Obamacare Packing Medical Offices Spurs Deal Surge
Obamacare and an aging U.S. population are spurring purchases of medical office buildings, with investors sending prices to a record on bets that Americans’ demand for health services will increase.
Sales of properties leased by doctors and other health-care providers reached $6.67 billion in 2013, the second-highest total in 13 years of data-keeping by Real Capital Analytics Inc. Buyers including real estate investment trusts paid an average of $270 a square foot, up from $262 in 2012 and the most on record. The increase partly reflects deals for newer buildings with the latest technology, according to the research firm.
“It’s a really competitive space,” said Steve Sikes, manager of real assets at the Alaska Retirement Management Board, which is considering buying $150 million to $200 million of medical offices in what would be its first direct purchases of the properties. “Hopefully there’s enough of these out there for everyone.”
The buildings generate steady income from multiyear leases and offer higher investment returns than other types of commercial real estate. Buyers expect occupancies to climb along with the need for medical services as baby boomers age and more people get insurance under the Patient Protection and Affordable Care Act. More than 975,000 Americans signed up in December to buy plans under the law, which guarantees health coverage to all residents and penalizes those who aren’t insured.
The properties include doctors’ offices, urgent-care clinics and diagnostic laboratories and imaging centers. Their stable cash flow makes the buildings particularly attractive to REITs, which are required under U.S. tax laws to pay out at least 90 percent of their income to shareholders, according to Dan Fasulo, managing director at New York-based Real Capital.
“You have built-in demand drivers vis a vis the demographic trends that fundamentally don’t exist in other real estate,” said Jeff Hanson, chairman and chief executive officer of Griffin-American Healthcare REIT II Inc.
The Irvine, California-based company, a nonlisted trust, purchased $816 million of medical offices in the two years through Jan. 2, making it the biggest buyer after publicly traded Ventas Inc., which acquired 72 such buildings in its April 2012 purchase of Cogdell Spencer Inc.
Investor interest in medical-office buildings is driving up values. Capitalization rates, a measure of returns that declines as purchase prices rise, reached a six-year low of 7.3 percent nationally in 2013, Real Capital data show. That’s still higher than the 6.4 percent average cap rate for general offices and 5.7 percent for apartments, according to the firm.
More than 90 percent of about $1 trillion of health-care properties are still in the hands of hospitals and medical systems that may no longer want to be landlords, creating plenty of opportunities for institutional buyers, according to Hanson.
Among his company’s 2013 acquisitions were six buildings purchased from Middletown, New York-based Crystal Run Healthcare, a specialty physician practice group, for a combined $141 million. Crystal Run agreed to lease back the offices with 3 percent annual rent increases through 2033.
Griffin-American, owner of health-care real estate in 30 states and the U.K., buys stable, well-leased properties rather than buildings that need major renovations, Hanson said.
“We’re an income REIT,” he said. “Stability and growth of our dividend is paramount for our shareholders.”
The company’s medical offices are 94 percent occupied and have a lease-renewal rate of almost 90 percent, according to Hanson. That compares with a nationwide 65 percent rate for industrial real estate and other types of offices, he said.
“You typically don’t lose health-care tenants,” he said.
That stability helps make medical offices appealing to the Alaska Retirement Board, which oversees about $25 billion of assets as manager of the state’s pension funds. The properties fit in with the system’s strategy of building a diverse real estate portfolio, which already includes corporate offices and apartments, Sikes said.
“The main appeal to us is the income component,” he said. Rising health-care demand “will improve the economics of providing those services and translate into a better real estate experience from a rent perspective and occupancy perspective.”
The shift to outpatient clinics instead of much-costlier hospitals for many health-care services also has boosted tenant demand for office space, said Todd Jensen, executive vice president and chief investment officer at New York-based American Realty Capital Healthcare Trust Inc.
The nonlisted REIT’s medical office holdings almost doubled in the first nine months of 2013, according to a regulatory filing. As of Sept. 30, it invested $1.07 billion in the properties, up from $571 million at the end of 2012. More acquisitions are likely after a planned share listing this year, according to Jensen.
“Once you’re a publicly traded company, the Street wants to see you grow,” said Jensen, whose firm is managed by AR Capital LLC, the biggest fundraiser in the nontraded REIT business.
American Realty Capital Healthcare has $371.5 million of health-care property under contract, which will put its assets at $2 billion when the deals are completed, the company said today in a statement. Of that total, 44 percent will be medical office buildings.
Investors in public health-care REITs sold shares of the companies last year on concerns that rising interest rates would hurt the landlords’ ability to make money. Bloomberg’s index of 11 health-care trusts fell 11 percent, making them the worst-performing industry group in 2013. The broader REIT index slipped 1.4 percent.
Health-care landlords are more vulnerable to increases in borrowing costs because their buildings’ long-duration leases, which may range from three to more than 15 years, limit opportunities to raise rents. Income grows faster for owners of other property types that typically have shorter leasing periods and higher tenant turnover, according to Craig Guttenplan, a REIT analyst at CreditSights Inc. in London.
In times of strong economic growth, such as the years leading up to the 2008 financial crisis, health-care real estate wasn’t as popular as offices and retail properties, he said.
“It was not a sexy sector to invest in,” Guttenplan said. “As you see the economic recovery broaden and improve, you see some of the more stable property types get left behind.”
The large pool of properties to buy gives medical office investors ample opportunities to generate more income, according to Hanson of Griffin-American. A limited amount of construction should help landlords retain tenants and keep building occupancies high, he said.
Almost 15 million square feet (1.4 million square meters) of medical offices were completed in the past two years, compared with 41 million square feet in 2008 and 2009, according to Marcus & Millichap Real Estate Investment Services.
“You’ve got predictability and durability of income streams in medical office that you just don’t see in other real estate,” Hanson said. “You’ve got far lower risk in this sector.”
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