Fundamentals remain strong
Civitas Social Housing’s (CSH’s) discount to net asset value (NAV) has yet to recover from an activist short seller attack last year, with its share price almost as low as it has ever been in over five years since it launched. Although CSH’s manager made a strong rebuttal to the allegations made by the short seller, regulatory concerns around the financial strength of some of its housing association tenants has persisted throughout its existence. To aid regulatory compliance, CSH plans to add a new clause to leases that would enable greater risk-sharing with the housing associations and allow them to temporarily stop paying rent in certain circumstances.
The fundamentals that support growth in the sector remain strong and aren’t going away, namely increased demand from individuals and a lack of supply. The high dividend yield/large discount to NAV that CSH’s shares are trading on seem appealing.
Income and capital growth from social housing
CSH aims to provide its shareholders with an attractive level of income, together with the potential for capital growth from investing in a portfolio of social homes. The company expects that these will benefit from inflation-adjusted long-term leases and that they will deliver a targeted dividend yield of 5% per annum on the issue price, with further growth expected. CSH intends to increase the dividend broadly in line with inflation.
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CSH’s share price has struggled since a short seller attack last year wiped almost a quarter off the value of the company (you can read a detailed analysis of the short seller’s allegations and CSH’s rebuttal in our last note on CSH here). The share price has yet to return to anywhere near the levels of early in 2021, despite almost all the points made by the short seller being proved to be unfounded.
The main point raised that was irrefutable centred around disclosure of interests in a small number of ‘Opco-Propco’ investment deals (an Opco-Propco deal involves spinning off or selling the property owned by business, leaving the operational business as a standalone entity). In this case, these deals involved CSH bidding in tandem with a care provider to buy a care business – whereby CSH would acquire the properties and the care provider would buy the operating businesses. The company did not declare to shareholders that two directors of its manager, CIM, also owned a stake in the care provider, which was specifically established to work alongside CSH on a non-exclusive basis to acquire the care operating businesses and so enabling CSH to acquire the respective real estate assets.
CSH argued that by declaring the particulars of the deals it would lose significant competitive advantage over peers in sourcing these investments. Neither director made any economic gain from the setup, it added. Even though there was no legal or regulatory requirement to do so, we feel that CSH made a mistake in not disclosing the information about the transactions at the outset, and we are pleased that it has since committed to doing so. In our estimation, the decision not to disclose information was not done out of deceit but was a genuine attempt to gain a competitive advantage.
We continue to believe that from an operational viewpoint, the business is in a strong position. However, in defending itself from the short seller, CSH put a planned capital raise to grow its portfolio on ice and has shrunk in size in an attempt to moderate its discount. Until the share price recovers, the group cannot grow meaning that potentially thousands of people in need of the specialist social housing that CSH invests in – many of which have high-acuity care needs – are stuck in care homes and NHS beds and costing the UK taxpayer far more than they would if they were in specialist supported accommodation. The fundamentals that support growth in the sector remain strong and aren’t going away.
Substantial savings are available to local authorities if they can rehome a person in need of supported living (for example, people with learning disabilities, autism, mental health issues or physical disabilities) from a hospital into a property adapted to their needs. Research has also shown that these tenants then have an improved quality of life and better medical outcomes. Local authorities turn to care providers to manage the day-to-day welfare of the tenant and to housing associations to provide the accommodation. The housing associations lease property on a long-term basis from the likes of CSH.
The fundamentals that underpin the supported living sector – namely, the chronic shortage in supply of appropriate accommodation for the delivery of mid- to higher-acuity care, and growing demand – the better health outcomes that specialist supported housing brings to occupants – and the substantial cost saving to government – are only intensifying.
The Personal Social Services Research unit has predicted 30% growth in the demand for specialist supported housing in England by 2030 and 55% in respect of learning disability alone, as shown in Figure 1. Meanwhile, the National Audit Office has forecast a 29% increase in adults aged 18 to 64 requiring care by 2038, compared to 2018.
On the supply side, Mencap states that a significant undersupply of specialist supported housing has resulted in a significant number of people with long-term care needs living with elderly parents, and over 2,000 people with a learning disability being placed in inpatient units, miles away from their family. The supply of social housing in the UK fell from around 7m in 1980 to 5m in 2018.
