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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

Healthcare Trust Of America: The Best Way To Play Healthcare Trends

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While there is no question the demand outlook looks robust, the supply side of the equation remains a rough one for many property types.

Does that make many healthcare REITs uninvestable? No, but it could never justify pulling the trigger at current valuations.

When it comes to medical office buildings, however, there is a defensible moat here on an operational level and just as many, if not more, of the trends in healthcare benefit the industry. As the largest and most pure play on these assets, Healthcare Trust of America (HTA) trades at a clear discount to its intrinsic value. While not a home run type of purchase today, hitting singles and doubles never hurt anyone.

Overview of Healthcare, Medical Office Building Outlook

Everyone knows the bull thesis for healthcare. The Office of the Actuary for the Centers for Medicare and Medicaid Services (“CMS”) recently projected that national health spending will rise 5.5% annually from 2018 to 2027. That means that, once again, healthcare spend will outstrip likely GDP growth for the next ten years. Within the “buckets” of healthcare spend, no matter the category (hospital care, physicians, prescription drugs, nursing) cost inflation is on the rise.

Part of that is economic (inflation, higher wages, more demand) and part of that is demographic (Baby Boomers). No question that healthcare is and will be one of the fastest growing areas of the market. Who or what captures the economic value from that growth has profound implications across the industry, real estate included.

Investors will not find a healthcare REIT not citing rising spend and aging demographics as a bull catalyst. However, there is criticism of the supply side of the equation in recent years, including bearish calls on plays like New Senior (SNR), Ventas (VTR), or some skilled/assisted nursing home operators themselves like Senior Care Centers. Depending on the asset type, there is often very few barriers to entry – particularly in the senior housing whether it be skilled nursing or assisted living. As much as the industry tries to talk about “viable infill” opportunities in certain markets, even strong locales eventually reach operational parity as competition moves in. Bad markets just cannot be fixed.

Medical office buildings (“MOBs”) are an exception. Unlike other areas of the healthcare real estate market, there are actual barriers to entry. Location matters. On-campus and near-site off campus buildings within high demand medical areas have seen immense value growth. Cap rates have contracted by 400bps since the Great Recession and steadily improved even in recent years which is slightly unusual. All else equal, that implies a 70% increase of property values even on flat net operating income (“NOI”). In actuality, comps have been healthy (low to mid single digits) which has created riches for owners which often has been the hospitals and health systems themselves.

These assets also benefit from a litany of trends in the American healthcare system, the most important of these is the increasing move towards outpatient services. Readers already know procedures are just nutty expensive nowadays. The only way for service providers to somewhat constrain costs is by reducing patient time spent under medical care. Avoiding an overnight hospital stay can save thousands of dollars per patient, often without any change in complication or readmission rates. Insurers are more than willing to allow hospitals to capture higher incremental profits to encourage outpatient work. MOBs, by their nature, rent to tenants providing these kinds of procedures.

As the entire healthcare industry continues to consolidate, health systems will inevitably target expansion within the core areas of their network. Heavy capital investment and infrastructure build-out leads to adjacent MOBs seeing growth. Hospitals, who still remain the majority owners of MOBs, are also highly incentivized to sell. Whenever a hospital is the landlord and rents space to physicians, they run greater risk of violating the Anti-Kickback Statute which bans any type of payment for referrals. Selling to a REIT like Healthcare Trust of America frees up capital while also avoiding any potential allegations of favorable rent treatment.

Healthcare Trust of America

MOBs are the Healthcare Trust of America bread and butter. Nearly the entire portfolio (94% of gross leasable area) is in this type of asset. The company owns 23.2mm square feet, making it the largest publicly-traded pure play in this space. Assets owned are primarily located in major metropolitan markets like Dallas, Houston, Atlanta, and Boston. This has taken quite a bit of hard work and time. Operating a bit under the radar, management has been high-grading the locations of its assets over the past five years. Acquisitions have leaned towards more dense urban areas and there has been some decent efforts made in cutting underperforming properties, including $300mm worth of dispositions last year alone.

While major healthcare REIT players like Welltower (WELL) and Ventas (VTR) have significant MOB portfolios, it isn’t their primary business. On a comparable basis, Healthcare Trust of America has spent more acquiring and developing in this space than anyone else. It shows through the results. Funds from operations (“FFO”) per share has grown at a 5.2% clip since 2014, outstripping the peer group significantly which has struggled to see any material change. The largest contributor to that has been same store sales growth which has run well above average.

Management is very efficient with its capital spend, runs a solid investment grade balance sheet with lower than average leverage, and has still managed to outgrow comps. No wonder shareholder returns have eclipsed other healthcare players as well – and I’d argue that as far as the stock price goes it should have done better.

CEO Scott Peters believes the business can generate substantially similar FFO growth going forward to the rates it has earned in the past. Contributing factors to that remain the same: low single digit same store revenue growth, marginal annual expense savings, and a touch of occupancy rate improvement. The expense growth target an admirable one in particular. Unlike many other REITs in this sector, same store expenses has actually shrunk over the past few years as the portfolio has grown, something most REITs do not accomplish. Tie the cost focus together with acquisition and development and management believes that execution can deliver 8-12% annual shareholder return potential even assuming no multiple contraction over the medium term. This does not rely on further cap rate compression which could also boost the market’s outlook.

Takeaways

Is the dividend exciting? No, 4.5% isn’t anything to write home about. Is this a deep value opportunity or something that might make you rich overnight? No, this is not one of my usual deep value contrarian plays. Is it an investment grade player with long term contracted cash flows, making a dividend cut is incredibly remote? That it is. Using my usual REIT framework, does it trade at a discount to net asset value (“NAV”)? Arguably, yes. With projected $450mm in 2019 NOI and valuing the business at a conservative 5% cap rate, there is about 15% upside to reach NAV.

Not every investment needs to have 30, 50, or 100% projected upside to make sense. This one just works. Investors have seen quite a lot of dividend cuts over the past year.

 

Source: Seeking Alpha