Tag Archive for: medical office buildings

Despite a number of headwinds – and some quite worrisome headwinds they are – the juggernaut that is the healthcare real estate (HRE) sector should continue chugging along throughout 2022, according to a group representing some of the best-known and successful firms in the business.

Members of the HREI^™ Editorial Advisory Board (EAB), which comprises leaders and executives from firms involved in almost every aspect of the sector, gathered virtually in November to talk about current trends and the state of the industry. While a portion of their discussion was “off the record” in order to promote a free exchange of ideas, they later spoke “on the record” in discussing what they see for the year ahead in HRE.

For the most part, as noted, the HRE space should continue to perform well in the year ahead, in large part because the sector’s facility types, including medical office buildings (MOBs), have proven themselves to be recession-resistant during the COVID-19 pandemic and will remain in high demand from investors.

“Overall, I think the status of the industry is still extremely strong,” said Malcolm Sina, executive chairman of Palm Beach Gardens, Fla.-based Sina Companies. “Why? Because of the fundamentals in our business. (The U.S. population) is getting older. We all need more healthcare services, and more procedures are being done today in outpatient settings than inpatient, which of course is good for all of us in this sector.”

Mr. Sina, however, added that the current problems with “inflation and rising construction costs, as well as labor shortages, all really stem from a worldwide supply chain issue resulting from complications with the COVID-19 pandemic.

“But I believe all of it will start settling down in 2022, but maybe not really settling down until the fourth quarter,” said Sina.

Or course, as HRE facilities have proven themselves to be a safe haven for investors during the pandemic, keen demand from investors has driven pricing as high as ever and, subsequently, cap rates, or first-year estimated returns, as low as ever.

“I have to admit, I’m a little nervous about where MOB pricing has gone and what that means for us as a company, and it is equally difficult for other longstanding HRE companies, as we look to make acquisitions in the next year,” said Stefan Oh, executive VP of acquisitions for Irvine, Calif.-based American Healthcare REIT, a diversified real estate investment trust (REIT) formed in 2021 by the merger of Griffin-American Healthcare REITs III and IV. “MOB pricing is at a level that I never could have imagined it would get to. And I think in order to continue to invest in the space, at least for higher quality MOBs, (HRE firms) are going to have to find ways to lower your cost of capital. And we’re seeing many do that by the formation of partnerships (with large capital investors). Without doing that, it will be very hard to compete for acquiring MOBs.”

Mr. Oh added that he’s “very happy that we are a diversified healthcare REIT, because when pricing gets increasingly tough on MOB space, we can make acquisitions in other asset classes (including senior housing), and that’s what we’ve done, how we ended up building the portfolio that we have.”

Another formula for success when it comes to making acquisitions, especially of MOBs, will be to find “off-market deals,” according to James Schmid, chief investment officer and managing partner with Media, Pa.-based Anchor Health Properties.

“The sector will continue to reward those that can find off-market or lightly marketed opportunities,” Schmid said. “That was the bulk of what we’ve acquired (in 2021, when the firm made acquisitions totaling about $900 million)… So, it pays to be out there in the field making hay on unique business opportunities.”

When it comes to HRE development, the pace of construction starts has dropped a bit since the start of the pandemic, in large part due to complications and delays resulting from increased costs and supply issues. However, even as development has fallen off a bit, the amount of outpatient space absorbed continues to increase and the national MOB vacancy rate continues to drop, according to several EAB members. That means that physician groups and health systems are in need of space to continue to grow their practices and networks in order to bring their services closer to patients. Eventually, this will lead to an increase in HRE developments.

“On development side, I do think that there’s going to be some apprehension (from providers) because of the sticker shock with development costs,” said Peter Westmeyer, CEO of Chicago-based Remedy Medical Properties, a major buyer of MOBs that also has a strong development arm. “However, the demand side for space is going to be strong enough to overcome that sticker shock – at least in some cases. So, I think demand on the development side will continue to be robust.”

Mr. Westmeyer added that the need for new HRE development will be driven by, as other EAB members noted, growing demand for healthcare services in new and growing markets. However, he noted that one headwind that could deter many providers’ growth plans, and prove to be a difficult hurdle for new development projects, is the current labor shortage, including a shortage of healthcare workers.

“The (patient) volumes are there and are rising for a of service providers, but they can’t find workers,” Westmeyer said. “I talked to somebody in Iowa who said they can only find six people and they need 30. The demand is there, but they just literally can’t find the people, or the people are too expensive, as I’ve heard about wild upswings in nursing salaries and for temporary nurses that are prohibitive for the growth that the demand suggests should be there.”

And yet, Mr. Westmeyer noted, he remains upbeat about the overall HRE sector.

“There are some headwinds, sure, but I like where our firm is sitting as a company and where the sector is at moving forward,” Westmeyer said.

