Micro-Hospitals’ Growing Role In Net Lease Portfolios

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ST. LOUIS, MO—Micro-hospitals are inpatient facilities with a handful of short-stay beds. They offer a few of the same services as larger hospitals—typically emergency services, imaging, pharmacy, lab work and sometimes even outpatient surgeries and primary care—but are cheaper to operate, which is why they are becoming the darling of the healthcare system. And net lease investors.

“We have seen a number of health systems head more towards a hub-and-spoke model in regards to their facilities,” Jim Koman, Managing Principal and Founder of ElmTree Funds, tells GlobeSt.com. ElmTree Funds is a private equity real estate investment manager focused on the net lease, sale-leaseback, and build-to-suit sectors.

“Micro-hospitals are critical for hospital systems to be able to designate the surrounding free-standing emergency rooms as hospital outpatient department facilities—also known as HOPDs,” he also says. The HOPD facilities are branded under the same health system as the micro-hospital, and are slightly smaller in terms of size and scope of services provided, Koman explains. One significant advantage to HOPDs is that they can accept Medicare and Medicaid, which “significantly improves a facility’s brand image to commercial payors in the surrounding market due to the affiliation with a large health system,” he says.

Another advantage to these facilities: they allow health systems to expand their geographic footprint into areas not well served by larger hospitals increasing their patient base.

For all these reasons Koman predicts that net lease investment in micro-hospitals will be increasing along with the medical office building asset class. “Cap rate compression has really come into play for these assets,” he says, precisely because they’re typically backed by an A-rated health care system. They also have typically 20-year leases with strong annual increases in the rent. “They are becoming very sticky assets.”

Not that Koman is married just to these assets. He also likes industrial and office properties as well. Indeed, earlier this summer the firm acquired six net lease assets not only in healthcare but also in the industrial and office asset classes for a total of $300 million.

A Recession-Resistant Asset

If this sounds like a wide variety of bets to place, that is because the net lease sector in general is well positioned for just about any real estate cycle, including a recessionary one, he says.

Cap rates in the net lease sector during the 2007 and 2008 time frame only expanded out to anywhere from 8.5% to 9%—and that wasn’t for investment-grade type credits, it was for net lease in general. By comparison, Koman says, current cap rates are 6.5% to 7% for both office and industrial products. “Investors are always looking for a flight to safety during economic downturns, which makes investment grade tenants and net lease assets and long-term leases highly attractive for the predictability that they provide.”

Another plus to the sector right now is that it has become much more liquid relative to other cycles as seen from the higher transaction volumes over the last five years. Net lease trades have been clocking in at about $55 million per year compared with the $20-$22 million of the previous five-year period. “We’re seeing a lot more capital, especially institutional capital, investing in net lease, which also stabilizes the space,” Koman says.

Foreign Appetite

At the same time, foreign investors appear to be stepping up their appetite for these assets.

“We’re starting to see more investment coming from the Koreans, we’re starting to see the Japanese take a lot more interest in corporate real estate in the US, net lease in particular. The same with the Australians,” Koman says. “Saudi Arabian investors have really increased their interest in net lease and we think we’re going to see more of that for the foreseeable future.”