Healthcare Activos Yield SOCIMI S A : Property Report 2024

Healthcare Property Report 2024

3

The current state of health care real estate investment in Europe

get as a real estate investor is a very strong, very long-term rental profile", as Primonial put it to us. Over the next few decades there will be no shortage of investors looking for health care real estate investment opportunities, and plenty of opportunities for them to invest in.

But the short term picture is quite different. The rise in interest rates to

tackle inflation in 2022 and 2023 has negatively impacted investment flows in multiple ways. First and foremost, the increase in the cost of debt has made debt-leveraging prohibitively expensive, making larger deals for both opco and propco less viable. Some smaller deals are still happening, but in many cases without debt.

Contents
THE CURRENT STATE OF HEALTH CARE REAL ESTATE INVESTMENT IN EUROPE	2
MAIN INVESTORS	6
SECTOR OVERVIEW: ELDERLY CARE	8
CASE STUDY 1: HEALTHCARE ACTIVOS	14
CASE STUDY 2: TARGET FUND MANAGERS	16
SECTOR OVERVIEW: ACUTE CARE (HOSPITALS AND OUTPATIENT CLINICS	19
CASE STUDY 3: NORTHWEST HEALTHCARE REIT	21
SECTOR OVERVIEW: PRIMARY CARE	23
CASE STUDY 4: ASSURA	24
THE INCREASING IMPORTANCE OF ESG	26

Care home yields have risen, but much less than bonds (data provided by Cushman & Wakefield):

At the start of 2024 the short-term and the long-term view on the health care real estate investment landscape in Europe contrast sharply. Long term, the case for investing in this increasingly popular type of real estate asset is clear: the services provided by health and care providers are essential services that will always be needed; they are services that will always require a certain amount of real estate (they cannot, in contrast to some other industries, be moved entirely online);

demographic trends, in particular Europe's rapidly ageing population, means the need for elderly care and (to a slightly lesser extent) acute care capacity is only going to keep growing; the fact that a large proportion of the financingcomesfromnondiscretionary government expenditure provides a level of protection from economic cycles not seen in other sectors; and the leases are typically long term (15-20 years is typical) and inflation- backed. All this means that "what you

On top of this, the increase in the more or less risk-free return investors can get from government bonds has made investing in all types of real estate appear comparatively less attractive. Property yields have risen, but not by as much as yields on government bonds (see graph above). The corollary of this is that whilst both real estate

values and bonds values are falling, bond values are falling faster. This, in turn, can lead to a 'denominator effect', whereby the proportion of investment portfolios devoted to real estate grows whilst that of bonds shrinks, which can reduce the appetite for further real estate investments.

4

Investment volumes across Europe* 2006-2023 (data provided by CBRE):

5

their costs rise substantially over the past two years due to higher inflation and interest rates as well as severe labour shortages and increased use of agency staff. They've struggled to fully pass on these cost increases to payors and so their margins have been squeezed, and this in turn has negatively impacted the case for real estate investors to invest in health care property. And some of the larger care operators which own their own properties have a serious balance sheet problem, since they have a large amount of debt, the cost of which has increased dramatically, backed by real estate that has dropped in value, and high capex commitments on new developments. This has generated

adjusted their price expectations downwards to the same extent that buyers have, so few deals are taking place. In the UK there are still some transactions happening, but on the continent very little is happening.

Whilst there are still a small number of transactions for existing property taking place, new build activity has come to almost a complete standstill. The combination of falling real estate valuations with large increases in the cost of construction throughout 2022 and 2023 - driven by high inflation for inputs and the rising cost of debt - has meant that in most cases there's no return on investment for developers.

• Includes Austria, Belgium, CEE, Denmark, Finland, Germany, Ireland, Italy, Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, the UK and excludes France.

