Primary Health Properties PLC

LSE:PHP

Earnings Call Analysis

Solid and Stable Performance with Harry Hyman's Farewell

Primary Health Properties (PHP) has reported a stable performance for the fiscal year 2023, despite challenging financial market conditions. Founder and Chief Executive Harry Hyman, presenting for his last time due to his pending departure, underscored the ongoing demographic demand for healthcare in Britain and Ireland that propels the company's growth. PHP wrapped up 2023 with a slight decline in property values, mitigated by rental growth. This resulted in a modest decline in property values by GBP 53 million and an increased yield across the portfolio to just over 5%. The company achieved a milestone by delivering its 27th consecutive year of dividend growth, with dividends paid at GBP 0.067 and forecasts indicating an annualized dividend of GBP 0.069 for 2024.

Rental Growth Mitigating Interest Rate Volatility

In 2023, PHP's rental growth of GBP 4 million, supplemented by asset management activities yielding GBP 0.3 million, enabled the payment of the increased dividend and positions the company to maintain its 28th successive year of dividend growth into 2024 without relying on forecasted acquisitions. Interest costs rose by nearly GBP 5 million, attributable to an increase in net debt and interest rates on variable rate debt. Nevertheless, the adjusted earnings surged by 2.3% to 90.7%. PHP aims to save around GBP 500,000 per year to mitigate these expenses. The company anticipates savings and protects its solid financial standing with 97% of its debt hedged, ensuring resilience despite higher interest rates.

Defensive Portfolio and Debt Management

PHP's portfolio remains robust, with 89% of rent coming from the British and Irish governments and nearly full occupancy of 99.3%. The weighted average unexpired lease term (WAULT) exceeds 10 years, showcasing the company's solid asset base and active management program. Debt-wise, PHP has no renewal requirements until 2025 and boasts over GBP 300 million in financial headroom. PHP's loan-to-value covenants provide a safety buffer, requiring a dramatic portfolio value drop for any covenant breach, indicating a sturdy balance sheet.

Focus on Asset Management and Environmental Credentials

The company's investment focus remains reserved, with expectations for muted new investments. Instead, PHP emphasizes asset management, which yielded GBP 300,000 in additional organic rental growth and improved environmental credentials, with As and Bs EPC ratings increasing from 35% to 42% of the portfolio. One UK direct development is in progress, yet the primary strategy lies in maximizing existing assets. Over the next three years, an estimated GBP 35 million will be invested to future-proof assets and increase rents further. This focused asset management approach also aims to maintain PHP's influential position in healthcare real estate.

Earnings Call Transcript 2023-Q4

[Harry Hyman, executive]

