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Riding The Wave Of Surging MOB Demand

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In a country where over 10,000 people turn 65 daily, it’s safe to say that an aging population will drive the demand for healthcare resources for years to come.

Healthcare Trust of America (NYSE:HTA) is a real estate investment trust that seeks to not only ride the irresistible wave of current demographic trends, but also aims to carve out strong footholds in markets where high tenant quality can be secured and leveraged to more profitable relationships. As the largest dedicated owner/operator of medical office buildings (MOB’s) in the U.S.,

HTA is also well-positioned to benefit from the broad shift away from expensive inpatient facilities, and instead toward more cost-effective outpatient resources, as healthcare spending already projects to account for fully 20% of GDP by 2026.

HTA currently has lots of competition in the medical property space (not just from other REIT’s either) as the sector is one of the few areas where growth is almost guaranteed to exceed nominal GDP growth for years to come. This has pushed the price of related real estate assets sky high, and has been something of a double-edged sword, because profitability on leases takes a bit of a hit as profit margins are eaten away by the rising cost of asset purchases. Fortunately, HTA‘s focus on specific markets with strong demographic dynamics, its fully-integrated property development capabilities, and prudent cost management have all combined to insulate profits somewhat more than peers. Past is not necessarily prologue, however, and challenges from interest rate volatility to changing investor sentiment and MOB demand can affect spreads, margins, and FFO numbers. With respect to HTA, I’ll look at the company’s structure, competitive position, real estate portfolio, financial strength, and underlying fundamentals of the stock to help current and prospective investors assess whether HTA is a buy at current prices, and what the long-term outlook is for the company and the stock.

HTA company snapshot(Image source: HTA 2018 annual report)

Finding its Niche

As the single largest owner of MOB’s in the U.S., HTA‘s real estate portfolio comprises 23 million sq. feet of GLA (gross leasable area), having invested roughly $6.8 billion in those properties over the last 10 years. While the firm has considerable market breadth across the country, it does try to focus on 20-25 “gateway markets” where it seeks to “build critical mass,” especially in communities with universities and large extant medical institutions. The thinking is that this strategy presents not only favorable demographic trends for local demand, but also supply in the form of skilled-labor and job growth. Consequently, the company has already started to see some of the benefits via robust long-term demand for medical office management and leasing services. Overall, the firm has an integrated asset management model consisting of on-site leasing, property management, engineering and building services, and targeted real estate development. With a focus on operational efficiency and tenant quality, HTA has sought to build lasting relationships with dependable clients, and achieve real rental growth. Management hopes this combination will lead to peer-beating value-creation in the long-run.

HTA portfolio map(Image source: HTA investor presentation)

Founded in 2006 as a private REIT, HTA went public on the NYSE in 2012. Headquartered in Scottsdale, AZ, the firm has quickly expanded as it has not only emerged from the depths of the real estate and financial crash of 2007-8, but benefited from the growth of healthcare in general, and its own target markets in particular. This concentration in a few key markets has allowed the company to build strong competitive positions within those communities, and has actually led to relatively strong operating margins. Further, management’s focus on the firm’s financial strength and liquidity has allowed for continued investment and development, leading to accretive acquisitions and leasing relationships. Those strong tenant relationships foster increased margins, higher tenant retention, better leasing spreads, and more and better growth opportunities.

HTA d/a and d/e(Source: Author, Benjamin Black)

The operating platform consists of four main segments, including property management, maintenance services, leasing services, and construction & development. This multifaceted approach has allowed HTA to not only capitalize on leasing and property management fees, but also build its footprint through development and property investment. While 93% of the company’s overall GLA consists of in-house property, the top 20 markets comprise 75% of GLA as well, which is actually a 12% increase since 2013 (when it was 63%). What this shows, given HTA‘s ballooning real estate portfolio during this time period, is a strengthening position in the markets it chooses to focus on. The portfolio is increasingly concentrated in large and growing markets with high MOB demand, and top markets now include Dallas, Houston, and Boston, among other expanding metro areas with favorable demographics. Specifically, HTA targets strong same property cash NOI growth.

HTA portfolio(Image source: HTA investor presentation)

Growing the Portfolio

Since the end of 2013, HTA has doubled its portfolio in terms of GLA and property value (from $2.6 billion to $5.4 billion). Over this same period, leverage (net debt/EBITDAre) has remained fairly steady at a rate between 5 and 6X, falling at a respectable 5.8X in 2018. Cash from operations and use of the firm’s ATM equity program have largely financed the acquisitions. Solid enterprise value growth and normalized FFO growth of 27% (through 2018) help underscore the merits of a strategic focus on core-community, on-campus, and academic medical center locations. The economics and demographics of university-heavy cities favors MOB demand and related pricing. What sets HTA apart from peers is its vertically-integrated operating platform allowing it somewhat of a unique offering to customers. This has translated to success for investors in the underlying stock, as the REIT has outperformed not only broader REIT indices, but also the healthcare REIT index as well. Of course, this underlying performance does include some years as a private REIT, where returns are calculated mainly by factoring in total distributions over the period, but regardless, the 156% total return since ’06 compares favorably (bear in mind the period begins right around the height of the real estate bubble).

