Target Healthc. Regulatory News (THRL)

To: RNS

From: Target Healthcare REIT Limited

LEI: 2138008VQQ5Y9QXMX749

Date: 4 October 2018

Results for the year ended 30 June 2018

Target Healthcare REIT Limited (the "Company" or the "Group"), the listed specialist investor in modern, purpose-built UK care homes, is pleased to announce its results for the year ended 30 June 2018.

Financial Highlights

· EPRA* NAV per share up 3.7 per cent to 105.7p (2017: 101.9p)

· NAV total return of 10.5 per cent (2017: 7.8 per cent)**

· EPRA Earnings Per Share up 8.5% to 5.25p (2017: 4.84p)

· IFRS profit for the year up 44.5% to £27.6 million (2017: £19.1 million)

· Dividend increased by 2.7% to 6.45p (2017: 6.28p)

· Dividend cover of 82 per cent (2017: 83 per cent)

Portfolio Highlights

· Portfolio rent of £26.0 million (2017: £20.3 million)

· Number of tenants grown to 21 (2017: 16)

· Weighted average unexpired lease term ('WAULT'): 28.5 years (2017: 29.5 years)

* European Public Real Estate Association

** Based on EPRA NAVs

Malcolm Naish, Chairman of the Company, said:

"Our approach to care home investment is focused on the quality of the physical asset, alongside a comprehensive assessment of tenant capabilities before and after investment. The Manager continues to see acquisition opportunities which are attractive based on long-term sustainability of rental income and their ability to contribute to the diversification of the portfolio."

Introduction

On behalf of the Board, I am pleased to report on another year of progress. The portfolio has performed in-line with expectations and with the support of shareholders and lenders we have raised further capital to continue our assembly of a diversified portfolio of significant scale. Our approach to care home investment is focused on the quality of the physical asset, alongside a comprehensive assessment of tenant capabilities before and after investment. We expect the portfolio to provide stable and sustainable long duration rental income to support our dividend objectives.

During the year we marked the fifth anniversary since our launch in March 2013. Up to 30 June 2018, the Group has provided an annualised NAV total return of 7.8 per cent inclusive of dividends to shareholders. Annualised share price total return for the same period has been 7.7 per cent.

Performance & Dividend

The investment manager reports on the portfolio performance in more detail below.

The Group's EPRA NAV per share has increased by 3.7 per cent to 105.7 pence, delivering a NAV total return of 10.5 per cent when combined with dividends paid. Portfolio valuation growth of 5.2 pence per share has been the principal driver of NAV growth.

EPRA Earnings per share has continued to grow, with an 8.5 per cent increase to 5.25 pence per share. The Company has paid or declared dividends in respect of the year ended 30 June 2018 of 6.45 pence per share, an increase of 2.7 per cent year on year. Dividends were 82 per cent covered by adjusted earnings1, and we expect future dividends to be fully covered when the Group is fully invested in operational assets on a geared basis.

The Board remains committed to its strategy to provide a progressive dividend, with an increase to the quarterly dividend in respect of the year ending June 2019 of 2.0 per cent to 1.64475 pence per share, providing an annual total of 6.579 pence which reflects a dividend yield of 5.8 per cent on the share price of 112.5 pence as at 2 October.

Outlook

The care home investment market remains competitive, with several buyers and a shortage of high-quality homes resulting in tightening investment yields. The Manager continues to see acquisition opportunities which are attractive based on long-term sustainability of rental income and their ability to contribute to the diversification of the portfolio. Given activity levels in the market and the underlying demand/supply imbalance of modern beds with full wetroom provision for residents, the Manager remains confident and optimistic about our portfolio and the wider care home investment market.

In recognition of this outlook and noting the benefits to shareholders of a larger Group, we have agreed with the Manager to amend the management fee arrangements, moving to a tiered fee basis which has the benefit of reducing rates at increasing NAV levels and allows shareholders to benefit from the increasing economies of scale that a larger portfolio provides. In addition, the Manager has been entitled to a performance fee based on achieving certain targets, which have been met in every year since launch. As part of the amendment to the fee structure, this performance fee will be removed as we do not believe it provides effective and long-term alignment and creates additional financial uncertainty. The new arrangements will provide a significantly lower fee for shareholders than that achieved each year since launch, which has averaged 1.23 per cent per annum and will support our objectives to provide shareholders with progressive and sustainable dividends via patient and disciplined growth.

Financing & portfolio growth

Since the Company issued £94.0 million of ordinary shares in February, it has acquired, or committed to acquiring, £83.6 million of new investments.

