Healthcare Real Estate Grows Up – Part 1

Healthcare Real Estate Grows Up – Part 1

by CJ Follini

“It is not the strongest of the species that survives, nor the most intelligent, but the one most responsive to change.”—Charles Darwin

Ok, so by now every savvy investor that reads GlobeSt daily, watches CNBC hourly and subscribes to The Real Deal has heard of the wonders of healthcare real estate. The miracle cure for every recessionary illness that ails you. The reality is that there is more truth than hyperbole to this statement. First a quick primer – what is healthcare real estate? Here is a quick list:

  1. Medical office buildings (MOB’s) – office and clinic facilities, often located near hospitals or on hospital campuses.
  2. Ambulatory surgery centers – ambulatory surgery centers that are used for general or specialty surgical procedures not requiring an overnight stay in a hospital
  3. Specialty care facilities – include acute care hospitals, long-term acute care hospitals (LTACS) and other specialty care facilities.
  4. Senior Housing – independent living (IL), assisted living (AL), continuing care retirement community (CCRC)
  5. Diagnostic Centers or Medical Malls
  6. Hospital Parking Facilities

Now why do we love it so much; here are a few basic reasons:

  • Cash flow, cash flow, cash flow. While the current yield for the 5-year Treasury is slightly more than 2% and the Fed flirted with targeting the Fed Funds rate below, a stabilized MOB yielding an 8% -9% cash on cash return is suddenly the belle of the ball.
  • Aging customer demographics = steady growth. Between 2010 and 2050, the U.S. population over 65 years of age is projected to more than double from 40 million to nearly 87 million people. Older Americans as a percentage of the total U.S. population as the “baby boomers” enter their 60s. In 2010, the number of persons older than 65 will comprise 13.0% of the total U.S. population and is projected to grow to nearly 21.0% by 2050.
  • ‘Sticky’ tenancy = . Physicians and medical groups are loathe to move because of the enormous investment most have committed to their practice’s location (their brand, if you will) and in their offices physically which is why renewal rates are realistically modeled at 90+ % .
  • Higher rents and price inelasticity. Physicians will pay more for institutional proximity and being in a “medical only” building because of the importance of referrals to their business. Thus, MOB lease rates are less sensitive to price volatility in both high and low markets.

All of the above contribute to form an asset class with traditionally higher occupancy and greater stability. Since 1972, through six recessions, physician office employment has grown annually by approximately 4.8%, compared with the national private employment growth rate of only 1.8%.

Pricewaterhouse Coopers conducted a national survey of healthcare real estate professionals and compiled the following data for the first quarter:

CURRENT Q LAST  Q

UNLEVERED RETURN (IRR)a
Average                                                                10.86%                        10.08%
Change (Basis Points)                                          + 78

OVERALL CAP RATE
Average                                                                8.01%                         7.98%
Change (Basis Points)                                          + 3

RESIDUAL CAP RATE
Average                                                                7.92%                          7.88%
Change (Basis Points)                                          + 4

MARKET RENT CHANGE
RATEb
Average                                                                2.63%                          2.71%
Change (Basis Points)                                          – 8

EXPENSE CHANGE
RATEb
Average                                                                3.16%                       3.18%
Change (Basis Points)                                          – 2

AVERAGE MARKETING
TIMEc
Average                                                                5.14                             4.67
Change (%)                                                           + 10.06

Some of you may be wondering what’s so special about the numbers above unless of course you are an owner or seller of a traditional office property in which case you are already dialing your doctor to ask him/her who owns their offices. So what’s not to like? Healthcare real estate is very management intensive; it requires a special understanding of physician and healthcare practitioner needs not to mention the specific design characteristics of medical reasl estate – parking, HVAC, floor loading, electric, etc. Its reasonable to assume at least a 20% premium on the general operating expenses – Armchair managers need not apply.

WHERE?

So now you’re on board and you are wondering where can I find quality transactions? Is anyone selling? Are there distressed sales? The answers are…check back within two weeks for the answers and more in Healthcare Real Estate Grows Up – Part Two.

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4 Responses to “Healthcare Real Estate Grows Up – Part 1”
  1. Excellent analysis. Super-hot inudstry. when is part 2 coming out?

    by john d.
    on 14. May, 2009

  2. We’re architects who design medical office buildings and are key players in trying to create a few new projects. At some point in time every deal requires a design and construction element. I found the article a good analysis of why we’re working on medical office buildings in these turbulent economic times.
    Joel Ives
    The Ives Schier & Lesser Architects Studio
    Fair Lawn, New Jersey

    by Joel Ives
    on 15. May, 2009

  3. Hospitals will be shedding even more of their real estate assets over the next few years as they aim to be more lean and efficient. That should present an already hot industry with even more opportunities. There aren’t many players in this field so they should all benefit, especially since many of the johnny-come-latelys have already headed for the exists after misguided development projects; this has allowed cap rates to return to acceptable levels.

    by Mike
    on 19. May, 2009

  4. I have been working in the health care field [specifically, specialty care facilities and senior housing] as a real estate broker for 20+ years. When I first began, I was told that the field would not sustain me. In today’s market health care real estate is regarded as one of the few the recession-proof categories that is, if not thriving, surviving and continuing to post relatively strong numbers. Health care real estate is an expertise which requires specialized knowledge, dedication, and patience. It is a career-commitment.

    by Sue
    on 04. Jun, 2009

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