So good morning, ladies and gentlemen, and welcome to the Preliminary Announcement of our Results for 2023. For those who don't know, I'm Harry Hyman. I'm the Founder and Chief Executive of Primary Health Properties. Joining me today, we have our CFO, Richard Howell, we have our Chief Investment Officer, David Bateman. And I'm also delighted that we have our CEO-elect, Mark Davies in the room, who will be able to talk to people after the presentation.For me, this is a bit of a landmark. It is the 28th time I presented the final results and the -- 56 and barring disasters or something happening between now and the 24th of April, my 56th and last presentation of the PHP results. So anyway, I'm sure we can talk about that afterwards at more length. And some of the people who helped me start the company are also in the room. So welcome to them.Anyway, our results for '23 represent a very solid and stable result in what has been a very turbulent and difficult time for financial markets generally. The backdrop for PHP remains very strong. We have a huge demographic demand for health care, as everybody knows. The populations of Britain and Ireland are both growing. In the medium term, the populations are continuing to age, aging gives rise to a higher requirement for health care. And there is a very large degree of chronic disease like type 2 diabetes, osteoarthritis, cardiac heart disease. And health care strategies in both Britain and Ireland are designed to take more of that care out of expensive and inflexible hospitals into modern primary care accommodation of which there isn't enough.We've finished with COVID-19, I think, for good and COVID-19 demonstrated, although technology has a role to play in primary care through the initial triage. It certainly does not replace the need for new and extra space. Indeed, there are more face-to-face consultations going on in Britain than they were prior to the pandemic.I'm pleased to say that we delivered a very robust performance. We delivered our 27th year of consecutive dividend growth, paying a fully covered GBP 0.067. And the brokers' consensus for the current year, we're in '24 is that we will be paying an annualized dividend of GBP 0.069. And in fact, we've already paid the first quarterly installment of that last Friday.Our property return, which is something we want to focus on, has been very strong and has been consistently better than other players in our sector. And in fact, we've won awards from [ MSCI ] for our total property performance. Of course, properties have declined in value, which reflects the very volatile and higher levels of interest rates. But our rental growth, which is one of the key messages that we want to talk about today has largely mitigated the impact of that. So that in 2023, our property values only went down by a relatively modest GBP 53 million. And our yield across the portfolio as a whole is now just slightly over 5% and represents a 5.4% reversionary yield.The rental growth of GBP 4 million, coupled with asset management activities of GBP 0.3 million have resulted in the ability to pay that increased dividend and that continued rental growth, which we're very confident about delivering in '24, we'll continue to pay that GBP 0.069, our 28th successive year of dividend growth into the current year without any forecast acquisitions. Of course, if we are able to make accretive acquisitions during the year, as and when interest rates come down, then that will also be positive for the level of earnings and for dividend growth into the future.We are not diversifying away from our core business. 89% of our total rent roll comes from the British and Irish governments. Our portfolio is 99.3% let, it's effectively 100%. They're very small amounts of expansion space throughout the portfolio. And our weighted average unexpired lease term is still over 10 years. We have a very active asset management program that is aimed at maintaining the WAULT level moving forward. And we've done brilliantly on the debt side. Richard and his team have done exceptionally well. 97% of our total debt stack is hedged out, and therefore, the impact of higher rates has been relatively muted during '23. We don't have any debt coming up for renewal until '25, which is the convertible.And we have more than GBP 300 million worth of available headroom. So for that reason alone, we will not be coming back to the equity markets anytime soon and in particular, because there aren't that many accretive acquisitions for us to buy in the marketplace. Would that -- we would be someone like [indiscernible] but we're in a very different sector. And so we don't have the requirement to raise capital.We have a disciplined approach to pipeline, as I've mentioned, and the internal team's focus is on asset management. Ireland remains our markets of choice, and I'm delighted that the acquisition that we made in early '23 of Axis has gone exceptionally well. They've earned their earnout in full and that is a very useful addition to our business, having a team of 25-plus people based in Ireland, boots on the ground with an ability to secure and do work for the HSE alongside, the development of pipeline there.So, just to finish off on the first slide of the presentation, we've delivered this GBP 4 million of extra income, which is a very strong result and compares to GBP 3 million the year before and GBP 2 million 2 years before. We want to see this firmer continuation of rental growth into '24. There's a slight mitigation against that because inflation is obviously lower and 25% of our entire rent roll is inflation-linked. But we believe the pent-up historic rental growth that's still to come through from '21 and '22 and '23 will enable us to keep that forward momentum going.On this slide, we show our track record, a slide that we're very proud of. If you'd have bought shares at the very beginning, you'd have seen your income grow quite consistently. And you can see that our cover is absolutely fine because of our tight control of costs. And there is our comparative return on the property side, which I think speaks for itself. In particular, compared to MSCI, we don't see the volatility in our values that other sectors suffer from and our track record speaks for itself.So with that, I'm going to hand over to Richard, who is going to take you through the financial numbers in more detail.