As at 2 October, the Group has £21.2 million of cash and £64.0 million of debt available to be drawn. £35.8m of this is allocated to upcoming commitments of the Group's development program, which will support the construction of seven brand new care homes adding £3.8 million to portfolio rent annually once operational. In addition, the Group has £18.5 million of potential deferred consideration payments on eight previously acquired assets, this investment being contingent on stringent performance targets being met, and prudently requires £11.4 million of cash for general corporate purposes, including dividends and working capital.

The Group continues to see some attractive investment opportunities in the market, with five assets in advanced negotiations, which would total £79.1m if acquired. In light of these opportunities, and the Group's current cash position, the Directors are considering the optimum way to finance any further asset acquisitions, including issuance of new equity. Whilst a coupon is earned on forward funding developments, the Group is cognisant of the negative effect of cash drag on its returns. Accordingly, if an equity raise is launched, the Directors expect it to be relatively small allowing the Group to quickly invest the proceeds. Any equity raise in the near term is likely to be carried out under the remaining placing programme authorities. The Group is progressing with due diligence on these acquisition opportunities and will only look to raise new equity when this is at an advanced stage. A further update will be made in the next NAV statement, expected on 15 October.

Board

A comprehensive Board appraisal process has recently been performed by an external party. This has focused on succession planning with an emphasis on maintaining the various property, financial and care expertise that the skills and experience of the current Board currently provide. The recommendations arising are being assessed and will form the basis of the Board's succession plans over the medium term.

We have welcomed Craig Stewart to the Board during the year, and thank him for his contribution thus far, in particular his knowledge of the Jersey regulatory environment.

Malcolm Naish

Chairman

3 October 2018

1 See note 3 of the financial statements for a reconciliation of EPRA earnings to adjusted earnings.

Enquiries:

Investment Manager's Report

Portfolio review

The three core tenets of how the portfolio is managed, described in the business model in the Annual Report, are the key drivers of portfolio returns. Modern, well-designed homes are attractive to residents and tenants alike, supporting occupancy, care quality levels, trading performance and value. Assembly of a diversified portfolio drives sustainability of returns, as does our sector specialist knowledge and experience through ongoing dialogue with and support provided to our tenants.

The portfolio continues to perform in line with our expectations, outperforming its benchmark, the IPD UK Annual Healthcare Property Index, since IPO with an annualised total return of 11.9 per cent (benchmark 9.4 per cent). Our upwards-only rent reviews, trading performance and market yield tightening have each contributed to a like-for-like valuation increase of 6.6 per cent in the year.

Portfolio rent1 has increased by 3.2 per cent on a like-for-like basis and by 27.7 per cent inclusive of acquisitions and portfolio management activities, now standing at £26.0 million.

We are pleased to have continued diversification of the portfolio. The Group now owns 55 assets (30 June 2017: 45) let to 21 tenants (2017: 16) with an EPRA topped-up net initial yield of 6.44 per cent (30 June 2017: 6.75 per cent). The South East region at 17 per cent and Ideal Carehomes at 14 per cent retain the largest share of geographical and tenant concentration by income respectively; the South East's share of the portfolio has remained steady. The portfolio is further diversified through a balanced mix of bed registrations (nursing, residential) and with a mix of private and publicly funded residents which is more heavily in favour of private funding than the national average.

The majority of the portfolio continues to perform well, with 96 per cent of properties having maintained or increased in value. As previously reported, with a portfolio of scale there is the increased potential for challenges to arise, with two assets currently subject to more focused asset management. Asset performance can suffer from poor management at home level, and staffing pressures can arise from a shortage of qualified nurses, or homes being wholly reliant on local authority funding finding inflation-protecting fee increases hard to come by. Both scenarios put pressure on margins and the ability of the tenant to provide the high levels of care expected. Stable and talented local strong leadership can do much to mitigate these problems, and is something we focus on at investment appraisal and in managing the portfolio.

As part of our continued engagement with tenants, we consider the results of regulator quality assessments as part of the underwriting process in forming our overall view of tenant and asset performance. The results of the current portfolio compared to national averages is presented in the table below.

It is pleasing to see performance ahead of the average. We engage with our tenants to an unusual degree as landlord to ensure our healthcare team has visibility of standards of care and operational management. What is important to us are trends as opposed to snapshots, being able to discuss findings with our tenants to fully understand their business, and local home management presenting plans of substance to improve as required, as our healthcare team sees areas for improvement.

UK Care home investment market

The market for investment properties in the UK elderly care sector continues to be very active, particularly in the segment of the market in which we operate - modern purpose-built homes with flexible layouts and excellent resident facilities, including single occupancy bedrooms complete with en-suite shower or wetroom. What may be surprising to many is that this proportion of the sector comprises only approximately 100,000 of the overall 450,000 beds with an alarming 100,000 without any form of en-suite and 250,000 with WC and washbasin en-suite only.