Mr. Westmeyer is not even all that deterred by the rise in pricing for MOB acquisitions, which is causing some headwinds.

“But I do think, frankly, that maybe we’ve all been spoiled with our strong risk-adjusted returns, which have been, and still are, very favorably risk-adjusted returns compared to other asset classes,” said Westmeyer. “I think it is still mispriced, frankly. Because either the other asset classes are priced too high or we’re priced too low, but there’s some sort of mispriced element in the market, from my perspective, when you look at risk-adjusted returns.”

More On MOB Pricing

Darryl Freling, co-founder and managing principal of Dallas-based MedProperties Realty Advisors LLC, said he agreed with what Mr. Westmeyer, and others, said about pricing for MOB purchases, noting that as long as demand remains strong for the product type and new investors, including institutional capital continue to pursue HRE properties, cap rates will continue to drop.

“I’m of the personal opinion that healthcare real estate, while trading at historically low cap rates and high prices, is still less expensive than some of the other favored asset classes,” Freling said. “And, so as long as that differential exists, even though it has been narrowing, but as long as it exists, we’ll continue to see cap rates come down.”

There is the possibility, he noted, that if cap rates rise in some of the other highly sought-after real estate classes, such as industrial and multifamily, some of the HRE sector’s newest investors might “rotate some of that capital out of the space.

“But my own personal belief is that a lot of that capital flow is more permanent than not,” Freling added.

He noted that while pricing is indeed “clearly historically high right now, debt is also very, very low, and as a result we can still make our returns work. So, for us as a firm, having sources of capital and the lowest cost of capital possible is important for us in terms of maintaining our ability to compete.”

MOB Sales To Remain Strong In 2022

At the time of the EAB virtual meeting in mid-November, it was quite clear that the MOB sales volume for 2021 was going to be strong. Since then, information from HRE data firm Revista, which provides a wide range of information for its subscribers, indicates that 2021 will see a total MOB sales volume that will likely top $14 billion, perhaps approaching $15 billion. That would make it the second strongest year on record.

Christopher “Chris” Bodnar, vice chairman of the U.S. Healthcare and Life Science Capital Markets team with Dallas-based CBRE Group Inc. (NYSE: CBRE), said that while many business professionals are speculating that the stock markets will see a correction in the coming year, he does not see such an event as one that would necessarily slow down MOB sales.

“There is a lot of chatter in the market about a coming correction,” Mr. Bodnar said. “There are a lot of moving parts to this. The stock market’s at an all-time high while inflation is at a 30-year high. If anything is going to happen, it could be in the next 12 months, it could be in the next 36 months. I don’t know. But I think the question that we all like to ask is, you know, where would you want to put your money? Obviously, cash is not a great spot in an inflationary market. Instead, you want to put your money in hard assets to protect against inflation. You want assets with minimal ties to macroeconomic factors, assets that many countries outside of ours would consider basic infrastructure. And that includes healthcare real estate.”

While the supply of MOBs for sale is not likely to keep up with demand in the coming year or longer, that is not likely to slow the pace of transactions, Mr. Bodnar noted.

“Also, HRE is a very niche market and I think that that’s really going to protect us, too,” Bodnar added. “I think that for the foreseeable future, this is the place (where investors are going to put their money).”

Mindy Berman, senior managing director and co-leader of the National Healthcare Group with Chicago-based Jones Lang LaSalle Inc.said that the MOB sales sector is going to remain strong, in large part because of all the institutional capital entering the space.

Much of that new capital, she noted, is entering the sector by forming partnerships with long-standing HRE developers and full-service firms. Many of those partnerships are launched with recapitalizations of an HRE firm’s portfolio, or a portion of its portfolio.

“The amount of liquidity entering the sector is unprecedented,” Ms. Berman said, “and while that’s the macro-real estate theme, it is also a testimony to healthcare in general and also the coming of age of medical office from an investor perspective. The performance of the asset class during the pandemic has been the icing on the cake. The prime example of this is that there are far more recapitalizations in the sector than ever before, because the large new institutional investors really need to come in and buy scale, and they need to do it with an established operator that knows the space and really understands healthcare. All of this is a good sign for healthcare, and likewise there is a huge growth potential for service providers in the sector, and I’ll count JLL among them.”

More On HRE Development

When it comes to development, one of the strengths of the HRE sector is that it is typically not overdeveloped, according to EAB members.

“Development is picking up, though it is relatively controlled,” said Jonathan “John” Winer, senior managing director and chief investment officer with long-time HRE investment firm Seavest Healthcare Properties, which is based in White Plains, N.Y. “I would say, and I think most people in the sector would agree, that it is effectively a build-to-suit development industry at this point.”