[Richard Howell, executive]

Thank you, Harry, and good morning to everybody. Just looking at some of the key financial highlights, and David and myself will go through some of these numbers in a bit more detail in the subsequent slides. So net rental income was up GBP 7.8 million, or just under 6% to GBP 149.3 million. That was driven predominantly by rental growth from revenues and asset management projects, delivering GBP 4.6 million of additional income. The completion of a couple of developments in Ireland in 2022 and 1 acquisition in '23, delivered another GBP 2.5 million to income, but our tight control on property costs, in particular, we saw a reduction in those of GBP 700,000. So that was the result of that overall increase.However, we did see interest costs go up and overall interest costs did rise by GBP 4.9 million, and I'll explain that in a bit more detail on the next couple of slides, along with increased administration costs of GBP 2 million. Axis delivered, as Harry has already mentioned, and that delivered GBP 1.1 million of extra income. So overall, adjusted earnings up GBP 2 million to GBP 90.7 million, resulting in adjusted earnings per share of GBP 0.068, fully covering the dividend with dividend cover at 101%.Harry's already touched on some of these numbers, but like-for-like rental growth, 3% GBP 4.3 million, majority of that coming from rent reviews and GBP 300,000 coming from asset management activity. The revaluation deficit in the period was GBP 53 million due to 2 key factors, yield expansion, 23 basis points equivalent to a deficit of GBP 128 million, and this was partially offset by rental growth delivering GBP 75 million surplus. So overall, GBP 53 million deficit, equivalent to GBP 0.04 per share, and that was the key reason for the decline in the adjusted net asset value down to [ GBP 1.08 ]. The acquisition of Axis also impacted that number by GBP 0.005.Loan-to-value, 47%, still within our targeted range of 40% to 50%. And in terms of the key sort of operating metrics, long WAULT, just over 10 years, pretty much full occupancy. One of the lowest EPRA cost ratios in the whole sector, just over 10%. And notwithstanding the very large increases in interest rates we saw over the course of last year, the average cost of debt rose by 10 basis points to 3.3%.We've already been through some of these numbers already, but just to perhaps explain the increase in administration costs. The GBP 2 million increase is due primarily to the impact of performance-related pay. In '22, we saw a benefit of an accrual that reversed out GBP 600,000 related to the old performance incentive scheme that was never paid out. And this year, we carried out some voluntary redundancies to help reduce our admin costs and that costs GBP 300,000. Along with higher performance-related pay this year of GBP 800,000 was a key driver between -- behind that overall increase. But the voluntary redundancy program, we are hopeful we will save around GBP 500,000 per year.Interest costs up just under GBP 5 million. That was driven by 2 key factors: one, an increase in the average net debt drawn by just under GBP 50 million, and increase in interest rates on our variable rate debt of GBP 1.2 million. We also saw some accounting adjustments regarding interest receivable on our development that are now producing rent and that also added a further GBP 700,000 to that number.So as Harry mentioned, adjusted earnings up 2.3% to 90.7%. There are a number of IFRS adjustments. The key one there being the mark-to-market on the convertible bond, which is just a paper adjustment, and really the GBP 13.2 million loss reflects the reversal of the big surplus we saw last year of just under GBP 27 million as a bond gets closer to maturity.Looking at the balance sheet in a bit more detail. And the movements in the net tangible asset, started the year at GBP 1.126, adjusted earnings GBP 0.068 were pretty much paid out in full as a dividend, as already touched upon the revaluation deficit equivalent to GBP 0.04 and the impact of the Axis acquisition and some small costs relating to the listing on the Johannesburg Stock Exchange, GBP 0.005.Net initial yield, and David will come and talk about this in a bit more detail in a second, just under 5.1%, and we continue to see strong value of ERV growth at 3.5% over the course of the year. That, along with the actual rent reviews that we delivered in the year was a key driver behind the GBP 75 million surplus from rental income improvements.Just turning to the debt. Total debt hasn't really changed much. We did tap one of our euro private placement loan notes at the end of last year, fixed for 10 years at just under 4.2%, and those proceeds have been used to repay more expensive variable rate debt. As Harry has already mentioned, we have over GBP 300 million of undrawn headroom. And so unlikely to come back to the market for any equity in the near future. And 97% of our debt is fixed or hedged out for just under 7 years.Just to give you an idea of the level of protection in the portfolio, the portfolio would have to fall in value by just under 40%, GBP 1.1 billion for us to hit our loan-to-value covenants across our various facilities, which would imply the net initial yield across the portfolio has ballooned out to 8%. When we look at the debt maturity profile in future years, we're very focused on 2025. And the key numbers within that debt stack, GBP 372 million are the GBP 150 million convertible bond. We're already looking at options to refinance that at some stage over the course of the current year, but we do need to see the share price improve and the interest rate outlook also improve.There is a further GBP 70 million variable rate bond in there, which we're also keen to repay. And the key message from us is that all these repayments can be dealt with from the existing headroom in our other facilities. The balance of that number is GBP 100 million facility with Lloyds Bank, and that was only renewed at the end of last year for a 3-year term. And so we'd expect that to renew on normal terms over the course of this year.So lastly, on the finance section, here are some of the sort of key debt metrics. I won't repeat them again. But we did carry out some further hedging, taking advantage of cheaper euro generated debt over the course of last year and that was the sort of driver behind the increase in the total proportion of debt that's fixed or hedged out to 97%. And as Harry mentioned, over GBP 320 million of undrawn firepower across our various facilities.So at that point, I'm going to hand over to David.

