Healthcare real estate: money in bricks essentially needed for sustainable and efficient care

Not only is a significant expansion of assisted living accommodation required to be able to meet demand; the existing healthcare real estate must be made sustainable. That the market for assisted living accommodation is facing a considerable challenge was already evident from our report entitled ‘Residential care real estate at crucial crossroads‘.

These targets have to be met even though the pressure on the healthcare sector is steadily growing. Tightness in the jobs market and inflation are driving up wages and – given rising staff shortages – wage costs are only set to go up in the years to come. Besides staff costs, energy costs cannot be overlooked. The recent past has shown how vulnerable running a care facility can be if energy costs rise. At the same time, the government is tightening up the financing of these institutions and how much they can charge.

All of this means that healthcare organisations are facing an ever-increasing challenge when it comes to keeping their own operations healthy. Having care operations in good order is crucial if the expansion and sustainability challenges are to be tackled effectively. This major investment challenge combined with rising pressure oncare operations means that organisations are more inclined to critically consider the option of separating the care aspect from real estate and arriving at different decisions in this regard.

Rising staff expenses and shortages are forcing the residential care sector to improve efficiency

Shortages of qualified staff in the healthcare sector is a growing problem. As it stands now, around 1.4 million people work in this sector. In the wake of an ageing population and the demand for more intensive care, the ratio of number of people working in care must rise from one in seven clients, to one in four by 2040. That is unrealistic given the current shortages, and it is forcing the sector to change and adopt a more disruptive way of thinking and working. This will entail, on the one hand, saving on costs through more efficient care, albeit less but good care. And, on the other hand, increasing revenue by, for instance, going back to basic care combined with additional arrangements, more informal care and a more efficient deployment of professionals.

According to government information, the nursing, cares homes and home care sector is facing a shortage of 19,600 employees, of which 13,600 are in nursing and home care. By 2032, this will have shot up to an incredible 56,600, of which 37,800 will be in nursing and home care. This is an increase of 188%, and 178% in nursing and home care.

Figure 1: Forecast of staff shortages in residential care

The imbalance in care staff numbers is ratcheting up competition among for healthcare personnel and increasing the workload of care workers. Together this forces wages up, and in turn leads to higher staff expenses. This is already evident in the recent collective agreement, which has resulted in salaries for staff working in a nursing home or residential care home or in home care set to go up by between 10% and 14% next year. This rise is not only intended to offset inflation, but more specifically it is (1) an attempt to make jobs in residential care more attractive for people outside the care sector; and (2) to have more healthcare employees work fulltime.

Figure 2: Costs for staff in the care sector (% of revenue)

That the trend in staff expenses is essential for healthy operations is reflected in the fact that staff costs in the care sector equate to between 70 and 77% of revenue. Healthcare costs are expected to rise going forward across all the subsectors on the back of rising staff and procurement costs. Whether or not trends in residential care costs will actually prompt a decline in revenue depends in part on whether revenue rises in tandem with the costs.

Yet, according to an analysis of annual reports conducted by Intrakoop, the trend over the last ten years clearly shows that revenue is struggling to keep up with rising costs. Combined with austerity in healthcare expenditure, this can only lead to an untenable situation.

Uncertainty in energy prices driving need to take sustainability seriously

The healthcare sector has to contend with higher staff expenses and a huge challenge in terms of its real estate. Almost half of nursing and care homes are owned by care institutions, meaning that they are generally the ones responsible for their real estate.

Most care organisations have endorsed the Green Deal for Sustainable care. This deal aims at a 30% reduction in carbon emission by 2026 compared to 2018, followed by 55% by 2030 and a climate-neutral sector by 2050. Unfortunately, care organisations are dragging their heels when it comes to the sustainability of their real estate compared to other sectors and compared to nursing and care homes owned by housing associations or investors. The average energy-efficiency rating index for care organisations is higher (1.47) than that of housing associations (1.33) and investors (1.19).

Besides the targets set by the sector, the rise in energy prices is driving the urgency to make property more sustainable. Due to the narrow profit margins that many care organisations have to contend with, a sharp rise in energy prices instantly pushes the figures into the red. Uncertainty about future energy prices is inducing care organisations to accelerate sustainability. According to a report compiled by the Centre of Expertise for Sustainable Healthcare, the total investment required to make nursing and care homes more sustainable is between €9.3 and €15 billion. This equates to about €3.3 million per care organisation, excluding demolition and construction costs.

Another issue is that the care sector is facing tremendous pressure to expand. An estimated 433,000 assisted living homes will be required between now and 2050, which equates to €81.8 billion[1] in terms of construction costs. Even though investors will fund the lion’s share of this, around €26.4 billion in investment is required for care organisations, given the state of their properties as it stands now.

Suffice to say that care organisations are facing major challenges when it comes to real estate. The driving issues are whether these organisations can finance these investments, and the extent to which this could jeopardise their financial stability and operational capacity. This is particularly concerning given that the government’s contribution towards this is expected to shrink in the coming years.