The precise consequences of rising interest rates vary for different types of real estate investors. Listed real estate investment trusts (REITs) have seen dramatic share price drops. Sebastien Berden, healthcare COO at Cofinimmo, one of Europe's largest REITs, explained to us that it is difficult for listed REITs such as Cofinimmo to raise capital at the moment because issuing new shares would be dilutive, i.e. the earnings per share of the company would decrease. As a consequence most REITs are currently short of cash, limiting their ability to make new investments. Non- listed, open-ended real estate funds (funds which continuously issue and redeem shares based on investor demand, e.g. Primonial's PHEF fund) are coming under pressure from

their shareholders who are looking to withdraw funds because real estate investment has become comparatively less attractive. This has forced them to sell property as it is the only way they can get the necessary cash to allow people to get out of the fund.

To make matters even worse, all the pressures that health care operators are currently facing, financially and operationally, are having a knock-on impact on their landlords, since health care real estate owner's fortunes are much more closely tied to that of their tenants than is the case with residential or office real estate (because it is much harder to replace your tenant if they become unable to pay their rent). Health and care operators have seen

significant leverage concerns in the case of Orpea, and to a lesser extent Clariane (formerly Korian), which have also been hit by a major political storm in France after the publication of a book by a French journalist alleging widespread issues with care and management at Orpea. Charles- Antoine Van Aelst, chief investment officer at Aedifica, one of Europe's biggest health care REITS, told us: "From a listed perspective, we see a lot of our investors having some doubts about the health care market currently."

Whilst demand from real estate investors to buy properties is currently lacking, there are plenty of real estate owners looking to sell. With supply far outstripping demand, the market is currently very much a buyer's market. Consequently there is downwards pressure on valuations and upwards pressure on yields. But sellers haven't

Sophie Cooper, associate director at CBRE, a global real estate advisor, tells us that despite the short term challenges interest in the health care sector remains robust with investors taking a long-term view based on increasing demand and strengthening operational performance. She expects deal volumes to return to a more normal level over H2 2024 and into 2025, as investors price in expected interest rate cuts and their demand returns.

Aedifica's Van Aelst is slightly more optimistic, predicting that if there are no major economic shocks in 2024, we should expect volumes to start recovering around mid-year in 2024: "The market should stabilise around a new balance, pushed not only by stabilisation in the financial markets but also on the operator side."

6

Main investors

Sector overview: Elderly care

9

Care homes are the most popular real estate asset for property investors interested in the health care sector to invest in, comprising 40-50% of Europe's total health care real estate investment by value over the past five years. There has also been some investment into retirement villages and assisted living facilities, especially in France, Germany and the Netherlands, although this has been much less significant, comprising less than 10% of Europe's total health care real estate investment over the past five years.

There are multiple reasons why care homes are the most popular health care asset for real estate investors. Real estate plays a crucial role in the delivery of residential elderly care, perhaps to a greater extent than in any other area of health care. This is reflected in the financials: typically around 55% of care home operators' EBITDAR goes on rent. There is no shortage of assets to invest in, with around 50,000 care homes in the EU alone, a number which is only set to grow as the continent's population ages. And a much more significant proportion of care homes are run by private for-profit operators than is the case for hospitals in most European countries, meaning more assets available to buy in sale-and-leasebacks.

For-profit care home stock in Europe's four biggest care home markets:

Over the past twenty - and especially the last ten - years an increasing number of Europe's for-profit elderly care operators have decided to go asset-light and raise capital by selling their property to an investor. This has provided a steady stream of assets for real estate investors - who have become increasingly interested in health care over the same period - to invest in. The UK, France and Germany are the countries where this has happened the most, but it has also been a significant trend in Spain, Belgium, the Netherlands and the Nordics. Italy has also seen some activity but is not seeing much currently. Currently there is no significant market for health care real estate investment in Eastern Europe, although there is no reason why one couldn't develop in the future.

In France and Germany's elderly care sectors the sale-and-leaseback trend has been especially significant, to the extent that it is now the case that the majority of for-profit-run care homes are not owned by the operator.

In the past five years, the UK and Germany have seen greater investment volumes than France and Spain. This is largely due to the fact that the elderly care markets are much more fragmented in the UK and Germany, whilst in France and Spain the big pan- European elderly care providers such as Orpea, Clariane (formerly Korian) and DomusVi, who often own their own real estate, are dominant.

