area.
Driving much of the caution is the higher cost of borrowing following several increases in Bank of England Base Rate. In 2021 we were typically seeing combined payrates (base plus margin) of between three and six percent for secured loans, we’re now seeing variable payrates starting at around five percent and fixed rates starting at around 6.5 percent. This increase in turn feeds into the debt service calculation mentioned above, with lenders stress testing variable rate deals at around nine percent. In some cases, this is impacting the level of borrowing funders are willing to advance.
What hasn’t changed?
Secured lending margins themselves haven’t changed. High Street banks are still typically working on margins above Bank of England Base Rate of around two to three percent, Challenger Banks three to five percent and Tier 2 lenders five to six percent. If base rates peak and begin to fall in 2023, as is widely forecasted, then those opting for variable rates will no doubt be taking comfort they haven’t locked in at a higher rate than necessary for five to 10 years. The fixed versus variable decision has been a difficult call for operators and buyers during 2022, especially those that remember Base Rate peaking at around 15 percent in the early 1990s.
Loan to values haven’t publicly adjusted with lenders still offering up to 65 or 70 percent against the purchase price but with a tightening of debt service the reality has been slightly different. A reduction by stealth, then, rather than overtly amending primary criteria. The positive is that an experienced operator acquiring or refinancing a well traded home with a track record of strong profitability (around 25 percent of turnover) will still have the opportunity to apply for a high loan to value. And, lenders are still willing to support less profitable homes and new operators, but they will expect the buyer to put down a little more cash than in 2021.
Most importantly, the appetite to support businesses in the care sector hasn’t diminished. Yes, numbers and forecasts are being stress tested (in some cases repeatedly) and in some cases loan amounts have been reduced but we’re still securing funding for operators on a weekly basis, and a wide range of funders still see huge potential within the sector.
What’s likely to happen in 2023?
There appears to be a consensus amongst forecasters of a reduction in property values during 2023. How far they fall is anyone’s guess, but we know there are well capitalised investors with significant funds at their disposal ready to act if ‘opportunities’ arise. Unlike 2008/2009 most funders are telling us they’re ready to lend, and many are carrying higher targets for 2023 compared to 2022. They may be more selective about the borrower they back and/or expect them to introduce higher levels of cash to a deal but they are still motivated to advance funds. This is likely to remain the case if there’s a small downward adjustment in property prices, although lender strategies may change swiftly if the fall in prices is greater than anticipated in H1.
Taking an optimistic view, with growing demographic pressures beginning to manifest, there is an argument to suggest property values in the care sector may outperform other sectors such as hospitality and leisure. And, if we reach the mid-point of 2023 having avoided a significant drop in values, we may even see a reduction in margins from some lenders chasing deals before year end.
Given the increased lender focus on costs and serviceability there are things buyers and operators can do to get on the front foot, such as optimising utility bill contracts, business bank accounts, insurance and other supplier costs. Most of these can be investigated through the Swoop website but we also have a wealth of professional connections in the care sector that can help with procurement, accountancy, legal and care consultancy and more. We are always happy to leverage these relationships for our clients’ benefit and would welcome conversations with operators to see how we can help.
Cost control will clearly be vital over the next 12 months, but operators can’t afford to lose focus on standards of care as a downgrade in CQC or CIW rating could lead to a breach of lending covenants. This will no doubt be a tightrope for some operators, and the Swoop team will be doing everything in our power to offer support to our customers through 2023. We’ve recently had several successes for operators that have found themselves in a difficult position by working alongside care consultants (providing operational and regulatory guidance) to support our search for alternative funding solutions.
The main takeaway for the coming year remains broadly the same as last year. Commercial Mortgages are out there but need to be fought for harder than ever. A borrower that’s taken the time to understand both the operational challenges and opportunities of a care home and with a strong handle on their numbers will be an attractive proposition to lenders. We believe that having a broker on hand to help understand where the challenges lie and help negotiate terms will be vital, even for the most experienced operators.
At Swoop we love to hear from current and prospective business owners about the challenges facing them: we like to get our teeth into a project. If you haven’t signed up for Swoop, click here. Or to talk to the team about your ambitions for 2023, schedule a call here.