New lease clause in bid to achieve regulatory compliance
In an effort to address repeated concerns raised by the regulator in regards to the leased-based social housing model – namely the financial weakness of the housing association tenants and the mismatch of long-term lease liabilities and short-term income streams – CSH intends to add a new clause to leases that would enable greater risk-sharing with the housing associations. The clause would allow a housing association to temporarily stop paying rent in certain circumstances, such as if it had not received housing benefit from a local authority. This would apply after an initial period of time, and then only if paying the rent in full would cause the housing association to fail to meet the regulator’s standards. CSH would receive rent arrears as and when the housing benefit is subsequently received by the housing association. Under the terms of the clause, the housing association would provide CSH with full data and step-in rights (which allow one party to a contract to ‘step into the shoes’ of another party in certain circumstances).
CSH’s manager says that it anticipates that the clause will only be relevant to a small number of properties at any one time, and will not have any material impact on the company’s rental income.
The manager hopes that the move will enable the housing associations to be in a better position to achieve regulatory compliance with the RSH’s Governance and Financial Viability Standard and lift the long-standing cloud of regulatory uncertainty over its share price. Judgments passed by the regulator on CSH’s tenants are usually followed by a drop in CSH’s share price.
CSH intends to initially incorporate the clause into a limited number of existing leases on unencumbered properties. If the clause is well-received by stakeholders in the sector, it will be rolled out across the portfolio. The manager says it has formal written confirmation from valuers that the inclusion of the clause within new and existing leases will not impact on the value of the leases or assets. The manager believes that the enhanced regulatory alignment would, in fact, result in asset value appreciation over the medium term.
CSH’s leases are linked to the consumer price index (CPI), with its housing association tenants seeking sign-off from the relevant housing benefit officers within each local authority in which they operate for this amount. With inflation soaring to 9%, as measured by CPI, and forecast to increase further this year, this may give some cause for concern about the affordability of specialist supported housing. Across CSH’s portfolio, 27% of rents benefit from indexation at CPI+1%, with the balance of 73% at CPI. Additionally, 31% of rents are subject to a cap of 4%.
The manager says that it has engaged with its housing association tenants, who have confirmed that they have in recent months continued to achieve positive settlements with local authorities that reflect the current higher levels of inflation. The manager says that it will continue to monitor the situation but so far sees no sign of issues. Inflation uplifts come into effect on the anniversary that each lease was signed (with the CPI rate usually backdated two months to ensure availability of data) so the higher rates of inflation over the past few months may not filter through for some time.
The manager says that rental levels across its portfolio are regularly tested for affordability and agreed with housing associations. It adds that rent levels vary significantly, as they do in the general housing sector, depending on their location, as well as their use (properties that deliver high-acuity care will be more expensive than mid-acuity due to the extra cost of adapting the property), but usually make up a small part (10% – 15%) of the overall cost of the delivery of high-acuity care provision.
CSH has previously indicated that the average weekly rent for a mid-acuity property in its portfolio is £194 (which is in line with rents quoted by Mencap) and £311 a week for very high-acuity residential care accommodation. In both cases, this represents a significantly lower cost than other forms of accommodation such as institutional or hospital care. CSH’s small portfolio of properties for homeless individuals or refugees (see page 8 for more detail) have an average weekly rent of £124, due to the lower level of adaptation needed to deliver the care required.
CSH’s portfolio was valued at £946.3m (at 30 September 2021) and comprises 696 properties, let to 18 housing associations, with 4,592 individual tenants. The weighted average unexpired lease term (WAULT) on the portfolio is more than 22 years.
So far this year CSH has completed the acquisition of 47 four-bed properties in Yorkshire and Humberside for a total of £8.1m. It has signed an inflation-linked lease with Qualitas Housing and benefits from an underlease (sub-letting) with a leading national housing provider holding a long-term Government contract to deliver asylum accommodation. The properties are immediately income producing.
In 2020, CSH expanded its investment horizon to include other types of social housing including accommodation for homeless people. Properties providing homeless/asylum seeker accommodation now represent 3.7% of the company’s portfolio by value following the recent deal.
Strong ESG credentials
Investment in supported living has an obvious positive social impact. Investments are designed with the intention of enhancing the lives of people who, as a result of the homes, are able to benefit from the availability of secure, long-term, high-quality housing, whether of a general nature or as a base for the provision of more specialist housing and care.
According to social advisory firm The Good Economy’s Social Profit Calculator (SPC) – a social value consultancy that specialises in calculating the additional value of social, economic, and environmental impact – the social value of CSH’s portfolio in monetary terms was £127m of social value per year in 2021. This total social value figure was split between £51.2m of social impact (this is the value of the improved personal outcomes for residents) and £75.9m of fiscal savings generated for public budgets through the reduced cost of care packages. The total figure equates to £3.51 of social value being created for every £1 of annualised investment.
CSH is also pressing ahead with plans to increase the environmental credentials of its portfolio. It has an agreement with energy provider E.ON to undertake environmental enhancements that will help to reduce the carbon footprint across its portfolio and reach carbon neutrality.
