Civitas Social Housing — Initiatives to underpin consistent performance

Civitas has consistently delivered positive total returns3F1 on both an annual and quarterly basis since its initial public offering (IPO) in November 2016. Dividends have been the main component of returns, and these have increased each year. Despite the pandemic, operational and financial resilience has been maintained, rents have continued to be received in line with expectations, quarterly dividend payments have been uninterrupted, and there has been no discernible impact on portfolio valuations. This strong performance reflects the vital role of portfolio properties in the provision of an essential service; secured by long-term lease and care arrangements; providing good visibility of income with little direct correlation to the wider property market or economy; and capable of delivering stable inflation-indexed dividend growth.

From IPO in November 2016 to 31 March 2022 (end-FY22), Civitas has generated an aggregate NAV total return of 37.2% or an annual average of 6.1%. Dividends paid represent two-thirds of the total return in the period.

Civitas seeks to set dividends that broadly track inflation over time and although the 2.7% increase in targeted DPS for FY232 is below the current elevated level of inflation, we note that for much of the last financial year (FY22) price increases had remained relatively subdued. The average increase in DPS since March 2019 (when CSH completed payment of the first full dividend of 5.0p per share3) to end March 2022 was 3.3% compared with an average 2.6% increase in CPI over the same period.

We expect the continued rise in CPI-inflation to support future dividend paying capacity, as will the deployment of available capital into accretive acquisitions. Across the CSH portfolio, 27% of contracted rents are indexed annually, on the anniversary of the inception of the lease, at CPI+14 and 73% at CPI. Additionally, 31% of rents are capped and collared at 0–4%.

Although dividends have not been fully covered in the period to end-FY21 (the last reported data), as the portfolio has been built and capital deployed our current forecasts show this being achieved on a full year basis in FY23 (FY22e: 92%). We will review our forecasts with publication of the FY22 results in June. It is also worth noting that had the company elected to pay lower dividends, in line with historical EPRA earnings, the total returns generated over the period (Exhibit 1) would be unchanged, with faster NAV growth offsetting lower dividends.

All funding for accommodation that meets the strict requirements for SSH6F5 comes from the welfare budget of the central government and is distributed via the local authorities that commission the services. Civitas estimates that c 85% of the funding relates to providing care and c 15% to rents (including service charges).6 Within the SSH sector, housing associations, charities and specialist care providers typically agree annual settlements with the commissioning local authorities, with an adjustment for inflation, which reached 7.8% in April (CPIH), and the company expects this will continue to be the case. The investment adviser closely monitors the level of settlements that are being achieved. The indications that it has received from lessees are that, after making appropriate submissions to the relevant local authority, settlements have continued to reflect higher levels of inflation and the requirement that these reflect value for money at central government level.

For SSH, rents are set on a bespoke basis, primarily determined by the extent of adaptation that is required for the homes to meet the care needs of residents, as well as location. Civitas has increasingly targeted properties that are focused on delivering higher acuity care, which it believes enhance the fiscal saving to government compared with the alternatives of institutional or hospital care. This is reflected in residents within its homes receiving an average of 43 hours per week of delivered care, a metric that has continued to increase. To ensure these are set at an appropriate level, they are tested against the investment adviser’s extensive database and by external consultants and agreed with the housing association and other lessees. Housing associations and other leaseholders in turn seek sign-off from the relevant housing benefit officers within each local authority in which they operate. The objective is to confirm both the specific rent level and exempt rent status for the delivery of each SSH property.

In addition to SSH, the Civitas portfolio includes a small number of properties that provide accommodation for services, such as for the homeless or individuals with refugee status, usually in support of established and long-term government programmes. Reflecting a lower need for property adaption to deliver care, rent levels are correspondingly lower.

In recent months Civitas has engaged with relevant counterparties and undertaken detailed negotiations with several housing association partners, regarding ways to assist the latter in better meeting the requirements of the Regulator of Social Housing (RSH), particularly in respect of the Financial Standard.7 The sector is supported by strong demand for SSH, well in excess of existing homes, and generates significant cost savings while improving resident outcomes, but in common with the broader social housing sector the RSH requires from housing associations long-term financial plans that demonstrate the robustness and flexibility to adapt to unforeseen circumstances.

The consensus that has emerged from these discussions and negotiations anticipates the development of a new draft lease clause. The main objectives are to enable housing associations to:

The final form of the proposed new clause is yet to be finalised but if it is adopted, in addition to providing support for housing associations to achieve regulatory compliance Civitas expects to benefit with enhanced information transfer and step-in rights (additional to existing transfer and assignments rights). It is intended the clause will be incorporated initially into a limited number of existing leases on a retrospective basis, starting with properties that are unencumbered, before being rolled out more widely.

The company’s external valuers have provided formal written confirmation that the proposed new lease clause will have no negative impact on property valuation. Civitas believes that enhanced regulatory alignment may benefit valuations.

Specifically, the proposed draft allows for a temporary ‘pass through’ of rents on a property-by-property basis under limited circumstances when the housing association is not in receipt of full payment. Any pass-through of rents would remain the responsibility of the housing association and Civitas would not be liable for the obligations of other parties such as the contractual obligations of care providers to cover void costs. Furthermore, it will apply only after an initial period during and then only if paying the rent in full would cause the housing association to fail to meet the standards set by the RSH. Where subsequently recovered by the housing association, the pass-through rental income may be reimbursed. Meanwhile, Civitas operates with a liquidity buffer of c £30m, which provides temporary resources well ahead of what we would expect to be required and should have no impact on capital deployment. An example provided by Civitas of instances that may require a temporary pass-through of rents include simple delays in formally executing on the setting of ‘agreed’ rents in respect of properties newly commissioned by local authorities.

Civitas says that implementing the new lease clause will codify much of the general asset management work it already undertakes and its approach to sector collaboration. Each year a small number of buildings require ‘future proofing’. Typically, local authorities and/or care providers identify certain adaptions that are required to enable a change of use. Ensuring longevity of occupation and the maintenance of resident satisfaction. As a responsible landlord, Civitas undertakes the necessary investment and the support this provides to housing association revenues is not recognised formally.