This relative paucity of appropriate quality buildings that meet our appropriate investment criteria has resulted in our pipeline including a larger number of forward funding and forward commitment opportunities to construct brand new properties. We remain very selective about the development partners we work with and all of our development projects are pre-let and include a maximum funding commitment ensuring that developers' profit is at risk before any further capital is needed from the Company. The current commitment to forward funding and forward commitment projects represents 13 per cent3 of the gross assets, well within the 25 per cent limit set out in the Group's investment policy.

There has been a general inward movement in investment yields in the sector, largely driven by the search for yield. Sharper yield tightening has followed for the best assets let to the strongest financial covenants, often acquired by more generalist property/ annuity investors who lack sector specialism.

There is an active current M&A landscape with three of the five largest operators currently for sale. HC1, Care UK and Barchester make up just 9 per cent of beds which underlines how fragmented the UK elderly care market is. Much of this activity is driven by normal private equity market exit requirements and we think endorses our favouring of good local operators with longer term operational horizons to whom we bring stable capital.

Health and social care

Politics

'What a difference a day makes' - the old idiom held true at the turn of the year when Jeremy Hunt, then Health Secretary, came out of a No10 reshuffle as head of the "Department of Health and Social Care". A change widely unnoticed by the general public, but of significance to the Social Care sector who had felt unloved for decades. 2018 of course heralded the 70th 'birthday' of the NHS and the government duly announced a £20bn 'birthday present' albeit as an IOU, and the sourcing of which is a matter of ongoing debate. Closer cooperation between Health and Social Care is much discussed, as it has been for decades, with wide recognition that if the NHS is to cope with the demands of an ageing society, better resourcing and coordination of services is urgently required. This provides at least one issue for the long promised 'Green Paper' which unfortunately seems to have taken a backseat while Downing Street grapples with Brexit.

Funding

The elephant in the room is Local Authority funding of carehome residents with low savings/assets. Much new carehome development is now polarising around geographical areas which can support a helpful degree of private fees, and established homes which are heavily reliant on public funding are feeling stretched. Most councils in April 2018 exercised the Adult Social Care Council Tax legislation allowing up to 3 per cent extra on council tax to be collected, and while this has no doubt been helpful for their social care budgets, little has found its way through to carehome operators. This issue should be a high priority in the aforementioned Green Paper, but there is a general consensus within the sector that other political matters will divert attention.

Operation

Care remains a challenging sector to operate in; a constantly changing regulatory landscape; difficulties with staff recruitment and retention (particularly nurses); and profit margins in services with a high proportion of local-authority funded residents continue to be eroded. Social media quickly highlights any deficiencies, genuine, misguided or scurrilous, and a popular press is often happy to expand thereon. Many questions abound regarding the impact of Brexit, not least from a staffing perspective. Overall however, we feel that operators will find a way through, perhaps even with more open availability of staff from the 'old' geographies of India, the Philippines and Asia more widely.

Despite the apparent gloom, well managed and forward-thinking operators continue to thrive and they value our specialist support.

Target Fund Managers Limited

3 October 2018

1 Excluding the effect of short-term rent-free periods

2 Inspection ratings issued by other regulatory bodies have been converted to the most appropriate CQC rating. Homes which do not have a current rating are assumed to be Good unless there is an earlier CQC rating for that location issued to the same provider

3 Date of this report

Strategic Objectives

Risk Rating

The principal risks faced by the Group together with the procedures employed to manage them are described in the table below:

Malcolm Naish

Chairman

3 October 2018

Consolidated Statement of Comprehensive Income (audited)

For the year ended 30 June 2018

The total column of this statement represents the Group's Consolidated Statement of Comprehensive Income, prepared in accordance with IFRS. The supplementary revenue return and capital return columns are both prepared under guidance published by the Association of Investment Companies.

All revenue and capital items in the above statement are derived from continuing operations.

No operations were discontinued in the year.

Consolidated Statement of Financial Position (audited)

As at 30 June 2018

Consolidated Statement of Changes in Equity (audited)

For the year ended 30 June 2018

For the year ended 30 June 2017

Consolidated Statement of Cash Flows (audited)

For the year ended 30 June 2018

Statement of Directors' Responsibilities in Respect of the Annual Financial Report

In accordance with Chapter 4 of the Disclosure Guidelines and Transparency Rules, we confirm that to the best of our knowledge:

· The financial statements contained within the Annual Report for the year ended 30 June 2018, of which this statement of results is an extract, have been prepared in accordance with applicable International Financial Reporting Standards, on a going concern basis, and give a true and fair view of the assets, liabilities, financial position and return of the Company;

· The Chairman's Statement, Investment Manager's Report and Strategic Objectives include a fair review of the important events that have occurred during the financial year and their impact on the financial statements;

· 'Risk Rating' includes a description of the Company's principal risks and uncertainties; and

· The Annual Report includes details of related party transactions that have taken place during the financial year.