Taking a long-term view, new licences for new properties are handed out as demand rises - whilst new builds are largely not happening at the moment, that is a short-term issue. The long-term increase in need will mean steadily increasing capacity, and much - perhaps the majority - of that additional capacity will be in the for- profit sector.

Additionally, a significant proportion of the existing stock is old and poor quality, and will need to be replaced or renovated. Many of Europe's care homes are poorly designed and/or too small. This is especially the case in the UK, where a lot of care homes are converted houses.

Alberto Fernandez, CEO of Healthcare Activos, a pan-European REIT headquartered in Spain, emphasised the importance of care homes being the right size to us: "A minimum size is required for the operator to get critical mass (financially, operationally and for medical purposes). In the UK 75% of private homes have less than 50 beds, which is very suboptimal. In Spain it's 50%, in Germany it's 31%, in France it's 7%. Ideal buildings should have 90-120 beds, and they should be 'sectorised', i.e. divided into smaller 'homes' or sectors of 15-25 beds) to specialise the residents and the workers, because there are significant differences in caring for physically dependant residents vs. palliative care vs. dementia or Alzheimer's."

10

In Spain new regulatory requirements have been introduced post-Covid, imposing limits on the layouts and sizes of buildings, making much of the existing stock obsolete. And across Europe much of the existing stock does not meet ESG standards on energy efficiency which investors increasingly expect.

Fernandez: "Long-term, the supply/ demand imbalance is attractive as it is a sector that requires a significant amount of investment. If you assume a 17% 80+ y.o. coverage ratio for Western Europe and the closure of 10% of existing beds due to regulatory and profitability constraints, 1-1.2 million new care home beds are needed in the next 10 years. That represents an investment of at least €150-200bn at current average construction prices. This figure excludes the significant investment that will be required in

1. rehab, post-acute, chronic and palliative centres to ease up pressure from hospitals and (ii) mental care and neuro-rehab facilities."

So there is a clear need for large amounts of investment into either new builds or renovating and/or expanding existing buildings. Fernandez and some others we spoke to expressed a preference for new builds, as it allows the investor to get involved in designing the building from scratch.

But Impact Healthcare REIT, a UK REIT focused on the UK's care home sector, told us that refurbishment, improvement and expansion of existing properties is also needed,

especially given how few new builds are happening currently with the elevated cost of construction and debt. Refurbishing and expanding existing properties is much cheaper than building new properties - both for the investor and the ultimate payor. Impact is able to rentalise investments for renovations and expansions at an average yield on cost of 8%.

There are other challenges. The inflationary pressures seen in 2022 and 2023 have been an issue across all sub sectors, but care home operators have been hit especially hard, due to labour, energy and food featuring so heavily in their costs. And the tightening of regulation since Covid and the Orpea scandal has further added to cost increases. Across Europe, regulators are increasing staffing requirements and inspections, forcing operators to comply with HR requirements in regulation. In most places costs have been increasing more rapidly than fees.

And some of the risks related to investing in care homes are slightly greater compared to other types of health care real estate. There is probably a slightly greater risk of an elderly care provider becoming embroiled in a reputational scandal which impacts its ability to turn a profit and pay rent than there is with acute care. The Orpea scandal which began in France in 2022 and has had a major knock-on impact on the entire French sector, shows just how bad things can get for elderly care providers.

11

And the competitive pressures are greater than in other areas of health care. A hospital is unlikely to have its patients drawn away by a new hospital being set up down the road, but for care home operators this risk is ever-present.

All the investors we spoke to emphasised the importance of investing in the right care home, with the right design and amenities, in the right location and run by the right operator.

The falling risk premium (difference between care home yield and yield on 10-year government bonds) for investing in care homes since 2021 (data provided by Cushman & Wakefield):

According to Stephane Pichon, the reputational and political risks were not completely priced into market valuations pre-2022, but now the pendulum has swung the other way, "maybe too much". Sellers have, however, been reluctant to accept the lower valuations that potential buyers are now expecting. So valuations

12

have fallen (and yields have risen) but they haven't fallen anywhere near as much as government bond valuations, or by the amount that would be required to bring demand back into balance with supply.

