FOCUS

Keypoints

  • Healthcare institutions receive a fee for accommodating residents.
  • This NHC fee will be reduced ('recalibrated') by 4.2 per cent in 2024.
  • The recalibration results in the postponement or cancellation of investments in healthcare real estate.
  • The recalibration will affect the operating income of healthcare facilities.
  • For investors, short-term rental risks increase, depressing real estate values.
  • In the medium term, the risks decrease as the CPI is expected to rise less than the NHC indexation.

RECALIBRATING THE HEALTHCARE HOUSING RATE AND THE IMPACT ON INSTITUTIONAL INVESTORS

Housing rates for healthcare institutions will fall by 4.2% in 2024. This will not only affect healthcare providers, but also investors. This Focus looks at the background, the changes and the potential impact on healthcare real estate investors.

Financing care housing in residential care

Healthcare providers can finance the purchase or rental of healthcare real estate in a number of ways. This largely depends on the type of care provided. This Focus looks at housing for people who live in 'sheltered housing' and are cared for 24 hours a day.

The best known and most common form of sheltered housing and care is residential care in 'traditional' nursing homes. Here, nursing homes receive a standard fee from the government to cover the cost of housing, in addition to a fee for providing care. Overall, there are about 130,000 places in nursing homes in the Netherlands. Including care for the disabled and the mentally ill, there are around 225,000 places. One trend in care and its financing is so-called extramural care, for example in private residential care homes. Here, the resident is responsible for the cost of accommodation.

This Focus looks specifically at the financing of accommodation in traditional residential care facilities. The pricing of this type of care is changing as a result of a political reassessment, with consequences for care institutions and landlords of care real estate.

THE NHC EXPLAINED

The normative compensation that healthcare institutions receive for (replacement) (new) construction and maintenance is called the normative housing component, or NHC. The NHC is used to finance or rent healthcare real estate. The height of the NHC is determined by the Dutch Health Care Authority (NZa). It consists of an indexed annual contribution that is sufficient to cover the investment, interest, depreciation and maintenance costs over the entire life cycle (30 years) of a newly built facility. Maintenance costs include the cost of major renovations, functional adaptations and minor repairs. The NHC is not only intended to provide accommodation for residents, but also to reimburse the costs of providing supportive counselling, treatment and support services. This includes office functions, including those provided by a central office. The NHC is a daily amount that adds up to an annual housing allowance per resident.

Specific features such as the type of construction required, type of accommodation, characteristics of the target group and special facilities are included in the construction costs. The standardisation was based on input from the Construction of Care Institutions Board and TNO. The standardisation dates from 2008. The specific care indication of a resident determines the amount of NHC a care institution receives. In general, the more severe or intensive the care required, the higher the reimbursement. The normative building costs have not changed since 2012. When the NHC was introduced in 2012, it was stipulated that changes in regulations or building requirements could be grounds for an adjustment. However, there were no political decisions or new requirements from the Health and Youth Inspectorate (IGJ).

However, a surcharge was added to the NHC in 2019 as a result of changes in laws and regulations on sustainability and fire safety. For this purpose, the annual indexation was increased by 0.16 percentage points. This is in addition to the 2.5% annual indexation that has been in place since its introduction in 2012. As a result, the NHC received by healthcare institutions will increase by 2.66% annually.

Another component in determining the NHC is the actuarial interest rate. This is used in the normative determination of financing costs. This variable will change in 2024. More on this in the section 'Tariff reduction: what will change?

From 2018, the NHC will be included in the so-called integral tariffs. This includes reimbursement for care provided by healthcare institutions. In practice, the NHC is still used as a measure of the accommodation costs (financing or rent) that a care institution can pay.

"The NHC is used as a measure of rental costs."

HOW THE NHC WORKS IN RENTAL SITUATIONS

Landlords of healthcare properties, such as Achmea Real Estate, use the NHC minus a discount as a guideline for the rental cost of a healthcare facility. Valuers also use the NHC as a measure of market rent. Landlords and care institutions can decide which part of the NHC they use to determine the rent. As the NHC is intended to finance housing costs other than rent, in practice several deductions are made from the NHC. Commonly used deductions are:

OVERHEADS

For example, to pay for facilities such as a head office or central kitchen. Generally around five per cent.

MUTATION COSTS

There are costs associated with changing occupants, including vacancy and any maintenance of the space. This is usually around 2%. The NHC already takes into account an occupancy rate of 97%.

PRESERVATION

This applies to both minor and major maintenance. In a rental situation, it depends on the agreement with the landlord who is responsible for major maintenance. Minor maintenance is always the responsibility of the tenant. Generally speaking, this is around 5%.

SAFETY MARGIN

Buffer for unforeseen changes in the rental situation or NHC. In practice, a possible future discount on the NHC was already taken into account. This was usually 5-10%. This discount may now be smaller as a discount has already been applied.

