Dialysis Clinics: The True Commodity Asset of the Healthcare Net Lease Sector

Dialysis clinics, dental clinics, and urgent care centers have always been the closest thing to a commodity asset within the healthcare net lease sector, but in the past few years, dialysis product has separated itself from the pack. Although there has been some consolidation within the dental and urgent care spaces, those sectors remain fragmented. The dialysis industry, however, features two primary players and one secondary operator – the two behemoths in this space are DaVita Kidney Care and Fresenius Medical Care, with U.S. Renal Care being the smaller, yet still significant, third operator. By looking at the development strategies employed by these tenants, along with what differentiates the three primary operators, we will begin to see what has driven investor interest in this space and what variables ultimately affect the valuation of a clinic.

Investor Demand

When retail dynamics began to shift in 2015, we immediately saw an increase in 1031 exchange needs. Those of us who primarily represent sellers started to receive calls from buyers’ brokers who were seeking out “internet proof” investments, and that search was leading them to the commodity healthcare sector. These buyers were looking for service-based industries – an investment product that would be considered insulated from Amazon and other web-based competitors. These buyers soon discovered other factors that enhanced their attraction to healthcare assets, such as the highly specialized build-outs and specialized equipment that make it difficult for tenants to relocate once established. Additionally, for retail investors that were accustomed to underwriting assets based on credit ratings, location, and lease economics, dialysis clinics were able to offer them a comfortable and familiar alternative to traditional retail investments.

The timing of the buyer directive to seek “internet proof” investments coincided well with a boom in the development and delivery of new, freestanding dialysis clinics. In what appears to be a race to grab market share, even in tertiary and rural markets, DaVita and Fresenius, as well as some smaller operators like U.S. Renal Care, have been rapidly expanding and developing new clinics.

Sources of Capital and Development Strategies

Along with the acquisition of competitors, all three of the main operators have been expanding their footprints by using a combination of self-development and private development strategies. While self-development is fairly straight-forward, private development typically comes in four forms: institutional developers, regionally-based preferred developers, one-off equity partners or first-time developers, and physician development. Because of the benefits to the operator and the physician-investor, this latter strategy has become popular. By allowing physicians to own the real estate behind the practice, the physicians are tied to the operator and their respective markets, ensuring the long-term viability of the operation. Additionally, it has become a powerful recruiting tactic for the operator and a form of enhancing the income of the physician.

DaVita Kidney Care: DaVita has begun selling facilities on a one-off sale leaseback basis to maximize pricing by engaging a broker to help facilitate these sales. The assets are easily identifiable because their lease term, typically 15 years, commences upon the sale.

Fresenius Medical Care: All self-developed clinics have historically remained corporately owned. That said, Fresenius recently completed a large sale leaseback portfolio disposition to SunTrust Bank in February 2018. These assets have recently been listed for sale again, this time as individual assets, providing investors with the unique opportunity to own a Fresenius property with a 20-year lease term.

U.S. Renal Care: This operator leans primarily toward self-developed and physician-developed facilities. They recently received a credit downgrade by Moody’s based on their leverage. However, much of this leverage stems from U.S. Renal Care using internally generated cash to fund the development of new clinics. While DaVita and Fresenius have been executing sale leaseback transactions, U.S. Renal Care’s holding strategy for these self-developed clinics is unclear at this time.

Valuation of Assets

As with any investment property, a variety of factors can influence an asset’s value. Lease term remaining, rental rate increases (both the amount and frequency), what entity guarantees the lease, how the expenses are structured – these all can add or subtract from the value as perceived by the marketplace. But like dialysis centers’ counterparts in the commodity retail space, having comparably structured leases and similarly constructed facilities can provide investors with a level of familiarity and comfort as they consider their next investments.

Conclusion

While no industry is completely immune from technological advances that could jeopardize future growth and sustainability, dialysis services are projected to increase in the coming years. As the U.S. population ages and more patients with end-stage renal disease need care, widespread access to the latest treatments and services will be crucial. We expect to see continued development of new dialysis facilities by all operators as they look to gain market share, and this expansion strategy translates to new opportunities for investors. It is important to remember that every facility and clinic has its nuances, so investors should always seek the guidance of advisors who truly understand the industry and what factors can ultimately influence value of those individual assets.

Colin Cornell is an associate director at Stan Johnson Co. The views expressed here are the author’s own.