[David Bateman, executive]

Thank you, Richard. Good morning, everybody. I was going to give a quick summary or overview of what's really driven the portfolio during the course of the year. It's nice to be standing here, seeing this time last year, we were talking to the potential for increased rental growth. And indeed, during the course of the year, we've managed to show a growing momentum on that front. Indeed, during 2021, we showed GBP 2 million of organic rental growth; 2022, GBP 3 million of organic rental growth; and indeed, this year, a record GBP 4 million of organic rental growth, reflecting a 4% annualized rental increase via, I think it was 313 rent reviews.The makeup of the portfolio hasn't really changed on the basis we bought just 1 asset. I'll come on to that later. And indeed, we didn't sell any assets. So we still have a makeup of rent reviews that will allow us to drive that rental growth trajectory going forward with 60% -- 67% of the rents being open market led and the remaining 33% being either index-linked or fixed.Moving on with that theme, we remain positive about the rental growth trajectory going forward. And indeed, as you'll see from the next slide, the majority of our unrealized rent reviews date back to 2022 and 2023, whereby you won't be surprised to hear me say that during those periods, obviously, inflation was having a positive effect on rents. And indeed, we look to -- we look forward to harvesting more of those rent reviews during the course of this year and therefore, continuing to drive that positive rental growth trend.It's also worth noting that in terms of our -- the regional location of some of our rent reviews that haven't yet been settled, about 30% of those sit in London and the Southeast, obviously, with specific demographic drivers in those areas, that is also positive moving on. We obviously continue to work hard in the absence of accretive acquisitions during the course of the year, we've been very focused on active asset management, ensuring the buildings remain fit for purpose, driving the rents, extending their lease terms and taking asset management opportunities as a further opportunity to enhance the environmental credentials of the portfolio. Indeed, during the course of last year, we managed to improve the EPC ratings of the portfolio from 35% As and Bs to 42% As and Bs now, which is tough, granular going, but obviously something we're very focused on achieving.During the course of last year, we exchanged on 5 asset management projects. We regeared 8 leases, and we let 4 small areas of vacancy in the portfolio, all in all, investing about GBP 5.2 million in the portfolio. And as I think both Richard and Harry mentioned, generating additional organic rental growth of about GBP 300,000. So positive. And it's nice to point out that on this slide, that in terms of the demand pull in the sector, every one of those examples, the GPs are looking for more clinical space. So the demand for space remains strong as services continue to rotate out of private hospitals or, sorry, hospitals and secondary care.Moving on. I won't dwell on this slide too long. I think most of you are pretty familiar with the portfolio. But what I will say is it continues to exhibit a very defensive granular nature, but a long WAULT of in excess of 10 years. It's effectively a 100% let. Crucially, 89% of the income is supported by either the British or Irish governments directly or indirectly. And we have a very low void risk and expect the majority, if not almost all of our leases to regear on favorable terms as lease expiries come up.We've touched on it already, but our Irish investment case remains, in our opinion, very attractive. The portfolio there is standout. We've got large average lot sizes -- 80% of the income is backed by the Irish government and the leases are all [ index-linked ] led to Irish CPI. We will continue to focus on growing our presence in Ireland. There are opportunities there to farm. And like with our more recent acquisition of the enhanced medical facility, near Cork in a place called Ballincollig, we'll be focusing on accretive acquisitions there, too.Moving on and a nice segue indeed, you'll be aware that we bought the asset management -- property management business, access technical services. And that's proven a very good strategic move. It's given us obviously more ability to provide for active asset management and property management in Ireland, sweating the assets, generating more forward momentum as the assets get a little bit older and importantly, maintaining our key relationship with the HSE in Ireland as our main tenant or client there.Perhaps moving on one more. I think looking forward, investments in new assets will remain relatively muted. As Richard alluded to, there may be some opportunistic deals to be reviewed. And if they are appropriately accretive, then we might well move forward with those. But I would suggest that in terms of the pipeline looking forward, we're not planning on any significant capital expenditure. We've got one UK direct development in legals, which we hope to bring forward, it's been a favorable position there in terms of rental award and indeed a capital contribution from the commissioning body.But the majority of our time, as I've said in terms of the year just passed, we'll be focused on driving the existing portfolio. And during the course of the next 3 years, we expect to invest a further circa GBP 35 million there, generating more rent, future-proofing the assets and enhancing the environmental credentials of our existing portfolio.Touching on development, just like investment, going forward, we expect this to remain muted. But I think the rental drop -- the rental growth background is improving. Demand for the assets, as I've already highlighted, with our asset management program is very, very strong. And I think the combination of those things is starting to move us towards a place where we can see some isolated opportunities of viability in that space, which will obviously look to progress if those opportunities remain appropriate.I think that's all from me. I'm going to hand back to Harry to sum up.

