High interest rates and sticky inflation have forced Target Healthcare (THRL ) to cut its dividend target by 17%.

At half-year results today, the £417m care home investor said it would ‘rebase’ its annual distribution target to a more ‘sustainable’ level of 5.6p per share compared to the 6.78p it worked towards last year.

The company said this would enable the dividend to be covered by earnings and set a platform for future annual growth.

The quarterly payer maintained its first half dividend for the six months to 31 December at 3.38p, in line with the previous target.

Shares in the real estate investment trust took the news well, steady at 67p. However, they trail on a 35% discount to their net tangible equity of 103p and have fallen 34% in the past year following the sector’s derating in response to surging bond yields in the second half of 2022.

Uncovered dividend ‘a problem’

Numis Securities analyst Colette Old was positive about the move which cuts the Reit’s yield from 10% to 8%. 

She said: ‘We believe the uncovered dividend was a problem for THRL’s rating, which trails that of Impact Healthcare (IHR ) on a 16% discount, 6.54p dividend representing a 7% fully covered yield.

‘We view the rebasing as a sensible and necessary move for THRL and would expect the rating of the two care home Reits to start to trade more in line.’  

Kenneth Mackenzie, Target’s founder and chief executive, said while the care home sector had welcomed the ‘easing of the persistent impacts of the pandemic’, it was now being hit by ‘inflation on the costs of delivering care’.

Alison Fyfe, who has replaced Malcom Naish as chair, said conditions in the care home sector had changed dramatically. ‘Inflation appears to be more persistent than many forecasts, and interest rates have reached 14-year highs, meaning our marginal rate of financing currently exceeds the initial rental yields we can obtain on new investments.

‘This changes our view on what earnings levels are achievable,’ she said, pointing how net initial yields on the prime, long-dated properties the Reit liked to buy had fallen from 7.3% to about 5.5% in the past seven years. 

The interims showed a like-for-like 5.5% fall in the value of its modern care home properties in the six months to 31 December as the entire real estate asset class was marked down in response to the rising cost of finance.

Fyfe said this was a ‘stable and resilient’ performance compared to the 19% slump in UK commercial property as a whole.

Rent from the 33 tenants operating 97 homes providing over 6,000 beds for residents, grew 2.9% over the six months to £57.1m and rent collection was 96% over the period.

However, the company’s portfolio ‘has a bias towards the private fee payer’ and there is ‘long-term evidence that this group is accepting of higher fees, particularly for quality real estate and care services’.

Recruitment problems ease

While there are well-documented staffing issues in the care sector, and costs are increasing with inflation, Mackenzie said this was ‘to be expected and encouraged’ and operators are ‘reporting easing in staff availability challenges’.

‘Visa programmes have helped, and many of our tenants have used these to sponsor overseas staff to fill a number of vacancies,’ he said.

‘All-in-all, we see underlying tenant profitability improving across our portfolio even while occupancy continues its recovery to pre-Covid-19 levels of 90%.’

During the six-month reporting period, the group completed a development in Weymouth in Dorset, adding 66 new beds to the portfolio, and signed a 35-year lease with a new tenants. 

This year saw the sale of a further four homes for £22m, with the pricing ‘ahead of both carrying value from June 2022, prior to the general decline in property valuations seen through the second half of 2022, and that of December 2022’.

Mackenzie said the investment market had ‘shown some signs of recovery’ following the pause in the second half of 2022 due to ‘uncertainty regarding valuation levels across the real estate sector’.

‘Deals are now being completed at pricing levels that reflect discounts that are consistent with the move in the valuation of the group’s portfolio,’ he said.

As ever, government policy plays a key role in shaping the path of the care sector and it recently announced funding to clear the backlog of older people stuck in hospital beds. However, Mackenzie said care home operators, while wanting to help, are ensuring the cost of helping is commercially viable and were ‘no longer rushing to fill beds ... even if that means occupancy trails behind the pre-pandemic norm,’ he said.