Mr. Freling of MedProperties Realty Advisors noted that if there is a headwind facing development it is the “rising cost of construction” and the subsequent increase in rents that owners must charge to their healthcare tenants.

“Unlike in other industries in which, whenever you are in a good economy, the businesses themselves are doing well, the commercial office tenants are doing well, those businesses can typically afford to pay higher rents,” said Freling. “But that’s not the case with healthcare providers. For them, their revenues, for the most part, are going down and their costs are going up. There’s just a limit to how much they can pay in rents. So, that’s going to really squeeze development yields and I do have some concerns there. But I do think this is one area where HRE firms with national platforms and institutional capital partners have more of an ability to scale and are probably in a better position and have a little bit of an advantage.”

As far as Sharon Harper, the CEO of Peoria, Ariz.-based Plaza Companies, is concerned, the HRE sector, including the development business, involves much more than just MOBs these days.

“I define the healthcare industry and healthcare real estate as medical office buildings, bioscience and technology facilities, senior housing and healthcare education,” Ms. Harper said. “And we at Plaza Companies are involved in every single one of those components. But it really does all come back to healthcare and wellness, and serving people, etc.”

She noted that as Arizona continues to see “tremendous growth, as is the case with many U.S. states, especially those in the Sunbelt, where there continues to be an increased need for new facilities across all aspects of healthcare.

“We have to feed the pipeline,” Ms. Harper said. “So, education, universities, training programs should be on everyone’s radar. That is really how we’re going to ultimately fill our buildings and serve our populations. That’s been a big platform for our company, working with Arizona State University, Creighton University, building their medical center, helping to train the people that are going to be serving in our hospitals and be tenants in our buildings. We have a lot of activity.”

Ms. Harper noted, however, that rising material and labor costs associated with the development and construction of healthcare facilities are causing Plaza Companies to constantly to reprice projects.

“We all know this, but rental rates haven’t quite caught up to these rising costs,” said Harper. “However, the tenants are starting to understand that these two are tied together. The higher costs and the longer time that it takes to deliver projects are starting to be reflected in rental rates.”

Eric Fischer, managing director in the Washington, D.C., office of Dallas-based Trammell Crow Company, said the firm’s healthcare project pipeline in the D.C. region is very “bullish.”

“As I look at our 2022 business plan right now, I’ve got roughly 11 projects, with about $2.7 billion of managed costs, fairly evenly divided between healthcare, life science and senior living projects, said Fischer. “In my estimation, healthcare is outperforming. We’re very pleased with where we are in terms of those projects and the lease-ups that are getting underway with those developments. It’s a good sign. On the senior living side, we’ve been able to pass through some very important and strategic rent escalations to account for this acute inflation that we’re experiencing, including labor supply. And likewise in life science, which is something we’re really embarking on, I’ve been very pleased with the capital and liquidity.”

However, like some other EAB members, Mr. Fischer noted that he is a bit cautious about certain economic conditions on the horizon in 2022, as this “acute episode of inflation worries us, whether it’s a long-term trend or just some stagflation. It could be a tough environment, even though it is yet to be determined.

“For now, however, we’re very pleased with the current environment and the opportunities, and we’re really grateful to our capital partners and likewise our lenders, as the liquidity in this sector remains unprecedented. It really is, for us, fueling some very exciting opportunities,” said Fischer.

An Attorney Among The EAB

All of the activity taking place in the HRE sector is certainly a positive occurrence for professionals such as Andy Dow, an attorney and chair of the Real Estate Industry Group with Dallas-based Winstead PC, a corporate law firm with a national platform. Mr. Dow is heavily focused on the HRE sector.

“It’s been pretty crazy for us in a number of respects,” Mr. Dow said, “First of all, the volume of deals happening in 2021, particularly in the last half of the year, has been incredible. Secondly, the size of the deals have increased a lot, as there are so many more portfolio sales, recapitalizations, multi-property types of deals. But the biggest change I’ve seen is the velocity of the deals from start to finish has really picked up. We’re seeing compressed inspection periods, compressed times to close on transactions, which is really putting a strain on third-party providers in terms of getting those surveys and environmental reports and everything done on time.”

Mr. Dow expects this frenzied activity to continue for a period of time, adding that perhaps the compressed timeframes for deals are being driven by “a fear out there that some kind of Black Swan event could take place and, you know, time also kills deals and that’s probably no more true than today. To me, it looks like a lot of people are kind of waiting for that other shoe to drop and they want to make sure that they get these things done before something like that happens.”

Overall Outlook, Other Thoughts

As Shawn Janus, national director of healthcare for Seattle-based Colliers International looks to the future, he says the fact that more and more health systems and providers are turning to firms such as Colliers to help them develop overall real estate strategies is a good sign.