On behalf of the Board

Malcolm Naish

Chairman

3 October 2018

Extract from Notes to the Audited Consolidated Financial Statements

1. Dividends

Amounts paid as distributions to equity holders during the year to 30 June 2018.

Amounts paid as distributions to equity holders during the year to 30 June 2017.

It is the policy of the Directors to declare and pay dividends as interim dividends. The Directors do not therefore recommend a final dividend. The fourth interim dividend in respect of the year ended 30 June 2018, of 1.6125 pence per share, was paid on 31 August 2018 to shareholders on the register on 10 August 2018 amounting to £5,470,000. It is the intention of the Directors that the Group will continue to pay dividends quarterly.

2. Fees paid to the Investment Manager

The Group's Investment Manager and Alternative Investment Fund Manager ('AIFM') was Target Advisers LLP. With effect from 2 November 2017, the Investment Management Agreement was novated to Target Fund Managers Limited (the 'Investment Manager' or 'Target') reflecting a transfer in the Investment Manager's fund management business from a limited liability partnership to a newly incorporated limited company. The key contractual arrangements, as set out below, remained unchanged.

The Investment Manager was entitled to an annual base management fee of 0.90 per cent of the net assets of the Group and an annual performance fee calculated by reference to 10 per cent of the outperformance of the Group's portfolio total return relative to the IPD UK Annual Healthcare Property Index ('the Index'). The maximum amount of total fees payable by the Group to the Investment Manager was limited to 1.25 per cent of the average net assets of the Group over a financial year.

Performance fee periods were annually to 31 December, in line with the Index. Portfolio performance was measured over three cumulative rolling performance periods whereby any performance fees paid to the Investment Manager are subject to clawback if cumulative performance underperforms the Index.

A performance fee in respect of the performance period to 31 December 2017 totalling £946,000 has been paid of which £396,000 was accrued in the accounts at 30 June 2017. Subsequent to the period end, an amendment was agreed to the Investment Management Agreement which adjusted the annual base management fee to a tiered fee basis based on the Group's net assets. As part of this amendment, the performance fee ceased to apply from 1 January 2018. See note 13 for further details.

The Investment Management Agreement can be terminated by either party on 12 months' written notice provided that such notice shall not expire earlier than 30 September 2019. Should the Company terminate the Investment Management Agreement earlier than 30 September 2019 then compensation in lieu of notice will be payable to the Investment Manager. The Investment Management Agreement may be terminated immediately without compensation if the Investment Manager: is in material breach of the agreement; is guilty of negligence, wilful default or fraud; is the subject of insolvency proceedings; or there occurs a change of Key Managers to which the Board has not given its prior consent.

3. Earnings per share and Net Asset Value per share

EPRA is an industry body which issues best practice reporting guidelines and the Group report an EPRA NAV quarterly. EPRA has issued best practice recommendations for the calculation of certain figures which are included below.

Earnings per share

The EPRA earnings are arrived at by adjusting for the revaluation movements on investment properties and other items of a capital nature and represents the revenue earned by the Group.

The Group's specific adjusted EPRA earnings adjusts the EPRA earnings for the performance fee and for development interest in respect of forward fund agreements.

The reconciliations are provided in the table below:

Net Asset Value per share

The Group's Net Asset Value per ordinary share of 105.7 pence (2017: 101.9 pence) is based on equity shareholders' funds of £358,607,000 (2017: £256,937,000) and on 339,217,889 (2017: 252,180,851) ordinary shares, being the number of shares in issue at the year-end.

The EPRA Net Asset Value ('EPRA NAV') per share is arrived at by adjusting the net asset value ('NAV') calculated under International Financial Reporting Standards ('IFRS'). The EPRA NAV provides a measure of the fair value of a company on a long-term basis. The only adjustment required to the NAV is that the EPRA NAV excludes the fair value of the Group's interest rate swaps, which were recognised as a liability of £115,000 under IFRS as at 30 June 2018 (2017: liability of £9,000).

EPRA believes that, under normal circumstances, the financial derivatives which property investment companies use to provide an economic hedge are held until maturity and so the theoretical gain or loss at the balance sheet date will not crystallise.