[Harry Hyman, executive]

Thank you very much. Just 1 -- 2 points to make that perhaps didn't come out of what you were saying just now is that the -- what's very interesting overall is that the replacement cost of our entire portfolio is higher than the current valuation, which kind of indicates that it represents pretty good value. And the point being that replacement cost is a sort of surrogate proxy for what rental levels actually are in the sector. And just moving on from that, the sort of rental increases that are needed to get developments back on track from an NHS and HSE standpoint is somewhere between 20% and 30%. Now that's not going to -- sadly, not going to feed back pound for pound into the existing levels, but it is going to act as a very strong pull factor for rental negotiations across the piece over time.So anyway, to summarize, you've heard that you've got a very soundly financed, very strong balance sheet, a lot of capacity for future deals, rental growth is coming through, finally, at the sort of levels we've wanted to see for some time. There's a backlog on rental levels. We have to work very diligently with the District Valuer's office to get that backlog down, whereas inflation is coming down and interest rates are coming down, which are very good bull cases for new development moving forward.We should be back, growing the portfolio as we need to do to meet the demographic demand that there is in the business. So 89% of our total rent rolls still paid for by the Irish and British government. We're very keen on maintaining that, 27% index-linked, strong occupancy, strong WAULT and most importantly of all, a very hedged out position on the debt side. So there's absolutely no problem at all about us maintaining our progressive dividend policy into the future, no immediate requirement for capital to be raised. The prospects are very good, and it represents a good opportunity for shareholders to buy into the company at what is an attractive initial yield where the share price is today.So with that, I'm going to open the floor to questions. If you want to ask a question, please could you tell for the benefit of everyone else, your name and where you're from. So your first question, please.

