Investors shy away from care homes as operator insolvencies rise sharply

A wave of insolvencies in Germany's care home sector is scaring off investors in an asset category that, until recently, was seen as a one-way bet on Germany's ageing demographics.

The latest large nursing home operator to file for part-insolvency is Dorea GmbH, which applied last week to the Berlin-Charlottenburg District Court for protection from its creditors while it tries to restructure itself. The filing affects 25 of its operating companies including about half of its nursing homes and assisted living facilities. The company operates 80 in-patient facilities, 17 assisted-living sites and 9 outpatient care services.

For the moment, Germany's Federal Employment Agency is stepping in until end-June to cover the wages and salaries of Dorea's employees while the restructuring is underway. Dorea's management blames the increased costs for energy, rent and materials for its difficulties, while the Corona period would have eaten up the reserves, it said. The company, which is part of French group Maisons de Famille, turned over €280m in sales in 2022.

There's no doubt that investors have taken a major step back from investing in the Germany healthcare property market, cautious of making ongoing assumptions about the financial viability of many facility operators, who are now facing a range of new problems in trying to stay profitable.

In this year first quarter, figures from CBRE show that transaction volume in the German healthcare real estate investment market was €407m, down 39% on the corresponding figures last year. International investors' share fell 21 percentage points to 15%, while portfolio transactions rose by 17 percentage points to 38%.

The focus of investment activity was on nursing homes, which accounted for a share of 47% - 17 percentage points less in the prior-year period. Assisted living accounted for a share of 43%, up ten percentage points. Over the past twelve months, the peak net initial yield for nursing homes rose by 0.7 percentage points to 4.6% - 0.2 percentage points of this increase is attributable to the first quarter of 2023 alone. 

Dr. Jan Linsin, head of research at CBRE Germany, said the Q1 result was in line with the 10-year average for the corresponding quarter, but that the interest rate climate had made investors cautious, while uncertainty surrounding operators' financial health was dragging the market down. Linsin said, "This is another reason why it is important for operators to become more transparent to investors - similar to the hotel market, where a corresponding development of business practices has proven successful. Nevertheless, operator risk is overestimated by many investors, as it is becoming apparent that there is great interest in the market from other operators to take over properties affected by operator insolvencies on comparable terms."

His colleague, Tim Schulte, senior director for valuation services at CBRE, pointed to the role being played by ESG in evaluating healthcare assets. "Many investors and banks no longer look at properties that do not meet ESG criteria at all. This is because ESG risk is added to operator risk. The exception is a few experienced players who can also better assess existing properties and their ESG potential or hurdles."

"Given the challenges, it is not possible to forecast how the healthcare real estate investment market will perform in 2023," said Schulte. "It is becoming increasingly clear that the state must create better framework conditions in order to put the financing of care and thus of urgently needed senior real estate back on a more stable footing. Otherwise, Germany faces a glaring shortage of care places," he warned.

Max Eiting, associate director for operational capital markets at Savills, says that within the healthcare sector, assisted living and medical specialty centres were still enjoying investor favour, largely due to the greater independence of their operators and better third-party usability. "However, while more product is available for investors with a higher affinity for risk, suitable supply for risk-averse investors is scarce. Basically, there are big differences between the price expectations of owners and investors," he said.

But overall the segment lacks core products, especially in nursing homes, making the market increasingly a playing-field for real specialists. "The search for possible replacement operators in the event of insolvency, the adaptation of properties to new state home laws or even the refurbishment of older stock requires extensive detailed knowledge as well as distinctive asset management skills. Accordingly, value-add strategies are likely to become formative for the nursing home investment market," said Eiting.

The trend reversal in investors' seemingly undying love for the sector comes despite Germany's ageing structure, which resembles an inverted pyramid with a preponderance of oldies at the top. Investing into the sector seemed like a no-brainer. The market seemed to come up with imaginative new products on almost a weekly basis, in the form of special funds, new bond issues, or even as timeshare-like offerings where individual investors could buy units within a healthcare complex. But one factor was never fully taken into consideration - operator risk. This is now coming back to bite investors, and casting a shadow over the sector.

