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What’s Behind Medical Office Buildings’ Strong Trajectory

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One of the US’ fastest growing industries, healthcare spending reached almost $3.5 trillion annually in 2017.

The US Centers for Medicare & Medicaid Services anticipates national healthcare expenditures to grow to $5.7 trillion by 2026. With this growth, healthcare real estate, specifically medical office buildings, are poised for further success.

Medical Office Buildings

Medical office buildings comprise approximately 10% percent of the US office sector. These buildings are typically about 40,000 square feet and range from small physician offices to large healthcare systems. Investors are attracted to this asset class due to its stability and positive forecasts for a strong performance. On the rise for the last four years, medical office sales totaled $10.4 billion in 2018.

“Medical office buildings are so popular and are in demand as a renovation or as new construction,” says Jason Signor, CEO and partner of Caddis Healthcare Real Estate. “The market is phenomenal and occupancy levels and rental rates are healthy.”

It is well-known that the the aging US population is directly correlated with the rising demand for healthcare as doctor visits dramatically increase with age. Individuals 65 years and older spend five times more on healthcare than those who are younger. Yet, even with the favorable demographic and economic backdrop, new healthcare construction has not kept up with demand.

“With the continued shift from inpatient to outpatient care, new real estate strategies are being implemented which includes moving to urgent care centers, MOBs, micro-hospitals and health-system sponsored wellness centers,” says Signor. “ Outpatient care is booming and will continue to flourish in the future. The challenge, of course, is for our sector to keep up with the growing demand.”

Ambulatory Surgery Centers

Ambulatory surgery centers—healthcare facilities which offer patients the option of having procedures and surgeries performed outside of the hospital setting—have drastically reduced healthcare costs. According to the American Hospital Association, the number of ASCs and hospitals are almost equal with 5,534 hospitals and 5,532 surgery centers. While hospitals have declined by 5%, surgery centers have grown as much as 82% since 2000.

“ASCs will continue to dominate the healthcare real estate landscape,” says Signor. “We won’t see these large hospital campuses being built as much. As the campuses get older however, you will see more renovations as hospitals keep up with medical technological advances and stay abreast with ASCs.”

 

Source: GlobeSt.

The Risks For New Investors In Healthcare

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There’s a lot to like about the healthcare sector right now.

While other commercial sectors struggled during the recession, healthcare persevered. And, with 10,000 people turning 65 each day and then living longer, demand should remain strong for the sector.

“The overall demand for health care is incredibly high and growing,” David Lari, partner at Cox, Castle & Nicholson LLP tells GlobeSt.com. “Trips to the doctor for healthcare services are high and very likely to continue to increase. The medical sector—doctors, physician groups and hospitals—tend to be pretty good tenants, especially if you compare it to retail, for instance, where a lot of tenants have gone out of business.”

Investors from around the globe see these positive demographic trends. For instance, Lari says Asian investors, in particular, have been targeting American healthcare properties because their populations are also aging.

“By all accounts they understand how senior facilities work, from their experiences in their home country,” Lari says. “We’re also seeing Middle Eastern money coming into various health care facilities as they understand it more and see it as a way to diversify their portfolios. We’re also seeing a lot of large institutional private equity groups and pension fund groups get into the space where maybe they weren’t before.”

While the traditional players—healthcare REITs and institutional players—have the industry knowledge and know the major players and key issues, these newcomers often have to get up to speed. Just because the demographics are pointing in the right direction doesn’t mean they aren’t plenty of risks for healthcare investors.

“I think there are higher barriers to entry than some other classes of real estate, especially when you’re dealing with the acquisition of licensed facilities, such as a hospital, senior living facility or skilled nursing facility,” Lari says. “If you’re dealing with an on-campus medical office building, many of them tend to be ground lease and you need to navigate through those issues.”

Investment groups also need to understand their tenant mix and the long-term desires of the local hospital system when they purchase on-campus buildings.

“In essence you’re doing a joint venture when you’re buying an on-campus asset, which has restrictions with the hospital system,” Lari says. “If you’re not well aware of their short- and long-term plans and how you’re going to fit into those, you could get burnt quite easily.”

Lari says investment groups also need to spend time thinking about tenant acquisition. If they’re banking on getting physician groups to move from far away to their location, they may need to rethink their strategy.

“Typically speaking, physicians and physician groups don’t want to move too far,” Lari says. “If they do, oftentimes they will lose their patient base.”