4. Investments

Freehold and leasehold properties

Changes in the valuation of investment properties

The properties were valued at £385,542,000 (2017: £281,951,000) by Colliers International Healthcare Property Consultants Limited ('Colliers'), in their capacity as external valuers. The valuation was undertaken in accordance with the RICS Valuation - Professional Standards, incorporating the International Valuation Standards June 2017 ('the Red Book') issued by the Royal Institution of Chartered Surveyors ('RICS') on the basis of Market Value, supported by reference to market evidence of transaction prices for similar properties.

Market Value represents the estimated amount for which an asset or liability should exchange on the valuation date between a willing buyer and a willing seller in an arm's length transaction, after proper marketing where the parties had each acted knowledgeably, prudently and without compulsion. The quarterly property valuations are reviewed by the Board at each Board meeting. The fair value of the properties after adjusting for the movement in the fixed or guaranteed rent reviews and lease incentives was £362,918,000 (2017: £266,219,000). The adjustment consisted of £21,181,000 (2017: £14,847,000) relating to fixed or guaranteed rent reviews and £1,443,000 (2017: £885,000) of accrued income relating to the recognition of rental income over rent free periods subsequently amortised over the life of the lease, which are both separately recorded in the accounts as non-current or current assets within 'trade and other receivables'.

5. Investment in subsidiary undertakings

The Group included 22 subsidiary companies as at 30 June 2018. All subsidiary companies were wholly owned, either directly or indirectly, by the Company and, from the date of acquisition onwards, the principal activity of each company within the Group was to act as an investment and property company. Other than two subsidiaries, which are incorporated in Gibraltar, all subsidiaries are incorporated within the United Kingdom.

The Group acquired THR Number 17 (Holdings) Limited ('THR17 Holdings') and its wholly owned subsidiary, THR Number 17 Limited ('THR17'), on 22 November 2017 and acquired THR Number 20 Limited ('THR20') and THR Number 21 Limited ('THR21') on 28 June 2018. These acquisitions were accounted for as Investment Property acquisitions.

In addition, the Group established four newly incorporated companies during the year to 30 June 2018: THR Number 15 plc ('THR15'), THR Number 16 Limited ('THR16'), THR Number 18 Limited ('THR18') and THR Number 19 Limited ('THR19').

6. Bank loans

The Group has a £50.0 million committed term loan and revolving credit facility with the Royal Bank of Scotland plc ('RBS') which is repayable on 1 September 2021, with the option of two further one year extensions thereafter subject to the consent of RBS. Interest accrues on the bank loan at a variable rate, based on three month LIBOR plus margin and mandatory lending costs, and is payable quarterly. The margin is 1.5 per cent per annum for the duration of the loan and a non-utilisation fee of 0.75 per cent per annum is payable on any undrawn element of the facility. As at 30 June 2018, the Group had drawn £30.0 million under this facility (30 June 2017: £40.0 million).

On 30 August 2017, the Group entered into a new five year £40.0 million committed term loan facility with First Commercial Bank, Limited ('FCB'). Interest accrues on the bank loan at a variable rate, based on 3 month LIBOR plus margin and mandatory lending costs, and is payable quarterly. The margin was initially 1.75 per cent but was subsequently reduced to 1.65 per cent per annum for the duration of the loan. The undrawn element of the facility does not incur a non-utilisation fee. As at 30 June 2018, the Group had drawn £36.0 million under this facility.

On 29 January 2018, the Group entered into a new five year £40.0 million revolving credit facility with HSBC Bank plc ('HSBC'). Interest accrues on the bank loan at a variable rate, based on 3 month LIBOR plus margin and mandatory lending costs, and is payable quarterly. The margin is 1.70 per cent per annum for the duration of the loan and a non-utilisation fee of 0.75 per cent per annum is payable on any undrawn element of the facility. As at 30 June 2018, this facility was undrawn.

The Group has entered into the following interest rate swaps:

Inclusive of all interest rate swaps, the interest rate on £66.0 million of the Group's borrowings is fixed, inclusive of the amortisation of arrangement costs, at an all-in rate of 3.12 per cent per annum until 23 June 2019 and 3.07 per cent per annum from 24 June 2019 to 1 September 2021. The remaining £64.0m of debt, if drawn, would carry interest at a variable rate equal to three month LIBOR plus a weighted average lending margin, inclusive of the amortisation of arrangement costs, of 2.12 per cent per annum.

The fair value of the interest rate swaps at 30 June 2018 was an aggregate liability of £115,000 (30 June 2017: liability of £9,000) and all interest rate swaps are categorised as level 2 in the fair value hierarchy.