This new combination of economic uncertainty, the effects of COVID, a shortage of personnel and soaring operating costs have thrown the traditional operator model into chaos. Many operators are now close to insolvency, threatening to add to a recent list that includes big names such as Primus Concept, Convivo, Curata, and the developer Terragon.

So, while the forecasts for long-term demand for age-appropriate living and care facilities remain on track, the big problem is in the short term where operators are struggling, and their business models aren't working. Matti Schenk, associate director research at Savills, puts it bluntly: "The financial pressure on nursing home operators is getting stronger. Higher wages in the wake of the Tariftreuegesetz, significantly increased costs for energy and consumables as well as increased lease payments due to indexation clauses are leading to massive cost increases. 

"At the same time, investment cost rates, for example, are rising only slowly and, in the opinion of many market observers, too little. The imbalance between costs and revenues is thus growing. What's more, if operators are short of staff, they cannot fully utilize their nursing homes and their income actually falls. Even seasoned operators are therefore under financial pressure. The sword of Damocles of operator insolvency is literally hovering over the market. 

"Because there is a risk that lease payments will not be made, many investors are reluctant to buy both project developments and nursing homes in need of conversion and refurbishment. This capital will be lacking to realize the necessary expansion of bed capacities and the upgrading of older existing buildings. As a result, the shortage of nursing places is likely to become even more entrenched."

Officially, Germany has about 11,700 nursing or care homes, and there have always been isolated insolvencies. Not all of these involvencies have resulted in the home closing - frequently they've been take over by other operators, or have been refurbished, often with state subsidies, and carry on. However, according to portal Pflegemarkt.de, last year 142 homes closed permanently, along with 431 outpatient facilities. In the first quarter of this year there have been at least 200 further insolvencies, with private employer organisation Pflege AGVP warning of a gradual "dying out of homes". A real problem, with the number of those in need of care rising from its current 5 million to 5.6 million by 2035, according to the Federal Statistics Office.

Operators complain that part of the problem is the under-financing of the healthcare insurance market, which is supposed to fill the gap between what patients can pay themselves and the costs of their care and lodging. The operators are increasingly finding that their negotiations between insurers and state subsidies, plus the patients' own resources, are leading to an ever-wider gap. On average, in 2023, patients have to stump up more than €2,400 per person, monthly - impossible for more than a third of patients, who are dependent on state help, according to the national insurers' association, the Spitzenverband der Gesetzlichen Krankenversicherung.

Further figures show that nursing homes need to operate at at least a 95% capacity to cover their own financing costs. Should a patient die, that room needs to be re-occupied three days later - humanly barely do-able. But most operators are achieving at most an 85% occupancy rate, due to the shortage of qualified personnel.

Figures indicate that the care sector is suffering more than any other sector from a shortage of qualified labour. A study by Germany's Institut der deutschen Wirtschaft (IW Köln) points to a shortage of 18,000 qualified workers in the sector (not support staff). If it took four months in 2015 to fill a qualified position, that has gone up to more than nine months now, says the study. New guidelines coming into effect in June may worsen the situation, by raising the qualifications necessary to carry out certain jobs, in an attempt to raise salaries and working conditions for staff. This could wipe another nearly 50,000 jobs from the sector, according to observers.

Operators report that attempts to hire suitable candidates from the Philippines fall at the requirement of at least eighteen months German language learning first before taking up their jobs. Visa hurdles for other potential staff from India and Tunisia, for example, have also made hiring potential staff from those countries unworkable. For many operators, the only solution is hiring more temporary workers, from labour agencies, whose costs can be nearly twice that of regular staff. Not surprisingly, many regular staff are now jumping ship to work for these agencies, where they can earn more and have more say in the hours they get to work. Or they're choosing to work in hotels or restaurants, or do other jobs, where the pay and the hours are more suitable

When interest rates were low, investing in the healthcare sector was very profitable for private equity investors, who promised THEIR investors juicy yields by squeezing the operators to ever-higher levels of performance. This led many operators to take on more borrowings, creating ever-bigger portfolios to achieve effects of scale. Rising interest rates have now trapped many of these operators who expanded too fast, including the recent high-profile insolvencies. Investors are going to be looking at the health of their operators far more closely under these new business conditions.