With the demand-supply imbalance, care home investment volumes dropped by around a quarter in 2022. They would have dropped a lot further in 2023 had it not been for one very large acquisition: Primonial REIM's acquisition of Icade's health care portfolio, for around €7bn.

13

Andrew Cowley, managing partner at Impact Healthcare REIT, tells us there will be a lot coming up for sale in the UK market in 2024: "There are a number of larger groups who for different corporate reasons want an exit. A lot of successful mid market operators were founded in the '80s and '90s and the founder is now 72 or

73. The government might put up capital gains tax. It's going to be interesting to see how it plays out."

With the demand-supply imbalance, care home investment volumes dropped by around a quarter in 2022

But there are still plenty of properties available to buy. Continental Europe's two elderly care giants, Orpea and Clariane have historically owned around 50% of the real estate they use, but both are now trying to sell much of it off to shore up their finances. However, with current market conditions they aren't having an easy time finding buyers.

So there will be some deal activity in Europe in 2024, although it remains to be seen when the market will return to pre-2022 levels of activity.

Some notable care home acquisitions in 2022 and 2023 (data provided by Cushman & Wakefield):

European* care home investment volumes 2016-2022 (data provided by Cushman & Wakefield):

*Belgium, Finland, France, Germany, Ireland, Italy, Portugal, Spain, Sweden, The Netherlands and the UK.

14

CASE STUDY 1:

Healthcare Activos

15

• Medium-sizedEuropean REIT with operations in Germany, Portugal and Belgium, as well as Spain (where it is headquartered)
• Soon to have a presence in Ireland, France and Italy
• Currently owns 65 properties in its ~€1bn portfolio, 12 of which are new builds still under construction
• Growing this portfolio through acquisitions as well as new builds
• About 70% of its portfolio is care homes; the remaining 30% includes hospitals, outpatient clinics, diagnostic centres, rehab clinics and psychiatric facilities

the building. We don't wait for the operator to design it, if the operator doesn't like the design then we may not be the adequate partners. We build it ourselves. We take construction risk. We know it is an asset that is bullet proof for the next 25-30 years."

Activos has a strong focus on efficient building design (both economically and in terms of quality of care). One way in which it achieves this is through 'sectorisation', which means having

a sector for palliative care. That's why we're shifting from elderly care to mid and long term stay.

"We tell investors we are not the fastest growing, nor the most profitable, but we are the safest. Why? Because we understand the operations so well. We apply a conservative rent. If the operator is profitable after paying the rent, then they will always pay their rent. All our assets perform very well. Throughout Covid we had zero defaults

Activos makes for an interesting case study because it takes a more hands-on approach than other REITs. While investing in health care real estate generally requires some level of understanding of the tenant's operations, Activos takes this to the point of drafting their own full-blown business plans for their tenants, complete with staffing sheets and fully-costed P&Ls.

Alberto Fernandez, Activos' CEO, tells us: "I have a financial background, but everyone else in the management team is a former operator. We know not more but also not much less than the operator.

"We approach everything we do from the long term fundamentals. We always

ask: what is the sustainable long term P&L, the catchment area dynamics, is the design of the building adequate long term? We never buy an asset if we aren't capable of building the full long term P&L from scratch."

This means Activos never buys a portfolio of assets: "Every single asset we've bought, the decision has been an individual decision. In health care a bad asset is a bad asset forever. And a bad asset can have infinite negative value - it can ruin your entire portfolio."

And, where possible, Activos prefers to build the properties from scratch: "We think greenfields are the best asset you can have, not because of the yield, but because you can select the location and catchment area. We can design

the accommodation divided into living units ('sectors') of no more than 15-25 residents.