[Bjorn Zietsman, analyst]

Bjorn Zietsman from Liberum Capital. Just a quick question on the costs. So you mentioned the one-offs, the GBP 300,000 and the GBP 800,000 that came through during the year. Should we then think of the cost as increasing by GBP 900,000? And then following that, just the guidance for cost growth going forward, should we think of it as growing in line with inflation.

[Richard Howell, executive]

Cost inflation is probably the right assumption to make. And the other assumption you talked about is probably correct as well.

[Bjorn Zietsman, analyst]

And then secondly, just on potentially accretive acquisitions, how would you think about funding those going forward? Would that be through capital recycling potentially or is that [ reason ]?

[Harry Hyman, executive]

Bank debt, I think, is the simple answer. And if we have -- if we have come to a trough in values, then that won't be too big of a strain on the LTV. Our range is clearly between 40% and 50%. We understand investors' nervousness. But you have to remember that this is a portfolio that can withstand quite substantial levels of leverage because of -- I'm sorry to keep repeating it, the 89% of the income that comes from the government, the almost 100% occupancy and the very long WAULTs. But we don't want to push things too high, too quick. But anyway, there aren't that many acquisition opportunities for us to get into right now. So that's kind of okay. And that's why we're focusing on the rental growth, which bolsters the values in a constant yield environment and gives us additional cash flow.We may want to rotate a little bit of stock out later in the year to increase the average lot size and move things forward. We bought a lot of portfolios historically and not everything fits with our current requirements. But we -- I don't think there are some new entrants into the marketplace in the last week or so, I've seen some press releases about people saying that the yields available are now very, very attractive, right, more attractive than they were in the era of 0 interest rates and some people paying 3% or lower for assets in this space. We've never done that, and we never will. We want to maintain a balanced, disciplined approach to our portfolio.Next question, please.

[James Carswell, analyst]

James Carswell from Peel Hunt. I probably asked this question 6 months maybe even 12 months ago. But just on the negotiations you talked about with NHS on new developments. I mean, can you just give us a bit of an update as to how those discussions are continuing? And I guess, in particular, are you seeing not necessarily within your own portfolio, but across the market. Are we seeing any signs of some of these developments now coming throughout those higher rents or are we not there yet?

[Harry Hyman, executive]

I think David Bateman referred a bit to this during his presentation. We are seeing some movement. I think there are 42 ICBs or ICSs across Britain and some have got some really acute health care problems. And the short answer is that they want to see new buildings built, they have to either put in a capital contribution towards the cost of the scheme, right, or alternatively increase the rent or both. And we are -- it's a shame that we have got further along the line with it, but the NHS is always under a lot of different pressures, but we are making progress. So I'm reasonably comfortable that during maybe the first half of the year, we should see some of those come forward.Sadly, it's patchy, but that kind of reflects the fact that the NHS is a very disparate organization that covers the whole of the United Kingdom. It's just the way it is. And it takes a long time. And whereas it's obvious to us what should happen, there are conflicting priorities like waiting lists, cancer care, all of which puts a big revenue strain on the NHS. One of the key points we've been trying to get into the NHS mind is that, rather like a finance director wanting to sanction additional cost to get a production facility that doubles output or doubles productivity, the cost of the rent of a new center will be more than offset by the savings in treatment cost. But that's very hard to demonstrate to the treasury taskmasters.And it's actually quite hard to demonstrate to the NHS because they -- that takes time to come through and the pressure is always on the current revenue account within the NHS. But it's something that we've written reports about that are on our website or how external people right reports about, and it doesn't take a genius to see that if you're not having to refer a patient to a hospital to have an x-ray or a scan or to have an outpatient consultation, it's going to be miles cheaper to treat them in primary care. The tariff cost is like GBP 50 in primary care compared to GBP 300 or GBP 400 in secondary care, it's not quite apples and apples, okay. But it's incontrovertible that that is the case.And when we get into things like social prescribing and wellness, it's much better to stop people becoming overweight or having heart disease than wait for them to have the disease and then have to treat them. So that's very much the future of care. I think it's more about wellness and social prescribing in the country to help us overcome these health care issues. And that has to be carried out, I should have said the obvious point, that's carried out in primary care centers, not in hospitals.Next question.