The RBS loan is secured by way of a fixed and floating charge over the majority of the assets of the THR Number One plc Group ('THR1 Group') which consists of THR1 and its three subsidiaries: THR Number Two Limited, THR Number 3 Limited and THR Number 9 Limited. The FCB loan is secured by way of a fixed and floating charge over the majority of the assets of the THR Number 12 plc Group ('THR12 Group') which consists of THR12 and its three subsidiaries: THR Number 5 Limited, THR Number 6 Limited and THR Number 7 Limited. The HSBC loan is secured by way of a fixed and floating charge over the majority of the assets of the THR Number 15 plc Group ('THR15 Group') which consists of THR15 and three of its subsidiaries: THR Number 8 Limited, THR Number 10 Limited and THR Number 17 Limited.

Under the bank covenants related to the loans, the Group is to ensure that:

- the loan to value percentage for each of THR1 Group and THR15 Group does not exceed 50 per cent;

- the loan to value percentage for THR12 Group does not exceed 60 per cent; and

- the interest cover for each of THR1 Group, THR12 Group and THR15 Group is greater than 300 per cent on any calculation date.

All bank loan covenants have been complied with during the year.

Analysis of net debt:

7. Stated capital movements

Under the Company's Articles of Incorporation, the Company may issue an unlimited number of ordinary shares.

During the year to 30 June 2018, the Company issued 87,037,038 ordinary shares raising gross proceeds of £94,000,000 (2017: nil). The Company did not repurchase any ordinary shares into treasury (2017: nil) or resell any ordinary shares from treasury (2017: nil).

Capital management

The Group's capital is represented by the stated capital account, hedging reserve, capital reserve, revenue reserve and long-term borrowings. The Company is not subject to any externally-imposed capital requirements, other than the financial covenants on its loan facilities as detailed in note 6.

The capital of the Group is managed in accordance with its investment policy, in pursuit of its investment objective. The Company is able to pay a dividend out of the Stated Capital Account as permitted by the Companies (Jersey) Law 1991.

Capital risk management

The objective of the Group is to provide ordinary shareholders with an attractive level of income together with the potential for income and capital growth from investing in a diversified portfolio of freehold and long leasehold care homes that are let to care home operators; and other healthcare assets in the UK.

The Board has responsibility for ensuring the Group's ability to continue as a going concern. This involves the ability to borrow monies in the short and long term; and pay dividends out of reserves, all of which are considered and approved by the Board on a regular basis.

To maintain or adjust the capital structure, the Company may adjust the dividend payment to shareholders, return capital to shareholders, issue new shares or buyback shares for cancellation or for holding in treasury. The Company may also increase or decrease its level of long-term borrowings.

Where ordinary shares are held in treasury these are available to be sold to meet on-going market demand. The ordinary shares will be sold only at a premium to the prevailing NAV per share. The net proceeds of any subsequent sales of shares out of treasury will provide the Company with additional capital to enable it to take advantage of investment opportunities in the market and make further investments in accordance with the Company's investment policy and within its appraisal criteria. Holding shares in treasury for this purpose assists the Company in matching its on-going capital requirements to its investment opportunities and therefore reduces the negative effect of holding excess cash on its balance sheet over the longer term.

No changes were made in the objectives, policies or processes during the year.

8. Financial instruments

Consistent with its objective, the Group holds UK care home property investments. In addition, the Group's financial instruments comprise cash, a bank loan and receivables and payables that arise directly from its operations. The Group's exposure to derivative instruments consists of interest rate swaps used to fix the interest rate on the Group's variable rate borrowings.

The Group is exposed to various types of risk that are associated with financial instruments. The most important types are credit risk, liquidity risk, interest rate risk and market price risk. There is no foreign currency risk as all assets and liabilities of the Group are maintained in pounds sterling.

The Board reviews and agrees policies for managing the Group's risk exposure. These policies are summarised below and have remained unchanged for the year under review. These disclosures include, where appropriate, consideration of the Group's investment properties which, whilst not constituting financial instruments as defined by IFRS, are considered by the Board to be integral to the Group's overall risk exposure.

Credit risk

Credit risk is the risk that an issuer or counterparty will be unable or unwilling to meet a commitment that it has entered into with the Group. At the reporting date, the Group's financial assets exposed to credit risk amounted to £44.7 million (2017: £20.3 million).

In the event of default by a tenant if it is in financial difficulty or otherwise unable to meet its obligations under the lease, the Group will suffer a rental shortfall and incur additional expenses until the property is relet. These expenses could include legal and surveyor's costs in reletting, maintenance costs, insurances, rates and marketing costs and may have a material adverse impact on the financial condition and performance of the Group and/or the level of dividend cover. The Board receives regular reports on concentrations of risk and any tenants in arrears. The Investment Manager monitors such reports in order to anticipate, and minimise the impact of, defaults by occupational tenants.