"More and more elderly care assets are hard to define. 'Sectorisation' is the future - small sectors of 15-25 residents, with each sector having its own living unit, dining unit, nursing station, but in a bigger building with five to seven sectors in order to get economies of scale to make it profitable. In a 100- bed facility you'd have five sectors of 20.

"If you define it well, you can build your sites so that they have traditional high acuity elderly care, but also a sector for rehab, a sector for mental health,

and zero late payments. We're about to do a third round of full CPI impact to our rents, across every single one of our leases. We believe this is quite unique in Europe."

ALBERTO FERNANDEZ

CEO

Healthcare Activos

16

CASE STUDY 2:

Target Fund Managers

17

"Doing new builds allows you to get involved in designing the layout. You can optimise for efficiency, and can make sure all the bedrooms have wet rooms. We're also passionate about our homes having balconies and roof terraces - it's much better if everyone has space on their own level where they can get fresh air.

every single home they operate."

The majority of the revenue in TFM's care homes is private pay. "We never set out to be all private pay or whatever. But if you're entirely local authority funded you probably can't maintain your margin. With private pay you can put up prices a lot more easily. In reality ours will be a mix, but we are more

• A more niche UK health care
  REIT
• Focused exclusively on the UK's elderly care sector
• Owns around 110 care homes
• Portfolio size of around €900m

"When we set up the business it was on the back of being aware of the poor standard of physical real estate in the UK's elderly care sector. We said we need to do something to change that," John Flannelly, TFM's head of investment, tells us.

"We're passionate about making sure we only invest in best-in-class buildings, in which all the rooms have wet rooms en suite, that are nice places to live and good places for staff to work, with good amenities for both staff and residents. In the UK only 31% of care home bedrooms have a wet room ensuite, whilst in prisons all have wet rooms en suite. This has changed over time - it was only 12-13% when we started, so there's been some progress.

JOHN FLANNELLY

HEAD OF INVESTMENT

Target Fund Managers

"Some of the old ones we've seen have been dreadful. I was in a converted old home in England a couple of years ago. It was a house that had been extended into the back garden. It was a bit of a labyrinth, with very narrow corridors

• you had to walk all the way back to reception to let people pass you. This is an extreme example. But a lot of purpose built care homes built in the early '90s have very narrow corridors, they've crammed a lot into a small space. These are not spaces I would want my parents to live in."

TFM invests in new builds as well as existing properties. It currently has four under development, and typically builds about this many each year.

"In the team we have several operational experts, nurses, builders (they're very good - effectively amateur architects). We don't design/build ourselves, but we do set requirements for the builders and designers (which sometimes they reject). We derisk: we don't fund it until we've got planning permission and the occupier is signed on. We've been doing it long enough that any developer's profit is at risk before any capital from us, so we've never had a problem with something costing more than we've committed. We're pretty prudent and cautious. We probably see 100 development opportunities every year and end up funding only a few."

TFM prefers to work with smaller operators: "I think the bigger the group is, the harder it is to manage. If the business is run out of Paris or Brussels, it's not going to have its finger on the pulse of what's happening in Barnsley. Even within the UK context, big operators tend to not do as well as small and medium sized. We think each market is a local market, and it's better if it is locally managed. The operator needs to be really engaged in

towards private pay. If you had at least 50% residents privately funded (most of ours will be more, some are 90% or 100%, most are at least two thirds), if you have 7-8% cost inflation and local authority fees are only increasing 1-2% per annum, you can compensate by increasing private fees by 10-11%. It's a harsh fact that in the UK private fees subsidise the state.

"Private pay-focused care homes do tend to get slightly better margins. Before this current inflationary period private fees were probably increasing 5-6% per annum, and local authority fees were probably going up a bit lower than inflation. Care home cost inflation is typically higher than CPI. The government has been consistently putting the minimum wage up, electricity and energy, and food costs typically rise above inflation as well.