Appraisals show that the sum of these discounts on the NHC can be as high as 15-20%. This is how valuers calculate an assumed 'market rent'. However, there are no fixed percentages for these discounts. Both healthcare institutions and landlords deal with these discounts in different ways. Healthcare institutions often look at housing at a group level, so that 'expensive' and 'cheap' locations are balanced. Integrated tariffs even allow them to use costs earmarked for housing for healthcare operations and vice versa. For example, in some cases the entire NHC is used for rent, while it is also the case that a healthcare provider's profit comes entirely from property income.

"Healthcare institutions often look at housing on a corporate level, which means that 'expensive' and 'cheap' locations balance each other out."

Voor verhuurders van zorgvastgoed geldt de afslag als ‘risicomarge’ die is bedoeld om garant te staan voor een gezonde langdurige verhuring. Mogelijk kan de financiële en operationele situatie van de zorginstelling aanleiding geven tot andere overwegingen, evenals de locatie van het gehuurde. Afhankelijk van de gekozen afslagen kan de marge hoger of lager uitvallen. Een tot nu toe veel gebruikte ‘norm’ voor een standaardafslag bedraagt vijftien procent.

HOUSING RATE RECALIBRATION What will change?

The NHC will be reduced from 1 January 2024. The recalibration is part of the NZa's maintenance plan adopted in 2012. This maintenance plan includes regular monitoring and possible adjustment of market-sensitive components such as interest rates and the index if a range of half a percentage point is exceeded. This means that developments in other parameters such as construction costs, land costs, vacancy rates and maintenance costs are not taken into account when recalibrating. A review took place for the first time in 2018. A reduction in the actuarial interest rate - 4.65% compared to 5% previously - brought the reduction in the NHC to around 4%.

On 27 June 2023, the NZa adopted the new policy rule containing the rates of the NHC. The cost of capital rate used in the calculation system falls from 4.65% to 4.03%, a reduction of around 13% due to the low interest rates of recent years. The cost of capital is an important parameter within the NHC. The reduction results in a 7.2% decrease in the rate.

Although construction costs have risen significantly due to functional (changing housing needs) and cyclical (rising commodity prices) developments, these are not part of the reassessment of NHC rates. However, the annual payment of the sustainability investment allowance will be brought forward. Instead of an annual top-up of 0.16%, there will be a one-off structural increase of 3.25%. This was not previously anticipated. The net effect of these changes will be a 4.2% reduction in the NHC by 2024. The indexation of 2.5% will continue to apply. This effectively reduces the final rate by 1.7%.

"The one-off structural increase of 3.25 per cent was not expected beforehand".

IMPACT OF REDUCED RESOURCES ON HEALTHCARE INSTITUTIONS

A recalibration of the NHC leads to lower revenues and thus (without adjustment) has a negative impact on the financial viability of healthcare organisations. This is separate from other developments such as possible discounts due to the negotiability of tariffs from 2024 and developments in staff costs.

The recalibration affects both existing leases and new build projects. In an existing situation, there is often a long-term lease that is indexed annually to inflation (consumer price index). On the 'expenditure side', for healthcare facilities, there is a rent level that increases each year by indexation. On the 'revenue side', however, there is a one-off decrease due to recalibration. Regular indexation does not fully compensate for recalibration in the short term. Moreover, with the exception of last year, the indexation of the NHC has been higher than the development of the consumer price index since 2012.

Healthcare institutions that use the NHC to finance part of their care, or even all of it, could find themselves in financial difficulties as a result of the recalibration. It is therefore becoming increasingly important for healthcare organisations to separate their property management and care operations.

"In the current era it is extra challenging that construction and financing costs are higher than in recent years."

If healthcare institutions can absorb the recalibration, investment capacity will decrease. This will be to the expense of maintaining and improving property and quality of care. Sustainability ambitions or expansion plans will also come under pressure. Investment in real estate, among other things, is necessary for good and healthy operations. Healthcare institutions are looking for creative solutions, for example in cooperation with investors and health authorities.

What is even more challenging at the moment is that construction and financing costs are higher than in previous years. This reduces the feasibility of new projects. This applies not only to owner-occupied projects, but also to leased projects. Capitalised rents (read: NHC) offer relatively less scope for investment due to the recalibration on the one hand and investors' higher return requirements due to higher interest rates on the other.

The logical consequence is that projects will not be launched or will be postponed. This effect is already clearly visible in the market and has been emphasised once again in the manifesto 'Keeping the care real estate challenge feasible', submitted by care and industry organisations to the Parliamentary Standing Committee of the Ministry of Health, Welfare and Sport (May 2023). When investment does take place, the quality of new buildings is lower in order to reduce construction costs.

IMPLICATIONS OF NHC RECALIBRATION FOR INVESTORS

While recalibration is fundamentally a user issue, landlords and investors in healthcare real estate are indirectly exposed to the effects of recalibration. Tenant risk If a healthcare facility is under financial pressure due to recalibration, this is usually not the cause of the problems. There is often no business case for the care then. This is because a healthcare facility's key variables are staffing costs and occupancy rates. Recalibration can cause problems for healthcare facilities that depend on NHC revenue for their operating income. The 'operator risk' in healthcare is relatively low. Bankruptcies are rare. This is especially true in the care segment, which includes nursing care. Healthcare has a safety net that obliges care offices to continue providing care under the supervision of the NZa. In the extreme case of bankruptcy, a new start is made. If the leases were sound and in line with the market in the old situation, they will not be significantly different in the new situation. It is therefore important for landlords of nursing homes to charge market rents.