[Stuart Bell, analyst]

Stuart Bell from IDCM. There were stories, possibly transactions of aggressive buying of Irish assets during the course of the year. So there were some assets that came on the market that were snapped up at aggressive yields. And I just wondered how that changed in the -- did that come through in the valuations of the Irish portfolio versus the setback in valuations in the UK?

[Harry Hyman, executive]

Right. I thought you were going to ask a question with regards to that for the UK portfolio, because 2 years before, there were lots of aggressive purchases. And this is -- the fact we didn't take part in that is reflected in our superior total property return portfolio, right? Sadly, not so much sadly, the world doesn't all work with regard to income accounts. Our criteria is that acquisitions have to be accretive, other people in infrastructure and other sectors have more of an IRR-based return, so they can kind of pay more for infrastructure assets. And if they believe that they've got a perpetuity because it's certain that the Irish government will renew leases at the end, and they can kind of persuade themselves that something should be valued on a DCF basis rather than just on a more conventional property.So the answer to your question is, yes, we have missed out on assets there, but our valuers still maintain a very conservative approach to the valuation, they haven't kind of reflected that in the carrying value of our Irish portfolio. But it doesn't really matter because we're an income play, right? And it's all about the income. So buying an asset at north of -- just north of 5% with a 28-year lease to the Irish government -- 25-year lease to the Irish government doesn't strike us as a bad deal. And because we bought it attractively, we can finance that accretively using euro debt. It's a bit of a long rambling answer, sorry about that.Another question. We've got John.

[John Cahill, analyst]

John Cahill from Stifel. Harry, you've been really clear about what needs to happen with rents in order to get back to acquisitions, et cetera. And as interest rates fall, maybe that 20% to 30% increase in rents will not be quite so large. But nonetheless, they will need to move on substantially. Is the District Valuer mechanism sort of fit for purpose to get you where you need to go? Some time ago, now I don't know you've been into battle with the authorities before and one -- might you have to do something of that nature again?

[Harry Hyman, executive]

Well, I actually think that in time, it will be better if everything was index-linked because it will be faster, clearer, better but we are where we are. And the District Valuers have a clear job to do. They have to set a fair market rent. That's what the regulations say and we do have an appeals process, which we established several years ago. I'm afraid it's very slow grinding work. And of course, there's a very technical question here about what is evident because if the District Valuer sets all the open market value rents in England, which it does, then if it doesn't agree any increases, where is the evidence to support anything more? Anyway, the answer to that is through the appeals process, where you can go and argue for a secondary or tertiary office type location rent, right? Or you can argue for something based on replacement cost.I think the NHS and the HSE both understand the point. And the sad fact is, as we've told them, overtly, if you don't have high levels of rent, we won't be able to build any more buildings. And if we can't offer our shareholders a proper return, capital worldwide is volatile and will go to other spaces. So kind of their issue for new stock, it's our issue for the existing stock, and I'm very comfortable that it's impossible because of the appeals process for them just to say, well, there's never any increases. And it isn't so much interest rates that I think are the problem, it's more the fact we've been [ loss ] of cost price inflation. And although inflation is coming down, it doesn't mean the price is coming down, it means that's just going up less fast.So construction costs have seen a big increase. And specification creep, which is not a funny name for a quantity surveyor is -- or building surveyor, is actually behind that, too. So buildings today are built to much higher standards than they were in the 70s or 80s. So, you just have to be very patient in this space, I'm afraid.