HTA real estate assets(Source: Author, Benjamin Black)

Healthcare delivery is expected to shift to more outpatient facilities over time due to it being more cost-effective than inpatient care. Additionally, limitations to existing hospital resources have further enhanced outpatient visit growth. In fact, inpatient visits have begun to decline in recent years, despite the growing demand for healthcare overall, which is especially beneficial to MOB operators. While demographic and industry dynamics favor the MOB REIT sector generally, HTA‘s laser-like focus on key “gateway” markets further drives growth and profitability. In addition to this, the consolidation of healthcare providers will likely lead to increased opportunities for MOB operators with scale (such as HTA).

HTA P/FFO(Source: Author, Benjamin Black)

MOB’s are desirable to providers because they help augment provider growth by helping to limit capital outlay/commitments by providing leasable properties, and also limit the volatility of cash-flows. The ability to develop synergistic and profitable relationships with strong providers depends greatly on location, barriers to entry, and operational efficiency of both the leaseholder and the property manager. That said, the MOB sector is especially fragmented, as less than 20% of the market is institutionally owned. Further, REIT’s only have an 11% share of the MOB market, which is less than private equity, developers, and providers themselves. Of that relatively small slice of the pie, however, HTA is fast becoming a dominant player.

Competitive Position

From 2012-2018, annualized FFO growth of 4.6% matches that of Welltower (NYSE:WELL), and is above peers H&R REIT (OTCPK:HRUFF) (3.3%), Ventas Inc., (NYSE:VTR) (1.2%), and Healthpeak Properties (NYSE:PEAK) (-1.7%). Same-property cash NOI growth, which I’ll refer to as SS (similar to same-store growth in retail), averaged 3% from 2013-2018, bested only by HRUFF (3.2%), and ahead of Physicians Realty Trust (NYSE:DOC) (2.6%), WELL (2.3%), VTR (1.4%), and PEAK (1.3%). Total shareholder returns meanwhile, have outpaced them all, coming in at 68% over the period (vs. a range of -6% to 54% for the previously mentioned companies).

MOB REIT returns(Image source: SEEKING ALPHA HTA STOCK PAGE)

PEAK (formerly HCP) in particular, has struggled over the last 5-6 years, and HTA may stand to benefit as a result. Note that in 2 of the last 4 quarters, SS growth fell below the REIT MOB average of 2.6%. Prior to that, from 2014-17, HTA grew cash NOI at a range between 2.8-3.3%. It has hit a low of 2.3% in 1Q18, but has since recovered to 2.7% as of 4Q18. The good news, however, is that since 2014, SS expenses for the company have actually declined, averaging -0.8% vs. an average of +0.9 to 3.4% for peers (including WELL, VTR, HCP, DOC, and HRUFF), which collectively averaged 1.75%. This disparity shows HTA‘s greater efficiency and cost management than peers. So, over the last 5-6 years overall, same-property figures look healthy, but keep an eye on the trend, and take special note of any further deterioration in NOI growth rates, or rising same-property expenses.

HTA SS-NOI growth(Image source: HTA investor presentation)

It’s important to note that the MOB sector (and healthcare real estate investment generally), is currently experiencing a period of record low cap rates. Cap (capitalization) rates are the ratio of net operating income (NOI) to property asset value, and such rates have fallen in recent years due to high investor demand and fast-rising property values. One major reason for this trend is that health-related real estate is seen as a sector of fairly reliable growth; in fact, total number of outpatient visits has grown by almost 2% annually between 1994-2014. By comparison, over the same period, inpatient admissions actually declined by 0.67% annually.

HTA EV/EBITDA(Source: Author, Benjamin Black)

Investor demand remains at an all-time high for healthcare real estate assets, and especially MOB’s, consequently pushing down cap rates and therefore profit margins and ROI expectations. Because healthcare is seen as one of the strongest drivers of economic growth in the U.S. going forward, investors continue to position their portfolios to reflect that trend. Total healthcare real estate volumes, though, stayed roughly the same for 2019 as 2018, mostly due to the lack of available properties, presenting an opportunity for profitable MOB development in key markets where demand is particularly robust.

