Medical Properties Still Trail the Overall Net Lease Market

CHICAGO—While net lease medical properties have seen a strong increase in demand, they are still priced at a 10-basis point (bps) discount to the overall net lease market, according the third quarter 2019 Net Lease Medical Report from The Boulder Group. The Boulder Group primarily attributes this discount to the limited amount of investment grade tenants in the medical sector. In fact, only 27% of the medical property sector supply was leased to investment grade rated tenants in the third quarter of 2019.

But there are other reasons for this 10-bps discount to other net lease properties. Even though retail has its issues, it still boasts some advantages compared to medical.

“From a brand recognition standpoint, the general retail market has a lot more recognition and gets a lot more demand,” says Jimmy Goodman, a partner in The Boulder Group. “Investors understand the business for retailers models a lot more [than medical].”

Inside the medical sector, the most significant year-over-year jump in cap rates, by category, was for dialysis properties. Cap rates increased by 15 bps to 6.15%, which is primarily the result of an increasing supply of available properties with a shorter lease term remaining, according to The Boulder Group.

Even with the cap rate increase, dialysis properties do boast more investment grade tenants than other segments of the medical sector. That is because Davita and Fresenius Medical Care group, which have strong Standard & Poor’s credit ratings, control more than 80% of the kidney dialysis market, according to CNBC.

“Because of their credit rating, they command a premium as opposed to the urgent cares and general doctor facilities, which are usually not affiliated with an investment grade or highly rated public entity,” Goodman says.

Cap rates for urgent care properties, which declined five bps in 2019 to 7.25%, are the highest in the medical sector. Goodman says most urgent care facilities do not have a hospital or investment grade guarantee.

“The only time the urgent cares command what I would call a premium is if they are affiliated with a hospital and they actually have the hospital guarantee,” Goodman says. “For example, in Wisconsin, there’s a company called Aurora Medical Group. They’ve got a hospital and they’ an urgent care, but it’s guaranteed by an Aurora Medical Hospital as opposed to the doctors that are working there.”

While they rarely have investment grade backing, properties leasing to general medical practices saw cap rates fall by six bps in 2019 to 6.75%. In 2018, however, those cap rates jumped 31 basis points to 6.8% for those assets.

“I just think the only reason why those properties [general doctor’s offices] may have compressed is because there are a lot more investors out there looking for medical than in the past,” Goodman says. “I think there’s more of a flight to this industry.”

Investor interest in the medical sector should power the segment in 2020. Single tenant net lease medical properties will remain an active area of investment for the foreseeable future as investors are attracted to the long-term outlook for healthcare related properties, according to The Boulder Group.

“I think this sector will still be absolutely in demand,” Goodman says. “I don’t see any significant change in cap rates unless we see some type of change in the general financial markets.”