This is an HTML version of an article that ran in the April 2014 issue of Real Estate Forum. To see the story in its original format, click here.  

If slow and steady wins the race, then healthcare real estate has been racking up the trophies. Despite the uncertainty and concern over healthcare reform, the Affordable Care Act, the recent economic downturn and rising interest rates, healthcare has maintained consistent returns for investors and has even managed to grow at a time when other sectors were experiencing catastrophic losses. The combination of aging Baby Boomers needing more healthcare, consolidation among practices and the sea change of health systems seeking more cost-efficient operations has led to an increasing number of healthcare real estate investment opportunities producing steady profits. That's saying a lot for an element of an industry still catching its breath from the Great Recession.

Where Is the Money Going?

According to Real Capital Analytics, the healthcare real estate market generated annual sale volume in excess of $7 billion in 2013, a 7% increase over 2012. Toby Scrivner, director of Stan Johnson Co., tells Real Estate Forum that the breadth of these real estate investments has widened. Those healthcare real estate investors who had initially targeted on-campus, multi-tenant medical office buildings are now also investing in acute-care, post-acute care, urgent care, freestanding emergency departments, assisted living and memory-care facilities.

“Today, the healthcare real estate market covers a wide range of assets dedicated to providing facilities to different aspects of the healthcare-services continuum,” Scrivner says. “Each of these assets has different costs associated with its construction, different prospects for long-term use, different challenges for identification of replacement tenants and different risks associated with the operations and/or credit of the tenant. Therefore it follows that there should be a difference in the cap rates for these assets.”

Danny Prosky, founding principal of American Healthcare Investors and president and COO of Griffin-American Healthcare REIT II Inc., agrees that the scope has broadened, particularly for his REIT. “We buy medical-office buildings, hospitals, senior living and skilled nursing, and we compete with others in those categories. It's also going toward life sciences and biotech. All of those clinical-healthcare classes are in favor, although some types—such as medical office, senior housing and skilled nursing—certainly tend to trade at lower cap rates than others.”

Skilled nursing is leading the pack a bit more than the other healthcare asset classes, but this category along with medical office and senior housing are “definitely the most popular,” Garth Hogan, executive managing director of Global Healthcare Services with Newmark Grubb Knight Frank, tells Forum. “They're the safest choices of the healthcare REITs.”

The problem with healthcare investment isn't where to invest in order to get a safe, yet profitable deal, but simply finding the deals themselves. “There's a dearth of deals right now,” Daniel Turley, VP for healthcare in the capital markets group of JLL, tells Forum. “Anybody with product that is ready to harvest right now is going to have a lot of friends because everyone is chasing institutional-quality opportunities.”

Turley adds that his firm has seen a lot of investors honing in on the post-acute care spectrum, which includes rehab hospitals and behavioral health. “From our point of view, medical office has become a much more accepted niche asset, and while cap rates have compressed on the MOB side, there is still greater yield in this post-acute care spectrum. It's become a natural extension for healthcare investors to reach outside their standard strike zone for some of these asset classes. However, we're seeing a strong contraction of yield going on there as well. There are so many people chasing the healthcare space, and the demand is putting a lot of pressure on pricing and yields. “

In the search for yield, many US-based healthcare investors are looking at investing abroad. Jeff Walraven, a partner at international accounting firm BDO USA LLP, tells Forum that overseas, healthcare real estate capital is also being spread among a broad base of assets, but large transactions have occurred in the senior housing continuum and the acute/post-acute care continuum.

For Scott Peters, CEO of HTA, one of the largest dedicated owners of medical office buildings in the US, no matter which healthcare asset class you look at, you can't lose. “Healthcare as a whole is still a very attractive investment for different types of people,” Peters tells Forum. “There are great macroeconomic trends behind it. What medical office has in its favor is that it's more directly impacted by the ACA, plus it also typically has three- to seven-year leases in multitenant buildings, so it can see quicker improvement in rents as the economy improves.”

Peters adds that some of the money is also going to more mid-sized healthcare REITs rather than the large ones. “Depending on the asset class, we have the opportunity to be more targeted in our acquisitions and the ability to be a little more specific in what we buy with the mid-sized REITs. To grow 10% takes a lot more if you're $3 billion than if you're $18 billion.”