Future financial situation calls for different perception of property ownership

The challenges facing care operations (rising and fluctuating costs) and the significant investment challenge in real estate (sustainability and expansion) justifiably raises the question of whether it is feasible to finance operations given the gradual tightening of government budgets – including the reduction of the normative housing component.

To assess how care organisations are currently faring, both from the perspective of their operations and their real estate aspirations, insight was provided into how more than 900 care organisations score on their operating margins and their fixed assets-to-equity ratio. Using this as the basis, it is possible to estimate the extent to which care organisations have the scope to absorb higher costs on the one hand, and the financial resources (equity or ability to raise borrowed capital) to pay for sustainability and/or expansion targets on the other. Two scenarios were worked out in detail to assess this.

Right now, 15.9% of care organisations are running loss-making operations while 36.8% of care organisations have a fixed assets-to-equity ratio of above 1. The latter indicates that investment in real estate will partly depend on the ability to raise borrowed capital. This requires having a sound financial position in terms of operating margins.

Dividing care organisations into four quadrants sheds light on the extent to which these organisations must be capable of funding their operations and real estate ambitions themselves.

Figure 3a: Current situation and two scenarios for 2026 for fixed assets (buildings and land) / equity ratio and operating margin for more than 900 care organisations

Note 1: Hospitals have not been taken into consideration in this analysis.
Note 2: The impact and implications for the care organisation in question depend on their specific situation.
Operating margin = (income – costs) / costs

Figure 3b: Current situation and two scenarios for 2026 for fixed assets (buildings and land) / equity ratio and operating margin

Extrapolating the scenarios we have created shows that about 17.5% of care organisations fall into the first quadrant if no adjustments are made in terms of efficiency or the revenue model is not improved. At this point in time, this applies to 2.8% of care organisations. These care organisations all manage their real estate and run their care operations. Given the fact that their overall operations will – in all probability – become loss-making, this situation constitutes a considerable challenge to deliver more efficient care, on the one hand, and to find the financial scope to invest in the transition to sustainability, and replacement and expansion, on the other hand. As opposed to this, the number of care organisations with relatively little equity and property in ownership, and which are financially stable (Quadrant 2), falls from 34% to around 15-20%. The expectation is that these care organisations will be able to raise borrowed capital more easily to keep their operations sustainable, efficient and future proof by also improving their property (sustainability/expansion).

Of the care institutions in the Netherlands, 13.1% are already running their operations at a loss. However, these are mainly care organisations that do not have much property, or none at all (Quadrant 3). Under these circumstances, improving the situation will have to come primarily from making care operations more efficient and this means that the deficiencies must be tackled in part with the property owner so that a contribution can be made to improved and more sustainable care operations based on the housing component as well. That said, the number of care organisations in this group may well rise to between 38 and 43% by 2026.

The last (and biggest) group falls within the financially cost-effective operations that have a ratio of less than 1. This is an indication that, if these care institutions own their real estate, they also have a lot of equity capital – relatively speaking – to invest in their property. What’s more, their current financial situation is fundamentally positive, which is an important prerequisite for attracting external financing for their real estate aspirations. That said, we can see that this group shrinks by more than half in our scenarios. In other words, a substantial part of this group can no longer be complacent in their decisions regarding care and real estate.

Using real estate to make care operations efficient and future proof

A relatively large number of care organisations facing challenges in real estate exploitation as well as care operations (Quadrant 1) may well start to feel that real estate exploitation is a millstone around the neck of their operations. This millstone may well hinder improvements in the standards of sustainable quality of healthcare. The right use of real estate gives these care organisations the perfect tool to achieve sustainable, efficient and future-proof care operations.

In the coming years, residential care organisations will increasingly be faced with the all-encompassing decision of using (different) property management approaches to achieve positive results in care operations. This is much more likely to lead to the divestment of part or all of their real estate, and then leasing it back in the long term. These organisations can then move from Quadrant 1 to Quadrant 4.

By doing so, care organisations no longer have to contend with investment pressure. In the process, it gives the organisations access to capital (through the sale of the property) that can be used for structural operational improvements in care, such as scaling up, digitalisation and expanding operations by offering additional arrangements that cater to residents’ needs.

Agreements can be reached with the new owners regarding rental price movements, sustainability, expansion or modernisation of the buildings. This in turn means that real estate-related objectives can be achieved. Indeed, the scaling up of real estate can improve efficiency, which then also has positive implications for the costs per resident.

Nevertheless, opting for a so-called sale-and-leaseback is still very much dependent on the care organisation and the building in question. What’s more, it is no longer always self-evident that care providers are keen to take on the management of real estate for their own account and risk. There is a growing plethora of concepts, business models and ways of going about it to choose from. One may be mainly care oriented, while another may focus more on housing. Things are getting tighter, but at the same time there is more room to manoeuvre. They are getting tighter because costs are being reduced thanks to cuts in budgets. But there is also room to increase revenue based on other business methods and the associated revenue models, such as offering arrangements in addition to the basic rent, which in turn gives operations more scope. First and foremost, the goal should be to have a sustainable, efficient and future-proof care sector as the guiding principle, in conjunction with the sustainability and expansion of real estate.