Direct return In the event of financial difficulties, part of the solution can be found in the cost of accommodation. In this situation, healthcare institutions can ask landlords for a rent reduction or limited indexation, despite the current lease. It is up to the landlord to agree to this or not. During the inflation peak at the end of 2022, Achmea Real Estate implemented limited rent indexation for healthcare institutions. Adjusting leases has an impact on direct returns. Again, the risks for investors can be reduced by agreeing on market-based rents and indexation.

"The 'operator risk' in healthcare is relatively low. Bankruptcies are rare".

Capital growth When market conditions change, this is often reflected in the value of the property. In the case of the NHC recalibration, there will be a change in the market rent for valuers. It will be lower in 2024 than in 2023. With the same initial yield or capitalisation factor, this will theoretically result in a lower valuation, all other things being equal. For appraisers, the NHC fee is a tool for determining market rents. Whether the recalibration is fully included in the market rent depends on the case. Previous valuations have often included a safety margin or deduction from the total NHC income for the market rent (see section 'How the NHC works in rental situations'). Since the risk of a recalibration of the NHC rates was part of the discount, it could theoretically be smaller. According to this reasoning, a reduction in the gross NHC rent is partly compensated by a lower market rent.

HEALTHCARE BANKRUPTCIES (2 QUARTER MOVING AVERAGE)

Other property and tenant-specific situations may also influence the adjustment of the market rent. According to the appraisers, the effect of a lower market rent on the gross initial yield is not large, as the risk does not change. There is therefore little 'compensation' for the lower market rent in the form of a lower yield. Will there be a big change in valuations in 2024 compared to 2023 as a result of the recalibration (ceteris paribus)? Not much is expected. Appraisers indicate that the forthcoming recalibration has already been incorporated into valuations for the second quarter of 2023. After all, this effect was already known and therefore already incorporated into current valuations.

New investments It will be more difficult in the short term to expand the real estate portfolio with properties rented by intramural healthcare institutions that use the NHC. This is particularly true when it comes to purchasing new developments from project developers. This is partly due to rising construction costs and the (temporary) fall in market rents, which reduces the investment opportunities. See also 'Impact on healthcare facilities'. The tight supply of new construction will become even tighter, and together with the increased return requirements in 2023, this will make it even more difficult for investors to expand their portfolios with this type of healthcare real estate.

Recalibration in an example

The recalibration and the consequences from a rental perspective can be illustrated by an example. In this case, a healthcare institution has been selected that provides care and accommodation to 30 residents with care levels 5 and 7. The total available NHC reimbursement in 2023 is 388,000 euros (dark blue line in the figure). Taking into account indexation and recalibration, the reimbursement will fall to 381,000 Euros in 2024 and increase in subsequent years to 442,000 Euros in 2030 through indexation of 2.5%.

The hypothetical agreed rent in 2023 is 335,000 euros (orange line), and due to indexation with inflation (Oxford Economics forecasts, August 2023) the rent will rise to 348,000 euros in 2024 and further to 390,000 euros in 2030.

The ratio between the NHC rent and the agreed rent will be around 86% in 2023 (light blue area). Due to the recalibration of the NHC on the one hand and the rent indexation on the other hand, the ratio will increase to more than 91 percent in 2024. As the annual indexation of 2.50% from 2024 will be higher than the expected inflation, the margin will slowly increase over the years and the ratio will be more than 88% in 2030.

This general example shows that for a health care institution the tension between property-related income and expenditure will be highest in 2024. In the following years, this tension will slowly decrease if indexation is higher than the currently projected inflation scenario. This is positive for the long-term risks of investing in healthcare property. The short term is the most uncertain, but it is also easier to predict than other tenant risks. However, an investor in this example may experience financial consequences in terms of valuation (see also the 'capital growth' section).

HOUSING COMPONENT, RENT AND MARGIN (example)

Conclusion

The upcoming recalibration of the NHC will have an impact on the financial situation and investment capacity of healthcare institutions. Healthcare institutions will have to think even harder about the major challenge of investment and sustainability. The recalibration of rates will also be felt by investors in healthcare real estate. Tenant risk is increasing in the short term. This is because rents are becoming a larger proportion of NHC revenues. Although this share is expected to decline in the medium term, it will have an impact on the valuation of healthcare properties in the short term. The forthcoming recalibration of the NHC will have a negative impact on the market rent calculated by valuers. Currently, the average market rent for investors is often in line with the average contract rent. The margin between NHC income and market rent remains within safe limits. In 2024, however, the financial capacity of NHCs will need to be given special attention. Bringing forward the sustainability investment capacity provides some relief in the short term, but does not provide a solution for realising sustainability ambitions and increasing the share of heavy care categories in intramural institutions.

Sources

Sources used for this analysis include: AAG, Capital Value, Colliers, Cushman & Wakefield, Finance Ideas, TNO, Zilveren Kruis

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