From the perspective of Sonya Dopp-Grech, SVP/director of healthcare services for NAI Capital, senior living and assisted living are currently a big focus for healthcare investment. Also, larger medical groups are buying practices and acquiring real estate as a result. “Many medical groups are putting their real estate dollars into smaller buildings, retail centers and urgent-care locations,” Dopp-Grech tells Forum. “And hospitals are repurposing and repositioning their real estate with a focus on branding.”

Where Is the Money Coming From?

The buying pool for healthcare real estate continues to deepen, fueled by consolidation among healthcare providers and the growth of publicly traded healthcare REITs. Fitch Ratings reports that the merger of Brookdale Senior Living and Emeritus Corp. will spur more M&A activity. In addition, American Realty Capital Healthcare Trust Inc. recently began listing on the NASDAQ. Healthcare has become bigger business than ever before.

Scrivner says that several non-traded REITs specializing in the acquisition of healthcare real estate are raising money to the tune of $1 million per day. “Combine the money raised by these entities with that of the well-capitalized publicly traded REITs, as well as the private and syndicated funds that are in the market, and you are hit with the realization that the pool equity chasing quality investments within the healthcare real estate niche is enormous. This surplus of capital and limited available product has created unprecedented competition in the market, and cap rates continue to compress in response to this competition.”

According to Dopp-Grech, sales statistics for 2013 show that all-cash institutional and REIT buyers hold the market advantage. A full 25% of large MOB sales in 2013 resulted from purchase or sale activity within only seven portfolios, and 24% of buyers last year were REITs. However, 44% of buyers last year were private investors. Overpaying in order to get a piece of the pie is not unusual in this sector, she adds. “Medical real estate buyers are in many cases willing to pay A-quality prices for B-quality buildings.”

Hogan says that both public and privately traded healthcare REITs make up the majority of healthcare real estate investors, with $9.2 billion raised in 2013 primarily for senior debt and common equity. “Private equity is starting to enter this market, but at this point the REITs have been the most highly competitive on pricing.”

Prosky adds that REITs have been the most active buyers on the larger transactions. “You're seeing less medical-office investing from practice groups. You saw more of this in 2007 and 2008, individual practices that wanted to own their own real estate and take advantage of appreciation—but after the bubble burst and many of these guys got burned, that died down.”

Healthcare investment is also resulting from diversification among investors who typically bought more traditional real estate asset classes like office, industrial and retail, says Turley. “Groups that have historically focused on traditional food groups are taking a hard run at healthcare and are ultimately becoming another competitor group for the long-standing usual suspects like the listed and non-listed REITs and private-equity groups. The lion's share is still being sold to the healthcare-dedicated investment groups, but there's been an immense amount of interest in healthcare from unrelated groups looking for higher returns as compared to other asset types.”

Peters maintains that the mid-sized healthcare REITs, such as his firm, tend to be more nimble and better able to capitalize on smaller investments than the larger or more-diversified owners. “The larger healthcare REITs need to buy bigger deals to execute on their business model. For us, with medical office, we like that we can buy specific assets of $25 million or $50 million at a time because we're not a diversified owner. The atmosphere right now is there's a lot of demand for healthcare real estate, so if you're able to be more selective, you can be targeted in a manner that's appropriate to the size of your company. We invested nearly $300 million in 2012 and nearly $400 million last year, and we have discussed 2014 expectations in the $200-million to $300-million range. We don't have to go out and buy assets that don't fit with what we want.”

Trends among investors of overseas healthcare real estate echo what is happening domestically. According to Walraven, “Much of the foreign investment is being made by the traded and non-traded public healthcare REITs. Additionally, the private real estate funds are picking up their activity.”

What Type of Real Estate Is Currently In Demand?

All types of real estate are being sought by investors in this asset class, but experts see trends in a variety of categories. Overseas, Walraven says senior housing and acute/post-acute care assets are in demand, and foreign investors—particularly Canadians—are also seeking those assets here in the US. Meanwhile, domestically the targets vary depending on whom you ask.

“Over the last few years, senior housing, assisted living and memory care have probably been the most in demand,” says Prosky. “So much of that has traded in the last few years that there's not as much out there as in the past, but there's still tremendous demand for skilled nursing, medical office and hospitals, too.”

