• Strong performance over the longer term weakened by fears over local authority cost cutting

Care home properties have been underperforming the rest of the commercial property market since the start of 2009 making the restructuring of Southern Cross more complex says Wedlake Bell the City law firm.

As concerns over local government cost cutting have grown secondary healthcare property lagged the recovery of the broader commercial property market. Last year capital values of secondary healthcare properties* only increased by an average of 2.9% compared to an 8.3% average increase for all commercial property (year end Dec 2010).

However, Wedlake Bell says that investments in secondary healthcare property have outperformed since the start of the credit crunch showing average total returns of 5.5% compared to an average fall of 2.7% for all commercial property over the last four years (Investment Property Databank).

Comments Malcolm Macfarlane, Partner, of Wedlake Bell: "The owners of the underlying care home properties are for the most part going to be very reluctant to take back these assets - there are not many alternative uses for these homes."

"The most obvious alternative use for care homes is conversion into residential property. However, some local authorities will need convincing to allow a care home to convert into conventional residential property as they won't want to lose that public amenity or the jobs that a care home offers."

"Redeveloping a care home into luxury flats is only going to work in certain locations. A lot of care homes are too large for a simple low risk conversion into residential properties. Funding from banks for that kind of work is also not easy to come by."

Wedlake Bell says that if a care home operator does return a care home to the property landlord then the landlord may find themselves having to renegotiate their lending with their bank if they breach any rental covenant in their mortgage of the property.

Many commentators have said that care homes should have stuck with a business model where they owned rather than rented their property.

Says: Malcolm Macfarlane: "Where a sale and leaseback goes wrong it is inevitable that the company concerned will get criticised for selling off its assets. Perhaps future sale and leasebacks will be structured to ensure greater flexibility either with break clauses to allow tenants to exit excess space or in the event of landlords being unwilling to invest in the upgrade of the property."

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** IPD UK Annual Property Index

*Secondary healthcare properties include nursing homes, care homes, specialist treatment centres and hospitals

Primary healthcare properties are mainly let to PCTs and GP surgeries

IPD's data on healthcare property investments is based on 625 properties valued at more than £2 billion.