The current cost of living crisis has made it easier for operators to pass on cost increases to private payors: "when operators write to families to say 'my costs have gone up x%', to justify 10-11% fee increases, in the last year or two families have hardly pushed back on that because they see inflationary

18

spikes in their own household budgets. And post-Covid people are much more understanding of the great job care home workers do. So operators have been able to achieve slightly above- inflation fee increases. Rent cover is at pre pandemic levels, occupancy is a few percentage points lower. This is the same for our peers as far as I'm aware. It will be interesting going forward: when inflation comes down, will people expect fee increases to be in line with it?

"And in the last few years local authorities have been increasing fees. Covid put a spotlight on the sector. But I suspect the big fee increases are going to stop - authorities are not going to be able to afford to do another 4-5% increase next year. We still want to have two thirds of our homes' revenue coming from private pay, so we're not too exposed to that, and we have a bit more control of our top line.

"Our investment thesis is to work with operators that know what the cost of care is, so that each year they have the ability to adjust based on cost increases and maintain their margin, for the most part our tenants are able to do that."

Flannelly emphasised the local nature of the care home market. "Occupancy across UK care homes is probably about 87% (up from the low 70s at the peak of the pandemic). We tend to expect ours to get to 92%. So technically there isn't an undersupply overall. But in some locations there is - every area is a local market. We've had managers come

and say 'this area looks attractive', and then five or six new homes are built there. But everywhere there is a massive undersupply of quality beds. Sometimes when doing due diligence in a location, we have people say 'please build it' to us.

"There was a magnificent home in Exeter making huge money, everybody thought it was alovely home but the price was crazy. Three operators who were looking went and bought their own land and built their own homes and now that home can't get anywhere near as much

because there are 200+ new beds in the area. So the market works these things out. My father-in-law is in the only nice care home in town I live in, and a brand new home is getting built around the corner because other people have spotted the opportunity. We're taking a long term view, we see some of these windfall opportunities but we always ask whether it will work long term.

"Fees need to be commensurate with the fair fee for care in the market. You can get a small premium if the care is really good. If you see reviews on Carehome.co.uk (which is like Tripadvisor for care homes) with everyone saying they are happy with the service, people are generally willing to pay an extra £200, and I think the operator does deserve that. If you're only getting a premium because you're a local monopoly, another operator is going to see that opportunity and come in. It's very competitive in some ways."

19

Sector overview: Acute care

(hospitals and outpatient clinics)

The acute care sector is the second most popular health care vertical for real estate investors, comprising 25-30% of European investment volumes over the past five years. Typically real estate investors and analysts lump acute inpatient and outpatient facilities together under a broad definition of 'hospitals'.

Investment volumes in this vertical tend to be lower on an annual basis than for elderly care, primarily because there are fewer hospitals available to invest in and they are a much bigger ticket - and therefore less liquid - investment. On top of this, most European hospitals are operated by the public or not-for-profit sector and are therefore unlikely to come up for sale.

This also means investment volumes for private acute hospitals have been less consistent than volumes for care homes. There was a lot of activity in 2019 and 2020 in the UK, but by 2020/2021 much of the investable standing stock had been transacted and volumes dropped again. CBRE's Sophie Cooper tells us this had evolved into a typical three/four year cycle which repeats, but that the strategic positioning of independent hospitals alongside state hospitals is creating a new investment opportunity that previously didn't exist.

The UK and France have seen the most investment over the last five years, whilst Germany, the Netherlands and Spain have also seen some activity.

Investing in hospitals and acute outpatient clinics requires a slightly greater level of operational and medical expertise than care homes - just as with care homes, real estate investors have to have a fairly detailed understanding of the operations, but for hospitals these operations are more specialised and complex. Consequently there are fewer REITs investing in hospitals than in care homes.

On the other hand hospitals have a certain degree of security not afforded to care homes. The higher capex costs and greater requirements for medical specialism comprise significant barriers to entry. This means there is less risk of a new hospital being set up down the road and taking all the patients in the area than is the case with a care home; if you own a hospital in a location it's more difficult for someone to invade your catchment area. On top of this, effort rates (the proportion of the operator's revenue spent on rent) are much lower for hospitals, as they have much greater capex costs.