The manager says that it intends to expand the environmental-enhancing schemes across its portfolio over a number of years. As well as having the obvious environmental benefits, improving the energy efficiency of homes should also provide a small increase to the value of the portfolio, the manager believes.
Dividend target increased
CSH’s board is targeting a dividend of at least 5.7p per share for the financial year ending 31 March 2023, 2.7% above the 5.55p per share it has paid for the year to 31 March 2022.
As mentioned earlier, the effect of a jump in inflation is not immediately reflected in the leases. The average increase in CPI since March 2019 (when the company completed payment of the first full annual dividend) to the end of March 2022 was 2.6% a year and compares to an average increase in the company’s dividend of 3.3% a year over the same period.
CSH publishes two NAVs – an International Financial Reporting Standards (IFRS) NAV, which reflects the value of the portfolio if it was sold off on a piecemeal basis, and a portfolio NAV, which is based on the value if it were to be sold as a single portfolio. This is generally higher than the IFRS NAV, reflecting the fact that the properties are held in special purpose vehicles and attract a lower tax charge than selling properties individually. At 31 March 2022, the IFRS NAV was £675.5m or 110.3p per share. On a portfolio basis, the NAV was £752.3m or 122.84p per share.
CSH’s share price fell sharply in August 2021 after it was targeted by the activist short-seller. This coincided with the company dropping out of the FTSE 250 index, which saw index trackers sell out of their position in the fund. The share price has yet to recover its losses. It had been on an upward trajectory since June 2019, apart from the COVID-19 induced blip in March 2020 when its share price crashed as part of a wider sell-off due to fears over the pandemic. The share price quickly regained all its losses as investors recognised the strength of its government-backed income. Its NAV has trended upwards since its launch and over five years the NAV total return is 36.8%.
Peer group comparison
CSH sits within a small group of listed peers comprised of Triple Point Social Housing REIT (SOHO), Residential Secure Income REIT (RESI) and Home REIT (HOME).
RESI’s focus is more on retirement properties and shared ownership housing (without leases), whilst HOME launched in October 2020 and is solely focused on providing homeless accommodation. Therefore, SOHO may provide a better direct comparison.
CSH is larger and has a longer track record than SOHO, a greater yield and a comparable performance over all periods to three years in both price and NAV terms.
CSH’s shares initially traded at a premium to its IFRS NAV, but moved to trade at a discount due to the concerns that the regulator highlighted regarding some of the housing associations in its portfolio. As the company demonstrated the underlying fundamentals supporting growth in the supported living sector and its leading position in it, the discount narrowed from July 2019. Following the short seller attack, the premium narrowed from a peak of around 10% in August 2021 to a discount and has yet to recover. At 25 May 2022 it was trading at a discount of 22.9%.
To defend its discount following the short seller attack, CSH has been repurchasing shares (it is authorised to repurchase up to 14.99% of the issued share capital). As at 25 May 2022 CSH had repurchased 11.725m shares to be held in treasury since 20 September 2021 at an average price of 91.2p per share and a cost of just under £10.7m. This represents 1.88% of the issued share capital.
CSH has invested £835m to amass a portfolio of diversified supported social housing assets since it launched on 18 November 2016. It raised £350m at IPO and expanded in November 2017, raising an additional £302m through a C share issue (whereby C share investors own a separate class of shares which has its own portfolio). These two pools were merged together in December 2018.
CSH aims to provide an attractive dividend yield, with stable income growing in line with inflation and the potential for capital growth. Its diversified portfolio is let to housing associations and local authorities (referred to as registered providers) on long-term lease agreements, typically 25 years. It buys only completed homes, which includes acquiring new developments on completion, but it does not get involved with forward funding deals (putting up money to finance the construction of new social homes), or the management of social homes directly.
CSH’s portfolio has a low correlation to the general residential and commercial real estate sectors, as the supply and demand demographics driving the social home sector do not move in line with that of the wider real estate market. It is a real estate investment trust (REIT), giving it certain tax advantages. As a REIT, it must distribute at least 90% of its income profits for each accounting period.
The adviser – Civitas Investment Management
CSH is advised by Civitas Investment Management (CIM), previously named Civitas Housing Advisors, a business established in 2016. Many of the 40-strong team have long experience of working in the sector and in specialist healthcare, and collectively they have been involved in the acquisition, sale and management of more than 80,000 social homes in the UK.
QuotedData has published seven previous notes on CSH. You can read them by clicking the links below.
|Figure 10: QuotedData’s previously published notes on CSH
Source: Marten & Co
The legal bit
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