As at 30 June 2018, the Company had fully provided for overdue rental income from a single tenant totalling £170,000 (2017: £nil). There were no other financial assets which were either past due or considered impaired at 30 June 2018 (2017: nil).

All of the Group's cash is placed with financial institutions with a long-term credit rating of BBB or better. Bankruptcy or insolvency of such financial institutions may cause the Group's ability to access cash placed on deposit to be delayed, limited or lost. Should the credit quality or the financial position of the banks currently employed significantly deteriorate, cash holdings would be moved to another bank.

During the year, due to the quantum of cash balances held, counterparty risk was spread by placing cash across different financial institutions. At 30 June 2018 the Group held £20.9 million (2017: £10.4 million) with The Royal Bank of Scotland plc, £20.0 million (2017: £nil) with HSBC Bank plc and £0.5 million with First Commercial Bank, Limited (2017: £nil).

Liquidity risk

Liquidity risk is the risk that the Group will encounter difficulties in realising assets or otherwise raising funds to meet financial commitments. The Group's investments comprise UK care homes. Property and property-related assets in which the Group invests are not traded in an organised public market and may be illiquid. As a result, the Group may not be able to liquidate quickly its investments in these properties at an amount close to their fair value in order to meet its liquidity requirements.

The Group's liquidity risk is managed on an ongoing basis by the Investment Manager and monitored on a quarterly basis by the Board. In order to mitigate liquidity risk the Group aims to have sufficient cash balances (including the expected proceeds of any property sales) to meet its obligations for a period of at least twelve months.

Interest rate risk

Some of the Company's financial instruments are interest-bearing. Interest-rate risk is the risk that future cash flows will change adversely as a result of changes in market interest rates.

The Group's policy is to hold cash in variable rate or short term fixed rate bank accounts. Interest is received on cash at a weighted average variable rate of 0.24 per cent (2017: 0.01 per cent). Exposure varies throughout the period as a consequence of changes in the composition of the net assets of the Group arising out of the investment and risk management policies. These balances expose the Group to cash flow interest rate risk as the Group's income and operating cash flows will be affected by movements in the market rate of interest.

The Group has £130 million (2017: £50 million) of committed term loans and revolving credit facilities which at 30 June 2018 were charged interest at a rate of three month LIBOR plus the relevant margin (see note 6). At the year-end £66.0 million of these facilities was drawn down (2017: £40.0 million). The bank borrowings are carried at amortised cost and the Group considers this to be a close approximation to fair value. The fair value of the bank borrowings is affected by changes in the market interest rate.

The Group has hedged its exposure on £66.0 million (2017: £30.0 million) of the loans drawn down at 30 June 2018 through entering into fixed rate Interest Rate Swaps (see note 6). Fixing the interest rate exposes the Group to fair value interest rate risk. At 30 June 2018, an increase of 0.25 per cent in interest rates would have increased the fair value of the interest rate swaps and the reported total comprehensive income for the year by £0.6 million (2017: £0.3 million). A decrease in interest rates would have had an equal and opposite effect.

The Group has hedged its exposure on the entire £66.0 million of loans drawn down at 30 June 2018. As at 30 June 2017, the Group had not hedged its exposure on £10.0 million of the loans drawn down on which interest was payable at a variable rate equal to three month LIBOR plus the lending margin of 1.50 per cent per annum. This balance exposed the Group to cash flow interest rate risk as the Group's income and operating cash flows would be affected by movements in the market rate of interest.

Market price risk

The management of market price risk is part of the investment management process and is typical of a property investment company. The portfolio is managed with an awareness of the effects of adverse valuation movements through detailed and continuing analysis, with an objective of maximising overall returns to shareholders. Investments in property and property-related assets are inherently difficult to value due to the individual nature of each property. As a result, valuations are subject to substantial uncertainty. There is no assurance that the estimates resulting from the valuation process will reflect the actual sales price even where such sales occur shortly after the valuation date. Such risk is minimised through the appointment of external property valuers.

9. Capital commitments

The Group had capital commitments as follows:

10. Related party transactions

The Board of Directors is considered to be a related party. No Director has an interest in any transactions which are, or were, unusual in their nature or significant to the nature of the Company.

Mr Webster, who retired as a Director on 22 January 2018, was an employee of the Company Secretary, R&H Fund Services (Jersey) Limited, which receives fees from the Company. Mr Stewart, who was appointed as a Director of the Company with effect from 22 January 2018, and Mrs Jones are both directors of the Company Secretary, R&H Fund Services (Jersey) Limited. Mr Stewart was admitted to Rawlinson & Hunter's Jersey Partnership in 2003, which in turn wholly owns R&H Fund Services (Jersey) Limited.