Hogan says the most popular asset class is on-campus medical office buildings greater than 50,000 square feet and less than 10 years old. “The second most popular would be off-campus, fully leased by a health system, with institutional-grade credit preferred.” He says this type of real estate has been performing fairly consistently, with cap rates between the high 5%s and 8%.

From Peters' perspective, two types of assets have currently been in demand: triple-net-lease assets that don't require a management team and multi-tenanted assets where owners who do manage assets can have an advantage. “There's also demand for larger, diversified types of assets where folks are buying and have operators run the business for them, such as senior housing and assisted living, which are underneath triple-net leases. Each type fits a different type of buyer.”

Dopp-Grech adds that hot healthcare investment properties tend to be have at least one of these characteristics: retail based; on-campus and adjacent properties; group practices; urgent care; high-traffic locations with good access and visibility for branding purposes and convenient parking; and community-based locations that are closer to patients.

How Has Healthcare Real Estate Been Performing?

It's hard to find a more steadily performing asset class than healthcare. While the jury is still out on long-term performance of foreign healthcare assets, according to Walraven, domestically the sector's strength continues to be proven.

Prosky says the sector has been moving in a positive direction ever since he started in the business in 1992, no matter how the economy is doing. During the recession, while stock prices may have been slashed, distributions from healthcare REITs continued—which was not necessarily the case with other types of REITS, he points out. “Healthcare has a 2% to 3% rise in good times and in bad.”

From an occupancy standpoint, national medical vacancy is just below 10%, says Dopp-Grech, and vacancy rates have been decreasing since 2009. “As the demand for medical investment properties continues to increase, cap rates are compressing and landing typically in the 6% to 7% range.”

As health systems become savvier about real estate, Hogan says his firm has seen these systems begin to use real estate as a strategy to attract physicians and patients. “We will see health systems start to monetize non-core real estate assets. They used like to hang onto them, and now they're starting to think of this as less of a priority.”

Turley agrees that investors are falling all over themselves chasing on-campus medical-office buildings supported by a health system and containing a varied ecosystem of practices and supporting services. In fact, since health systems are attempting to create more branding, physician groups affiliated with a particular health system are reaping the benefits, and the buildings they occupy are in great demand by investors. “In general, the healthcare demand is driven by the clinical nature of the asset,” says Turley. “That's not to say an investor wouldn't buy a building occupied by administrative hospital personnel, but those assets with a higher acuity are more desirable. Once a practice is established, it's difficult to pull up stakes because patients don't like to move to a different spot to see their physician or travel to get the different services they need.”

Turley adds that distressed debt on medical office is rare, and healthcare in general is hard to run off-track “unless you do something terribly wrong. People are flocking to this space, whether it's for wealth preservation or cash-on-cash yields.” 

SIDEBAR

Investing In the Patient Room of the Future?

As healthcare becomes more focused on efficiency, keeping patients well and out of the hospital and treating more patients out in the community, hospital patient-room design is also changing, presenting yet another area for healthcare investors to place their capital. One example is Patient Room 2020, a 400-square-foot collaborative design prototype located at the DuPont Corian Design Studio in New York City, which was constructed by international hospital builder Skanska USA and NXT Health, a nonprofit based in Washington, DC, and New York. The design is intended to reduce hospital-related infections, falls, errors—and ultimately costs.

“Patient Room 2020 is more about the integration of services and technology and takes into consideration the ROI side of the equation,” Andrew Quirk, SVP with Skanska, tells Real Estate Forum. “In the industry, everything is related to ROI—every decision made. What kind of return are we getting on every bit of capital involved?”

Features include UV lights for cleaning as well as lights to remind providers to wash their hands, increased air circulation to reduce airborne bacteria, increased mobility from bed to bathroom to prevent falls and a variety of other state-of-the-art medical features to aid both the patient and the provider. While the prototype is applicable to the hospital setting, Skanska looked at prefabricating the patient room and making it both transportable and modular so that it could be easily delivered to outpatient services providers.

“Hospitals are absolutely not going away, but in the future people in hospitals will probably be very sick,” Salley Whitman, executive director of NXT Health, tells Forum. “There will be a reduction in the number of beds, but they're not going away.”