“We’ve seen tremendous growth in 2021 on the leasing side of our business, both on the tenant rep side and on the agency side,” Mr. Janus said. “And that’s a good thing, although I would add that while it is definitely important, it is, for the most part, kind of a short-term effect. From my perspective, our biggest increase in business has been, in what hopefully will be a longer-term effect, the fact that healthcare providers, the systems and the hospitals, are talking more strategically with us and actually getting us involved, asking us to help them understand more of what is going on in the industry. They’re telling us what their goals and objectives are and asking us to help them determine how real estate solutions can help them further those objectives, both from a healthcare perspective and also from an organizational perspective. They’re leaning on us to be more of the experts in the field, and I’m very bullish in terms of what could happen in this regard as we move into 2022 and beyond.”

Roni Soffer, founder and managing partner of Hallandale Beach, Fla.-based TopMed Realty, said that while he is concerned about the possible effects that inflation and a potential decrease in the “value of cash” could have on the sector, his firm “continues to grow by being very nimble and always willing to think outside of the box.

“We get very excited when we see a property which is not fully in a specific bucket,” said Soffer. “As we move forward, we will not compromise on finding properties in great locations, and we will diversify property types in looking at healthcare, research, academic medical – it’s all the same family. If you can find all of them one location, it’s a winner, and we’ll continue to look for these opportunities and continue to be very specific about how much we’re paying versus the replacement costs, which we believe this is the one element that can help us, along with being in the right location, to continue and be competitive on the market.”

Jim Kornick, principal and co-leader of the Healthcare Capital Markets group in the Washington, D.C., office of Toronto-based Avison Young, said that he has been predicting there would be a strong uptick in demand for healthcare services, and subsequently healthcare facility space, in the aftermath of the COVID-19 pandemic.

“And this is in addition to the availability of capital and is actually in addition to our usual story about the aging demographics of the country,” Kornick said. “Instead, I’m talking about all of the deferred procedures and damage done from a lack of managed control of chronic diseases and the damage done by the long-term effects of COVID. All of these are going to increase demand for services and space. Perhaps the only thing that can stop the development of new facilities, he said, is an ongoing labor shortage. We were facing a critical shortage of healthcare workers even before the pandemic, as well as before the Great Resignation. And you know, I think that’s like the only cloud on the horizon for the expansion of healthcare delivery and the demand for space. As for Avison Young, the firm’s healthcare arm will greatly increase the services it provides to health systems and other providers in 2022. We’re really strengthening our offerings, including providing data that is more valuable for our clients, helping them make decisions, including decisions about real estate. We’re also working hard to integrate our folks who deal with occupiers, healthcare occupiers, and the investor side.”

Some Final Thoughts

Mr. Winer of Seavest Healthcare Properties noted that the overall HRE sector, despite certain headwinds that include a high rate of inflation — which can cause “concern for the markets and concern for investors — the basic performance of the medical office and ambulatory sector will remain strong.”

“COVID has had an impressive effect on the industry because it confirmed the necessity for outpatient facilities and the importance of such facilities,” said Mr. Winer. “The asset class performed very well throughout the past year. And, if you look at the fundamentals of our business, they’re very healthy.”

For those who are concerned about a potential market correction, or perhaps other economic pitfalls, Mr. Bodnar of CBRE provided an interesting perspective.

“Our healthcare industry, we at CBRE truly believe, is too big to fail,” Bodnar said. “And so, if you’re an investor you have to kind of think about that. I also think that Sharon (Harper of Plaza Companies) is correct in that, you know, the growth of academic medical centers is not going to slow down anytime soon. There is a money grab right now by venture capital, or for venture capital money and through NIH funding, and the footprint of these academic medical centers is going to continue to get bigger.”

Ms. Berman of JLL noted that while the sector is currently going strong and MOB sales should remain quite active, she is a “little concerned, but just broadly, about volatility and financial markets and investment markets what with the inflationary impact, rising interest rates, etc.”

“That could turn into a macro issue,” Berman said, “So, while medical office is fantastic right now, I think other asset classes may attract relatively more capital because of inherent qualities that they have. So, a little concern about that, as I feel the risk of something coming out of the blue and biting our sector could happen. I’m just kind of keeping my eye out for that, even though I’m not sure what any of us could do about it, but I feel like we’re susceptible to that.”

Mr. Schmid of Anchor Health Properties was one of the only EAB members to bring up the topic of politics, as well as professional sports.

“For next year, the mid-term elections, I think the Republicans will take back, well at least the House (of Representatives), if not the Senate as well,” Schmid said. “I think the Golden State Warriors will win the NBA championship, and I think the Kansas City Chiefs will win the NFL Super Bowl. And those are my projections for the New Year. I wish everybody the best (in the year to come).”

 

Source: HREI