Steve and Scott attended the BOMA Medical Office Building and Healthcare Facilities Conference held in Chicago this past week.
If there is one phrase that summarizes our take-away from the conference, it would be “there is a lot of capital chasing too few deals.” Private REITs have clearly led the pack here, gobbling up whatever assets they can find with their hordes of newly raised cash. Beyond that, there are all kinds of players, most of whom are well-capitalized themselves, waiting for acquisitions, development, and joint ventures, including private equity, public and private REITs, hospitals, and developers.
The mood could not have been different from a year ago. This year’s conference was nearly all positive with significant market activity to discuss and the highest turnout in its history. Even new development is seeing a strong resurgence. Several national developers reported full pipelines of strong demand for new on and off-campus MOBs, surgery centers and other healthcare facilities. Clearly the access non-profit health systems have enjoyed to the bond market is helping move new projects forward, but one cannot overlook the surge of capital focused on this space right now as a significant contributing factor.
This is not to say there aren’t uncertainties. Obama-care, which in many ways is really just insurance reform, does not address long-term cost containment, among a number of other issues, and the debt market still seems to provide more support to the aspirin industry than would-be borrowers. But these issues tend to be ancillary to medical real estate investment and ownership. Fundamental questions may exist about whether primary care physicians or specialists will fare better in the next 5-10 years, but little concern seems to exist about whether either of those two groups (or any affiliated health system) will need additional real estate. The resounding consensus seems to be yes, they will.
So with another successful gathering of medical real estate junkies behind us, we look forward to seeing the predictions and shared expectations bare some fruit. We have highlighted the more pertinent predictions and expectations below.
Pricing/Cap Rates: - Cap rates have compressed 50-75 bps since a year ago and range anywhere from 7.5% for on-campus, Class A MOB to 9.5%-10% for off-campus, Class B.
- Additional compression is possible, but will likely be on lower quality assets and be incrementally small. The best assets are probably priced as good as they’ll get for awhile.
- Bank underwriting, which is slowly beginning to matter again, will help provide a sanity-check on cap rates.
Buyer Profiles- The REITs have had a buying spree, particularly Healthcare Trust of America. HTA has been raising $2-$4 million a day on average and has not been shy about putting it into acquisitions. In our opinion, HTA alone has caused cap rates for Class-A to compress by ±25 bps from a year ago.
- Big REITs have pursued nearly all deal sizes, but are starting to look larger. This will begin opening doors for other players, like private equity and non-REIT investors, to pursue deals.
- Leveraged players have generally been sidelined by all-cash REIT buyers whose yields just need to cover dividend payments and who generally don’t underwrite with exit plans.
- Foreign investors are showing “tremendous interest,” as one panel participant put it, in the medical real estate market due to the higher relative returns and lower volatility compared with many European markets. Healthcare reform has, however, kept some foreign capital at bay due to a perceived uncertainty of outcome in its application.
Acquisition targets/criteria- This conference attracts larger players, who by necessity, go after assets that will generally align them with health systems. For that reason, many of the participants commented they have sought on-campus assets. One fund commented that with the right tenant mix and fee-simple ownership, they will go off-campus. We predict off-campus assets become more attractive as good on-campus assets become more difficult to find.
- Buyers are seeking assets with longevity and stable returns, which is generally determined by the strength of the nearby health systems (especially if they are a tenant), the property’s cash flow compared against rent to calculate a coverage ratio, the ownership structure, e.g., fee simple v. ground leased, and the overall tenant mix.
- Senior care is a target asset class for most of the same buyers of MOBs, though there are significant underwriting differences and the need for a well-tested operator.
FASB Changes to Lease Accounting- The panel that addressed this topic did not have any serious concerns related to the proposed changes to lease accounting. The consensus was that analysts and ratings agencies are sophisticated enough to understand that any changes simply move things around and do not alter fundamental performance or economic position. As one panelist said, it will remain cumbersome for hospitals to own and manage real estate regardless of the accounting standards.
Development- Developers have full pipelines of new development, most of which is from tabled projects over the last two years. Health systems have been raising money and will continue to have access to capital, which, combined with a trend to bring more physicians in-house, will lead to a need for new real estate.
- National developers are looking to partner with local developers
- Investor/buyers, such as REITs, will fund development but vary widely on what and how to fund it. Some will JV while others won’t, and those that do seem to recognize the value local developers provide and seek to partner with them.
- LEED-certified construction is becoming very popular
- Regionalization of health systems will lead to new freestanding emergency departments with some MOBs as a way to limit costs while expanding footprint size
- Market size and location may or may not matter; it just depends on the developer. In a tertiary market, the returns might have to be slightly higher, but if the facility is sized right for the market, the returns probably don’t need to be much better
- There is a growing trend to redevelop retail space to medical use because:
o Retail provides immediate access to an existing consumer base
o Providers can leverage stronger branding of their names
o There will be a higher need for primary care as the insurance rolls expand
o Occupancy costs are generally lower, especially in the current real estate market
o Retail vacancy can provide immediate occupancy
o End-cap users, like Blockbuster, are leaving and providing premium locations
o Hospitals and providers want to be near their customers
o Retailers can leverage increased daytime traffic, particularly as most medical consumers going to these locations tend to be women