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Medical Office Buildings Continue To Stoke Net Lease Investors’ Interest

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Medical office buildings have emerged as a favorite among investors interested in single-tenant net lease opportunities, according to a new report from Colliers.

Overall, the STNL space posted strong performance in the first half of 2022 and hit a historic high of $40.1 billion in investment sales, according Colliers. However, volume in Q2 fell 35% over Q1 numbers and 17% year-over-year.

Despite that, the medical sub-sector remains strong. Colliers’ Jay Patel cites as one reason “predictable” cash flows and the price range on assets that appeals to both institutional and private investors alike. In addition, there’s COVID-19:

“Pandemic investors flocked to the medical office sector for its perception as a safe, interest- resistant and now pandemic-resistant asset,” Patel says. “During the pandemic, investors were eager to snatch up anything medical-related regardless of lease term, credit, and location.”

Construction pipeline delays have also contributed to an ongoing chasm between supply and demand, which has compressed cap rates.

“Net lease has also risen due to the ongoing supply chain disruptions, slowing the delivery of new product,” Patel says. “This has pushed more healthcare tenants to consider alternative space solutions like the adaptive reuse of traditional office or retail properties.”

Of course, the capital markets have changed this year — and medical office isn’t immune to those shifts. Patel notes that “while capital is still being deployed, investors are no longer scooping up just anything that’s healthcare assets.”

“Buyers are now taking a closer look at credit, lease terms and location. With inflation looming in everyone’s mind, assets that have strong rent increases are experiencing stronger activity,” Patel says. “To bridge the gap for investors that are feeling the burden of this rising interest rate environment, many developers and sellers are starting to shift pricing, which is creeping back toward pre-pandemic standards.

Colliers Julie A. Johnson predicts the asset class will continue to be strong in the near future despite rising capital costs.

“The past several years have been banner years for investors with historically low cap rates and many more buyers in the market than sellers,” Johnson told GlobeSt.com in an earlier interview. But “medical office buildings will continue to be strong with not only the increase of the senior population but also the population increase in many markets, specifically the Sun Belt cities.”

Patel says good lease terms and credit will be critical moving forward into 2023. While previously just one of those elements was needed to sell a property.

“Today’s market conditions necessitate all three factors carrying equal importance when appealing to investors,” Patel says.

 

Source: GlobeSt.

Diagnosing The Net-Lease Medical Sector

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What do dialysis clinics, urgent care locations, and dental offices have in common?

They are often net lease tenants and together these types of tenants make up the net lease medical sector.

Calkain’s just-released “Net Lease Report: Medical Sector” notes that net lease medical properties can prove to be viable investments, thanks to the following fundamentals.

In-Place Tenants

The main appeal of a net lease medical property is the tenants, which funnel capital into extensive space buildouts and industry-specific equipment. Furthermore, a net lease medical tenant is less likely to up and relocate, as moving X-ray machines, dental equipment and surgical suites can be a costly challenge.

In-Person Healthcare Delivery

Even with telemedicine and virtual healthcare becoming important tools, medical care continues to flourish through face-to-face interaction. The in-person, real-time relationship between patient and physician is difficult to replicate via the internet, meaning a continued need for physical space. Additionally, medical tenants set up shop in specific areas, based on proximity to target populations and lack of competition.

Financial Strength

Net lease medical tenants range from solo dental practices to regional stand-alone urgent care/emergency centers to national specialty clinics. Another aspect tying these businesses together is they are, for the most part, strong financially. A consistent revenue stream adds to the appeal of a net lease medical property.

As with any kind of investment, there are downsides. The net lease medical sector is no exception, and investors need to keep in mind the following.

Empty Space

As mentioned above, relocation is less likely to take place, but this doesn’t mean that it won’t happen. If a healthcare tenant decides not to renew a lease, backfilling the property can be difficult and tenant improvements to convert to general retail purposes can be costly.

Shifting Dynamics

Neighbors Legacy Holdings Inc., which owned and operated Neighbors Emergency Centers, filed for Chapter 11 bankruptcy protection in summer 2018. The year before, six urgent care centers in Southern California filed for bankruptcy protection. Increased competition, changing third-party payer conditions, and increasing overhead costs created financial difficulties for these and other companies. The bankruptcy process can kill a net lease investor’s revenue stream until a judge approves a reorganization plan.

Certainly, there are risks when it comes to owning a net lease medical property and due diligence is essential. The future is bright for the sector.  With advances in medicine, people are living longer and this creates a greater need for healthcare services. The growing demand could push net leased medical facilities to full capacity and lead to a need for additional medical offices, specialty clinics, and urgent care locations. As such, market fundamentals and increasing demand can make medical-sector properties attractive to a net lease property owner.

 

Source: GlobeSt.