[Richard Howell, executive]

I think also, John, it's important to point out that not all the evidence just comes from rent reviews and there will be evidence created slowly but surely from new developments and those developments aren't going to happen unless the rents are appropriate and that might be a combination of higher rents and development contributions from the ICV, which we're starting to see. And of course, one can devalue those into what that really means for the rent. So I think as that becomes more consistent, which in time, I'm hopeful and fairly sure that it will, I think that will also feed through.

[Harry Hyman, executive]

Any other questions? If not, we can go to those people attending on the webcast. Are there any questions for me to come from the moderator or for the team to come from the moderator?

[Operator]

[Operator Instructions] We do not have any audio questions at this time. We could now go to the questions that were submitted by webcast.

[Unknown Executive]

Our first question from the webcast comes from [ Shayan ] from Gravis Capital. He asks, regarding the 20% to 30% rental growth required to make developments attractive, how does that level change with rates on a downward trajectory?

[Harry Hyman, executive]

Well, I think we've partially answered that in one of the questions in the room. But just so that they don't feel they get shortchanged on this, it's really the building price inflation that is pushing things up on the rental side. The interest rate does have an impact. But interest rates are not, sadly, or good news. They're not going back to 0 where they were for 2 or 3 years. They're going to probably come out, it's a personal view of like 3% or something, maybe 3.5%. So that's not going -- but remember, we had like 4, 5, 6, 7 years of very, very low interest rates -- negative interest rates in the Eurozone.

[Unknown Executive]

Our next question is from Steve Bramley from HSBC. Can Harry please reexplain why development activity is more muted?

[Harry Hyman, executive]

Okay. So this is a question about the initial levels of rent and a point that -- which actually be of interest to people in the room is that the initial levels are set probably 3 years before a development gets on to site, maybe 5 years in the case of the HSE. In Ireland, they issue a letter that says the amount of rent that they're going to pay and developers tender against that. Well, clearly, if prices run away and have been averaging by 8% in Ireland increases in Irish CPI for 3 or 4 years, that's going to eliminate the developer's margin.So a simple answer might have been to index the initial level for the period between it, the letter being written and the start of the development, but the Irish government don't want to do that. So they're going to retender the procurement process. And in Britain, it's a very similar reason, the DV will issue his or her letter. And then the developer will have to go about getting planning, finding a site and building the building. So it's that lag impact because inflation has come back with a vengeance in both countries, that has meant that the rents are no longer viable in order to make sure the developments go ahead. So hopefully, that's a concise answer to that question.

[Unknown Executive]

The final question from the webcast comes from Callum Marley from Kolytics. What is the reasoning for not wanting to diversify the portfolio to more private health care tenants? Is the higher growth not worth the risk?

[Harry Hyman, executive]

Well, the simple answer is that we understand the attractions of investing in other parts of the health care system, but pretty much all the other parts of the health care system have what I would describe as operator risk, whereas you don't have operator risk with the British and Irish governments, you've got state risk. And we're very keen to ensure that our shareholders continue to have a very high percentage of the total rent roll paid for by the British and Irish governments.If we were to go into that space and there may be some attractive opportunities within it, that would be by way of a joint venture more than likely with us having a small capital position in the JV, rather than us putting it straight onto our balance sheet. So I think I can safely say that we won't be doing that. Any adjacencies or things like that will go into a JV, and therefore, the impact on that will be simply the return that we get on our equity investment, it's like 10% maybe and also monetizing our platform by using the undoubted expertise that we have in the team in order to put those opportunities in place for the joint venture partner who may not have the feet on the ground in Britain or Ireland in order to pursue those.

[Unknown Executive]

Those are all the questions from the webcast. So Harry?

[Harry Hyman, executive]

Well, that closes the formal part of the business, for the meeting. Thank you all very much for attending for those who've been to all 56, which probably is only myself, sadly. It's been great fun and I now look forward to inviting you to have a cup of coffee or tea and meeting Mark, the CEO-elect, who will be taking over from me on the 24th of April. Thank you all very much for coming. Thank you.