In A Squeezed Capital Market, What Makes Healthcare A Safe Bet?

In an increasingly competitive environment for investing in commercial real estate, the long-term safety that healthcare properties promise is what makes them unique. That and other topics will be discussed at Bisnow’s 2016 Philadelphia Healthcare Leadership Forum on Friday, April 22, at 7:30am at the Ritz-Carlton.

Across all asset classes, capital investment in commercial real estate has never been more competitive. Favorable conditions in the aftermath of the 2008 recession have met their logical conclusion of a market full of potential investments.

“We’re in an aggressive cycle that has been created by low interest rates for some time now," Jared Zeisler of Capital Solutions tells Bisnow. He'll be a panelist at our event on Friday.

That aggression has brought healthcare, once primarily funded by the providers or developers building it themselves, out into the open for equity investors.

“Medical office is really just now being recognized as a core, mainstream asset class,” says Ben Appel of HFF, also a speaker at our event. Now, it’s just as competitive in the capital markets as any other asset class—but with one major distinction.

Simply put, medical buildings of all kinds are occupied in more stable, long-term fashion than office, retail or multifamily properties. Primarily due to the preponderance of expensive technology in medical facilities and the necessity of location consistency for patient convenience, medical providers are significantly less likely to move locations.

Those factors, combined with the necessity of the product, make healthcare one of the safest bets in commercial real estate, one that’s drawing increasing attention from larger investment firms.

“Whether you’re an office investor or a multifamily investor, it’s another element of diversification that’s very secure,” Ben says.

That security also bodes well for equity firms looking to make long-term relationships with businesses—and healthcare is one of the longest-term industries there is. Hospitals are notably risk-averse, which means one successful relationship can stretch decades, according to Ben.

“Yes, MOB (medical office building) real estate development is a for-profit business," Ben says. "But it is one that provides life-saving and life-changing venues for healthcare providers to serve the community. So, as a real estate provider, if you understand a healthcare provider's needs and goals, it's relatively easy to build a mutually beneficial, long-term relationship and provide real estate services years into the future.”

In the United States at least, that future is rapidly changing, thanks to the Affordable Care Act. Changes in how healthcare is charged and provided to consumers has necessitated a move toward more outpatient care in smaller facilities more evenly distributed in the community. As companies look for new and different properties, many will look to developers for assistance.

“It’s our hope that developers will have relationships with these hospitals, long-term discussions for plans—and that they’ll look to us for investment capital,” Jared (snapped above with his family) adds.

The problem with those changes is that a nimbler healthcare property doesn’t necessarily carry with it the same safety as a larger hospital, according to Jared.

“We would lower our return threshold for a credit tenant transaction, i.e., a build-to-suit for a hospital, but where I see some concern in terms of valuation is in the multi-tenanted medical office buildings," he says, "especially off campus, where people are paying top dollar and potentially not getting paid enough reward for the re-tenanting and lease-up risk that will be required on these assets.”

At the same time, large hospitals aren’t exactly closing left and right—they’ve become prime targets for larger equity firms that previously hadn’t entered the healthcare market.

“There’s been a lot of very large-scale private equity and offshore capital that have been circling the medical space for a long time," Ben says, "but haven’t been able to find an investment large enough to make a splash.”

That could take the form of healthcare providers looking to become leaner selling off hospital-owned assets, or investors/developers monetizing a portfolio big enough to attract that scale of equity.

“We anticipate multiple $500M to $1B healthcare portfolio trades in 2016, which would be a sizable increase,” Ben says.

Year-over-year, there has been a significant increase in the level of MOB transaction volume, which is expected to continue in 2016. Best of the best product could trade in the high 4% to low 5% capitalization rates, Ben says, with a number of one-off and portfolio trades in the 5% and 6% cap range; a significant compression through this cycle.

The best value proposition for investors seems to be in new construction—the earlier in the process a firm can invest, the higher value they stand to gain once it’s complete (and the less competition they’ll have).

Because the stock of existing, quality healthcare real estate that’s on the market is relatively thin, says Ben, “When you can get your hands on high quality, new construction, hospital-anchored medical real estate, that’s highly valuable.” As a result, Ben (above) says he's seen an uptick in pre-sale business.

“Because of the low cap rates in the market, where people are accepting pretty low returns, we have had to look at new opportunities where it takes some more creative structuring and diligence to get comfortable exploring the investment," Jared says.

"For example, instead of funding a build-to-suit for an investment-grade credit, we might just as well be looking to invest into a newly opened hospital, surgery center, etc., where it is more of a bet on the operating business and less of a bet on a true credit tenant."

Another avenue for capital investors is in joint equity ventures, wherein developers look to ease the financial burdens of the plans that hospitals have, says Ben. “The same way that hospitals are leveraging third-party developers rather than self-developing, so too are professional developers leveraging professional equity.”

As healthcare real estate has become a more common target for diverse investment portfolios, multiple avenues into the market are necessary. As growth all across real estate has slowed, the safety that healthcare properties provide becomes crucial.

It’s an insulation against the concern that Jared voices: “In the past few years, real estate values have shot up significantly. One might ask, how much more can it go up?”

Learn more at our Philadelphia Healthcare Leadership Forum on Friday, April 22, at 7:30am at the Ritz-Carlton. Sign up here.