Healthcare investors also need to be aware of the merger-and-acquisition environment in this era of healthcare consolidation, such as the mergers of Advocate Health Care and Aurora Health Care and Beth Israel Deaconness Medical Center and Lahey Health.

“You need to know how your particular assets fit into the growth strategy of the acquiring entity,” Lari says. “If they’re going to consolidate, don’t need your particular location and are moving physicians and physician groups out of it, then it could be potentially detrimental to the real estate investor.”

Lari doesn’t think these challenges should push investors away from healthcare. They just need to understand that there is going to be a steep learning curve.

“The key is understanding where your asset is in the marketplace and what type of health care services are going to fit within your particular asset,” Lari says.

 

Source: GlobeSt.

The Top Three Reasons Why Healthcare Real Estate Is Recession-Resistant

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This has been a roller coaster of a year when it comes to the economy, and many are talking about the potential of a recession happening very soon.

According to the Conference Board Consumer Confidence Index, August has been just slightly down. Consumer spending makes up 70 percent of the U.S. economy. If sentiment moves down, consumers and purchasing managers begin to curtail spending and an economic slowdown is inevitable.

Unfortunately, the more the news and articles focus on the impending recession, the more it becomes a self-fulfilling prophecy. Other signs that point toward a potential recession include an unemployment rate that is at the lowest point in 49 years, trade wars that are causing material prices to increase, and geopolitical unrest abroad that could have a huge impact on the U.S. economy. On the bright side, wages appear to be moving up, initial unemployment claims remain low, interest rates support continued investment and inflation remains in check.

There is a close correlation between real estate values and the health of the U.S. economy, but like most things, it is quite nuanced. As companies retract and give back space, occupancies fall and therefore so does the value of commercial real estate. This problem is exacerbated when debt covenants are violated and/or maturities occur during a recession, often requiring re-margining of the debt and/or a fire sale to meet an impending maturity.

With all this in mind, one of the safest asset classes in commercial real estate during a recession is medical office. Below are three reasons behind this.

Tenant Retention

Medical tenants tend to be “stickier” than their general office counterparts. This is because landlords and their provider tenants typically make a much higher investment in the physical space and sign longer-term leases.

The current cost of typical West Coast medical tenant improvement is in the mid-$100s per square foot. In a contracting market, landlords are reluctant to make the necessary investment to entice medical tenants to move, and tenants themselves become more resistant to funding tenant improvements in times of economic uncertainty.

Under normal circumstances, medical tenants are “stickier” because they need to maintain a consumer-facing presence, more akin to a retailer. While consumers may cut back on their lattes during a recession, they are less likely to forgo medical attention and, often, services are covered by insurance. Even those consumers that lose their jobs are often covered by government plans, which helps to moderate the impact and allow them to continue seeking medical care when needed.

Demographics

Medical office also has demographics on its side. According to the U.S. Census Bureau, the number of Americans age 65 and older is expected to double over the next three decades.

An aging population requires more healthcare professionals and more space to deliver medical services. The silver tsunami’s demand for healthcare will cause the patient volume to increase beyond what the current infrastructure can support.

A recent article by The National Center for Biotechnology Information reports that patients age 65 or older make up 13.5 percent of the U.S. population, but represent over 45 percent of the utilization of healthcare. As this age cohort swells, we will need more physical space to meet the demand, as well as physicians and other medical practitioners.

Supply And Demand

A substantial rise in capital has occurred in this sector that is tied to a greater awareness and acceptance by investors of the durable income characteristics of medical office. There is up to $5 billion of buying power in this industry, which is reinforced by the need for late-cycle defensive plays in a challenging return environment, according to the August Healthcare Capital Markets Perspective report from JLL managing director Mindy Berman.

Healthcare is part of the wave of capital raised in niche sectors, notably outraising traditional real estate classes by a factor of four to one. An uncertain economic forecast and low interest rates create higher medical office rates and attractive, stable returns.

The supply of healthcare real estate is low; the sector is a fraction of the size of general office. The institutional investors and REITs are long-term owners, while the healthcare systems themselves own upward of 70 percent of the real estate in this space. This limited supply, coupled with the aforementioned capital, makes the space attractive.

The fundamentals of healthcare real estate are solid. Though a recession could be around the corner, Meridian, a developer and investor specializing in healthcare developments, believes real estate will remain a strong investment. An aging demographic, desire for recognizable, accessible space and the fact that demand continuously outweighs supply in this sector all contribute to this viewpoint.

 

Source: REBusiness Online