Healthcare Real Estate Opportunities Beyond Medical Offices and Hospitals

Investors have come to appreciate the recession-resistant returns offered by healthcare real estate. Different from other sectors, throughout and post-COVID pandemic, healthcare real estate has been resilient. While these property types haven’t gone through the rapid rent growth and construction seen in some of the other commercial property sectors, healthcare experienced moderate market contractions in rent rates and occupancy over the last few years.

The Increasing Needs that Drive the Demand When most investors think of healthcare real estate, typically Medical Office Buildings (MOB) and Hospitals are top of mind. Over the last decade, these healthcare property types have been able to maintain high occupancy levels, steady 2-3% rent growth, and predictable returns. Due to the needs-based nature of the medical sector and the specialized build-out of most tenant spaces, healthcare properties have a high tenant retention rate. Additionally, America has an aging population. Based on the data prior to 2019, the U.S. Census Bureau forecasted that by 2040, the number of Americans over the age of 75 would increase by approximately 93%. Further, the number of Americans over the age of 80 would increase by approximately 115%. The large increase in the elderly population is often referred to as the “Silver Tsunami.” Naturally, the elderly requires more medical care, leading to an increased need for more healthcare real estate.

Investors Favor Steady Returns in Healthcare Even Though Transactions Have Slowed In recent years, as more investors realize the investment opportunities and predictable, steady returns offered by the healthcare sector, competition for healthcare acquisitions significantly increased. Since 2020 and prior to the recent rate increases from the Federal Reserve Board (the Fed), there has been continual compression of capitalization rates in the MOB and Hospital product types, indicating increased competition from investors. As investment competition for MOBs and Hospitals increased, the yields once realized by investors have begun to shrink. Returns were further reduced as the Fed began to raise interest rates, causing reduced liquidity and increasing the cost of capital. The consequence is that many investors found themselves unable to achieve their targeted rates of return by investing in MOBs or Hospitals. Like all other sectors, healthcare transactions have slowed. However, the fundamentals of the healthcare real estate market remain strong, which is attracting new investors who have traditionally only invested in office, retail, multi-family, or industrial sectors.

Alternative Healthcare Properties are Garnering New Interest Fortunately, there are several other property types besides MOBs and Hospitals within the healthcare sector. Over the last few years, we have seen an uptick in investor interest in alternative healthcare properties such as Ambulatory Surgical Centers (ASC), Inpatient Rehabilitation Facilities (IRF), Substance Use Treatment Facilities (Drug/Alcohol), Behavioral Facilities, Cancer Centers, and others. Historically, many of these property types have traded at higher capitalization rates as compared to MOBs or Hospitals. Investors are usually able to achieve a more desirable yield with alternative healthcare properties because of the smaller buyer pool, less competition for each transaction, and higher cap rates.

These alternative healthcare properties are located across the country, in all primary and secondary markets. Most investors in this space are comfortable investing in the primary markets. Additional yield can be achieved by improved deal metrics (higher yields due to the typically higher cap rates, and less competition pushing the values up), often realized from properties located in the secondary markets.

Pros and Cons of Alternative Healthcare Properties Healthcare property types are evolving to meet changing demographic needs and trends. Investments in these alternative sectors are not without their own unique risk. Many of these facilities can be highly specialized in their program requirements, which means higher construction costs and difficulty in re-tenanting the buildings should they become vacant. These risks can be greater in the secondary markets. However, the same factors that add risk also add to the “stickiness” of the tenants. Alternative specialized space is often difficult to find or cost-prohibitive to move or construct in the current capital environment, resulting in long-term tenant occupancy.

Constrained Capital and Alternative Financing Opportunities Across all markets, access to capital has been reduced and become more expensive. Almost all lenders lowered their loan-to-value thresholds, limiting the amount of capital available to an investor from traditional financing sources. However, many investors are now looking for alternative financing to help achieve additional leverage. These typically include private money lenders, mezzanine financing, and Property Assessed Clean Energy (PACE) financing. While each capital source has its pros and cons, there is no debate that investors are now seeking alternative funding sources to keep their leverage at a level required to meet their yield expectations. In addition to the constrained lending market, there are fewer lenders for the alternative property types, as opposed to MOBs and hospitals.

Overall, the fundamentals of the healthcare real estate sector remain strong as the need for MOBs, Hospitals, and various alternative healthcare properties continues to increase. We anticipate more investors to allocate capital to traditional healthcare real estate (MOBs and Hospitals) and to the various alternative healthcare assets. Partner Valuation Advisors is in the process of conducting its 2023 U.S. Healthcare Investor Survey to learn more about investor sentiment and opportunities. The report will be available in early 2024. Contact us if you would like to receive a copy of the report.