The Directors of the Company received fees for their services. Total fees for the year were £165,000 (2017: £165,000) of which £18,000 (2017: £18,000) remained payable at the year-end.

The Investment Manager received £3,734,000 (2017: £3,758,000) in relation to the year of which £550,000 (2017: £997,000) related to the performance fee. Of this amount £960,000 (inclusive of VAT) (2017: £941,000) remained payable at the year-end.

11. Operating segments

The Board has considered the requirements of IFRS 8 'Operating Segments'. The Board is of the view that the Group is engaged in a single segment of business, being property investment, and in one geographical area, the United Kingdom, and that therefore the Group has only a single operating segment. The Board of Directors, as a whole, has been identified as constituting the chief operating decision maker of the Group. The key measure of performance used by the Board to assess the Group's performance is the EPRA NAV. The reconciliation between the NAV, as calculated under IFRS, and the EPRA NAV is detailed in note 3.

The view that the Group is engaged in a single segment of business is based on the following considerations:

- One of the key financial indicators received and reviewed by the Board is the total return from the property portfolio taken as a whole;

- There is no active allocation of resources to particular types or groups of properties in order to try to match the asset allocation of the benchmark; and

- The management of the portfolio is ultimately delegated to a single property manager, Target.

12. Contingent assets and liabilities

As at 30 June 2018, nine properties within the Group's investment property portfolio contained deferred consideration clauses meaning that, subject to contracted performance conditions being met, deferred payments totalling £16.0 million (2017: £5.4 million) may be payable by the Group to the vendors/tenants of these properties.

Having assessed each clause on an individual basis, the Company has determined that none of these deferred consideration clauses are more likely than not to become payable in the future and therefore an amount of £nil (2017: £nil) has been recognised as a liability at 30 June 2018.

It is highlighted that the potential deferred consideration would, if paid, result in an increase in the rental income due from the tenant of the relevant property. As the net initial yield used to calculate the additional rental which would be payable is not significantly different from the investment yield used to arrive at the valuation of the properties, any deferred consideration paid would be expected to result in a commensurate increase in the value of the Group's investment property portfolio.

13. Post balance sheet events

Subsequent to 30 June 2018, the Group has completed the acquisition of three further properties and exchanged contracts on a fourth for a total value of £31.0 million (including acquisition and forward funding costs):

• A modern, purpose-built 43 bedroom care home in Doncaster, South Yorkshire. Operated by Orchard Care Homes, an existing tenant of the Group, the home is let on a full repairing and insuring lease with 24 years remaining and is subject to annual RPI-linked rent increases subject to a cap and collar;

• A development site for an 80-bed care home in Burscough, Lancashire. The development will be carried out in partnership with Athena Healthcare ("Athena"), an existing tenant of the Group, under a capped development contract, and subject to a forward funding agreement. On completion of the building, which is expected in Q4 2019, the home will be let to Athena for 35 years on a full repairing and insuring lease with RPI-linked rent increases subject to a cap and collar;

• A development site for a 66-bed, residential care home in Wetherby, West Yorkshire. Having received planning consent, the development will be funded under a capped development contract by specialist elderly care home contractor, LNT Construction Limited. Upon the home reaching practical completion, which is expected in early 2019, the property will be let on a full repairing and insuring basis to LNT Construction's sister company, Ideal Carehomes Limited. The 35-year occupational lease will include annual, upwards-only RPI-linked increases, subject to a cap and collar; and

• The Group has also exchanged contracts to acquire a pre-let, purpose-built care home in Newtown, Powys. The acquisition is expected to complete in the second half of 2019 once the development has been completed and marks the Group's first transaction in Wales. On completion, the property will be leased to a new tenant, Caresolve Operations Limited, for 35 years on a full repairing and insuring lease.

On 3 October 2018, the Group entered into a side letter to the Investment Management Agreement. Under the revised arrangements, with effect from 1 July 2018, the Investment Manager is entitled to an annual base management fee on a tiered basis based on the net assets of the Group as set out below. No performance fee is payable for any period commencing after 1 January 2018. The termination provisions contained within the Investment Management Agreement, as set out in note 2, are unchanged.

The amendment to the terms of the Investment Management Agreement, as disclosed above, constitutes a smaller related party transaction under Listing Rule 11.1.10 R.

14. Financial statements

These are not full statutory accounts. The report and financial statements for the year to 30 June 2018 will be posted to shareholders and made available on the website: www.targethealthcarereit.co.uk. Copies may also be obtained from the Administrator, Maitland Administration Services (Scotland) Limited, 20 Forth Street, Edinburgh, EH1 3LH.