And the Survey Says…

In a survey of medical real estate investors, CBRE showed that 94% of respondents favored MOB’s for acquisition, by far the highest of any building type (ambulatory surgery centers (ASC’s) were 2nd at 69%, for some perspective). These results further underscore the high continued demand for MOB’s, and the resultant tight supply-demand and pricing environment. Expected cap rates for MOB’s in 2019 are between 5-6%, which represents the lowest cap rates for all medical building/real estate investment categories, including ASC’s, wellness centers, LTC hospitals, rehab hospitals, etc. Only 2% of survey respondents felt that 2019 would see lower investor demand for MOB’s than 2018, and only 1% of respondents said that occupancy rates of their MOB portfolio had fallen from the prior year (99% said it was the same or higher). Generally, survey results show that the bulk of those asked see annual growth for medical office lease rents falling between 2-3%, largely reflective of inflation expectations and GDP growth.

Cap rates

MOB cap rates(Source for the above two images: HTA investor presentation and Hammond Hanlon Camp LLC 2018 MOB report, attached at the end of the article)

In 2018, the “tightening of the spread between sales and development capitalization rates (had) many developers on edge given the rising interest rate environment.” Fortunately, interest rates have actually fallen over the last year, as the Fed has lowered the Fed Funds Rate by 0.25% on three separate occasions in the TTM period. In the 24 months between the beginning of 2017 and the end of 2018, construction costs generally increased between 15-30% (depending on the market). Despite this surge, rental increases generally kept pace with rising construction costs, as the growing economy allowed developers to pass on rising costs. Additionally, cheap credit continues to augment market growth as loan-to-value ratios remain elevated at between 65-90%, and are increasingly occurring at the higher end of that range.

The Fundamental Picture

While the healthcare industry is clearly growing (average healthcare spending per person rose 11% in 2017 alone, for example), not all MOB operators are created equal, and not all markets are especially geared towards that sector’s growth. HTA with its university-centric market approach (it targets a portfolio composition of 68% of GLA from on-campus properties, and 32% off-campus), seems to have found a profitable niche. Growing its real estate assets from $1.7 billion to $5.7 billion from 2009-2019 (12.86% CAGR), HTA has greatly expanded its portfolio and simultaneously managed to grow its FFO from $28.8 million to $317.7 million, producing a CAGR of roughly 27%. Meanwhile, management has grown overall EBITDA from $61.3 million to $416.2 million (21.1% CAGR) over the same period.

HTA FFO(Source: Author, Benjamin Black)

While the annual dividend was higher in 2010 at $1.46 per share (vs. $1.24 in the TTM period), the FFO payout % was also much higher, at over 85% (vs. roughly 80% today). Dividends have increased annually since 2013, but at a compound annual growth rate of only 1.26%. The P/FFO ratio is just under 20 (at 19.8), and is reasonable, if not a screaming bargain. Reflecting on these numbers, HTA‘s focus is expanding its competitive position, showing very impressive top-line growth, but due to historically low cap rates and exploding real estate costs, that is not necessarily translating to stellar profit and dividend growth.

HTA dividends

HTA FFO payout %(Source for the above two graphs: author)

The Bottom Line

While HTA is well-positioned as a leader in the healthcare REIT sector, shareholder returns will likely remain muted while asset prices and earnings multiples remain high (relative to historic norms). That said, this is a company to consider adding to your watchlist, as it is a best-of-breed operator in a growing sector of the economy in the long run. It’s a great company, but a so-so stock at the moment. If HTA were to fall 20-30% over the next few months, however, (or basically flat-line over the next 2-3 years),  a reasonable and profitable entry-point would present itself, but wait for the underlying fundamentals to catch up to the price first.

*Most market and company-specific data drawn from HTA’s 2018 annual report or most recent investor presentation, found on the company’s investor website. Data used to construct graphs drawn from Seeking Alpha’s HTA stock page.

 

Source: Seeking Alpha

107K SF Medical Office Building Coming To Medical City Campus That Housed Forest Park Medical Center

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Healthcare Trust of America is planning a $55M-plus building on a medical campus off U.S. Highway 75 in Dallas that used to house the Forest Park Medical Center.

The campus, which is now home to Medical City Heart Hospital and Spine Campus, used to house the Forest Park Medical Center flagship location. Forest Park was a physician-owned hospital that fell under the weight of bankruptcy and a federal investigation into an alleged physician kickback scheme.

Healthcare Trust of America out of Arizona said it will build another 107K SF of leasable space on the campus with construction set to launch in the fourth quarter.  The firm estimates it will cost roughly $55M to $60M to develop the Class-A building and a new parking garage.

HTA already owns two medical office buildings on the same campus and plans to acquire another 6 acres nearby for development.  HTA expects the project to have lease commitments of at least 73% prior to the start of construction, which begins this year and ends in 2021.

 

Source: Bisnow

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