Matthew Wild

Written by: Matthew Wild

Matthew Wild

Partner

Continuing challenges in the care sector

  • November 2017
  • 7 minutes

The care home sector presents both opportunities and difficulties for lenders. We have seen common issues occurring and have set these out below.

Profitability issues

Whilst care home owners continue to benefit from unprecedented long-term low interest rates on their funding, profitability continues to be a key concern for both small and large operators.

Revenues are under pressure as cash-strapped local authorities continue to squeeze the fees they are prepared to pay homes for residents. The high fixed cost base of most homes means that any fall in revenue, whether as a result of falling rates, or occupancy levels, will have a significant impact on profit and, ultimately, cash flow.

While revenues are under pressure, costs are continuing to rise.

Employment costs will rise as a result of:

  • staff costs account for c.60 per cent of total costs for most operators and from 1 April 2017, the living wage (formerly minimum wage) increased to £7.50 per hour (for those over 25) which represents a 4 per cent increase from £7.20.  Further increases are expected, and by 2020 a living wage of more than £9 is forecast;
  • pensions auto-enrolment should already be in place for most operators, although the legislation provides that minimum contributions are required to gradually increase at set times. The minimum contributions are currently 2 per cent of qualifying earnings although this is set to rise to 5 per cent on 6 April 2018 and then 8 per cent on 6 April 2019;
  • continued capital expenditure costs to comply with regulation and to keep homes attractive for new users;
  • we estimate that these changes have increased average employment costs per employee by c.10 per cent in the last two years and further increases of more than 20 per cent during the coming three years; and
  • energy bills have steadily increased year-on-year and whilst there are political moves to increase regulation and limit future energy costs paid by consumers. It is currently unclear if this will assist care operators.

Contractors’ rights

There have recently been high-profile legal cases involving Uber and Pimlico Plumbers, finding operatives engaged under agreements which define them as self-employed contractors were in fact employed workers. This entitles such individuals to greater benefits and protection (ie holiday and statutory sick pay). which inevitably increases costs for the employers concerned.

Whilst in our experience such arrangements are not always a feature of the sector (most staff are either contracted or agency staff), operators should ensure suitable contracts are agreed at the outset and reflect actual working practices within the business.

Management

Management quality is a key factor for smaller operators as it is with many owner-managed businesses. In the care sector, the owner-operator is typically from a caring background rather than a business background and either acquired or expanded existing businesses as a result of generous credit terms or rising property prices.

In many of the businesses we see in the sector, whilst management could survive in benign economic times (with low interest rates), they lack skills required to drive change and turn around under-performing businesses. An engaged, well led management team that is responsive to issues facing in the sector is critical to the immediate viability and longer term success of the business.

Ownership structures

We frequently come across owner managed businesses held within complex group structures and unclear ownership arrangements (a mixture of partnerships, sole trader ships, limit liability partnerships and companies). In most cases, these structures have arisen following expansion and acquisition and a lack proper planning on the part of the owner or professional advice during this expansion.

These complex group and ownership structures can cause problems when restructuring is necessary:

  • refinancing existing lending can prove challenging as complex group structures and ownership arrangements are likely to be unappealing to potential lenders; and
  • enforcing security can prove challenging, particularly where group structures that have assets held by individuals or partnerships.

Regulation

Several high-profile incidents have placed the sector under the media spotlight and regulation continues to be a key feature as government seeks to protect the more vulnerable members of society.

Adopting and maintaining appropriate policies and procedures within homes is a key part of ensuring compliance with regulatory requirements, this clearly requires investment and ongoing monitoring by management which inevitably increases costs for the operator.  

Well-funded homes with strong management teams that are aware and compliant of current regulations and able to quickly adapt to changes are, in our experience, generally stronger financially. Unfortunately, the opposite is also often true for cash strapped undermanaged homes.

The Care Quality Commission (CQC) remains the primary regulator and ensures homes and operators comply with standards through monitoring and regular inspections. Inspection reports contain ratings from inadequate to outstanding are published on the CQC website.

As with school league tables, the public is likely to research the destination home for a loved one and an adverse CQC report is likely to result in an alternative home being sought; particularly where a service user is entering care for the first time.

Even once deficiencies are remedied and ratings improved, rebuilding occupancy is a slow process and historic adverse information on a home remains readily searchable on the internet.

Where a home is performing badly and inadequate ratings are given, the CQC will act against the home and/or operator. The action taken by the CQC can range from issuing requirement or warning notices (which set out the improvements required and by when), to closing homes and removing and rehousing residents. In extreme cases, where people are harmed or in danger of harm, operators may be subject to criminal proceedings.

Maximising value in distressed situations

Care homes are generally valued on a multiple of EBITDA which when dealing with distressed businesses often reduces value, and in some cases to the underlying ’bricks and mortar’ value of the property. There can be greater value in selling all or part of the property for redevelopment than seeking a going concern sale of the operating business although such options are becoming rare in our experience.

Whilst insolvencies are less common, and managed disposals outside insolvency are generally preferable they are sometimes unavoidable. This can lead to a period of trading (generally in administration) whilst the business can be marketed, sold and transferred to an alternative operator. Trading insolvencies are costly and when a new operator acquires the business some time may be needed to allow the CQC to approve registration of the new operator.

Summary

The sector remains attractive to investors and continues to provide opportunities given positive trends. However, regulatory compliance is vital and a strong, focussed management team will be better placed to deliver positive returns in what continues to be a challenging sector.

Lenders should monitor operators closely and act quickly in the event of either a downturn in financial performance or regulatory compliance to keep all options open and protect security value.

For more information, please get in touch with Matthew Wild or your usual RSM contact.

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