The health care industry and its real estate providers are literally caught between two eras as the 2012 elections and a key U.S. Supreme Court decision that will determine the future of health-care reform play out against the backdrop of a strengthening, yet far from robust, economic recovery.
Richard Taylor, managing director with Jones Lang LaSalle’s Healthcare Solutions Group, said three key pressures are contributing to the current environment he described as “predictable uncertainty” for owners and operators of health-care real estate and their clientele.
“First, there are a multitude of laws inside the [health-care reform] bill that we don’t understand and haven’t even been created yet,” Taylor said in a video posted on the JLL web site. “The second is unemployment, which means lower revenue for hospitals, fewer elective surgeries, fewer people with commercial insurance, and lower reimbursements.”
The third pressure is deficit reduction, which will affect the key sources of revenue for the health-care industry. The federal government is reducing Medicare reimbursements, and cash-strapped states are having difficulty funding Medicaid programs, Taylor noted.
The path to hopefully greater clarity for investors begins March 26 at the U.S. Supreme Court, which will hear three days of oral arguments, the longest scheduled arguments in the court’s history, in a case challenging the constitutionality of the historic legislation signed into law by President Barrack Obama. The legislation would require most Americans to buy medical insurance by 2014. The High Court isn’t expected to render a decision on the Affordable Care Act before the end of June.
Despite the uncertainty, institutional investor interest in health-care properties is booming, as evidenced by the consolidation in the REIT sector specializing in medical office buildings (MOBs) and senior care and housing. And with the exception of rents, fundamentals in the medical office building (MOB) space continue to strengthen amid limited new supply of product.
The total vacancy rate for medical office space, which rose during most of the last decade, has edged down to 11.3% in the current quarter, the lowest since late 2008, according to preliminary CoStar data, which also shows almost 3.5 million square feet of new MOB space being delivered in the first quarter, the highest since early 2009 but still well below similar periods from 2004 to 2008. Net absorption of medical office space also appears to be rebounding from its 10-year low in mid-2009. Rent growth remains a problem for many landlords, however. Direct rents, which rose for several years during the middle of the last decade, have just as quickly fallen since their cyclical peak in mid-2008, according to CoStar data.
MOB investment sales reached $523.5 million in fourth-quarter 2011, the highest since third-quarter 2008, but nowhere near the fourth-quarter 2006 market zenith of $1.03 billion. In the fourth quarter of 2011, Ventas Inc. (NYSE: VTR) announced the acquisition of Cogdell Spencer Inc. (NYSE: CSA) for about $775 million, a deal encompassing 72 on-campus assets, making Ventas the largest MOB owner in the U.S. Healthcare Trust of America (HTA), a non-traded REIT, received an investment-grade rating last year from Standard & Poor’s, allowing it to access debt capital at more attractive and competitive terms. while another non-traded trust, Grubb & Ellis Healthcare REIT II, replaced its dealer-manager with Griffin Capital Securities and is now known as Griffin-American Healthcare REIT II, co-sponsored by American Healthcare Investors, a CRE investment firm specializing in acquisition and management of health care properties.
While the uncertainties over the impact of health-care reform will affect the portfolio and capital allocation decisions of health systems this year, strong investor demand for health care-related real estate will present attractive opportunities for the monetization of existing facilities and the third-party financing of new development, said Peter Bulgarelli of Jones Lang LaSalle’s Healthcare Solutions practice in a recent outlook.
“The relatively low-cost capital those investors and developers can provide will come at an opportune time, as we anticipate that more and more systems will proactively plan and eventually develop medical office and outpatient facilities this year. Those facilities will incorporate the collaborative, accountable care environment required by health care reform,” according to the JLL outlook.
“Strong investor demand for health care real estate will continue throughout 2012 because of attractive patient demographics and the sector’s proven record of success during economic downturns.”
Developers and their capital partners are actively competing for the opportunity to finance and own medical office buildings (MOBs) and other outpatient facilities affiliated with creditworthy hospitals and health systems, JLL said.
However, development activity is likely to remain muted this year as few health systems are willing to go full bore in building new facilities amid the current uncertainty regarding health care reform, JLL acknowledged.
That said, developers won’t sit on their hands. Planning for future MOB and other outpatient facilities will remain the busiest area of the industry as providers ensure their new projects will be ready to go when the time is right, JLL’s Bulgarelli noted.
A number of institutional funds, including foreign capital from the Kuwait Finance House and pension fund money from the Kentucky Retirement System and the Texas Health Municipal Retirement System, have made major allocations for core medical office facilities in the first two months of 2012.
However, very few properties that meet the funds’ criteria, which are generally newer buildings with credit tenants on long-term leases, have been available on the market, setting the stage for some top-dollar deals this year as these funds look to expend their dry powder.
The top investors in the space have been the health care REITs, which now have a market capitalization of about $50 billion or 13% of the market cap of all real estate product types, JLL reported. Publicly traded health-care REITs raised more than $18 billion in debt and equity capital in 2010 and through Nov. 1, 2011 — substantially more than other larger property sectors. Health care REITs are generating average dividend yields of 5.3%, compared to industrial, office and apartment REITs, which produced yields of no higher than 3.8%.
The top health care REITs, Ventas and HCP Inc. (NYSE: HCP) last month reported strong fourth-quarter results and solid property fundamentals and low cost of capital. Ventas has been active on the acquisition front, targeting larger deals and M&A plays such as the Cogdell transaction, while HCP has largely remained on the sidelines since last year’s acquisition of HCR ManorCare.
Although medical asset fundamentals have been stable, it’s been difficult to push rents because of the economic pressures on doctors and hospitals, noted Jeffrey H. Cooper, executive managing director with Savills US, who moderated a health care real estate panel discussion at last week’s Akerman Real Estate Summit in Miami.
While the market is flush with institutional capital, the MOB space, unlike the traditional product types, has many regional operators and developers that don’t have as much access to capital, said panelist Clint Hinds, senior vice president with Bentall Kennedy. Partnering with a real estate player that has a strong pipeline of activity and developing relationships with health-care systems, are ways for smaller operators to gain access to capital, he said.
Summit panelist Todd Lillibridge’s company was one of the largest private health care real estate development firms when it was acquired almost two years ago by Ventas, which has since acquired Nationwide Health Properties (NHP) and is under contract to acquire Cogdell Spencer.
Ventas, enjoys great access to debt and equity markets and the lower cost of capital was a major incentive for Lillibridge to join with Ventas, Todd Lillibridge said, but understanding the risk-adjusted return that an investor requires or can get in the marketplace for a certain portfolio is even more important.
“If we [Ventas] want to buy something, we have the ability, but we’re very selective,” said Lillibridge, whose company is now a wholly owned subsidiary of Ventas and now serves as the parent company’s executive vice president of medical property operations. “Owning an MOB on the campus of a failed hospital, I don’t care how new it is or where you set the rents, doesn’t matter if there’s no one there to rent your space. This is all driven by health-care fundamentals and dynamics and has little to do with real estate.”
Cooper noted that while hospitals could be expected to focus on building more outpatient and ambulatory care facilities as reimbursements decrease for inpatient treatment, yet hospitals haven’t to date developed many facilities or executed monetization or sale-leasebacks of acute-care facilities over the last couple of years to raise capital.
Outpatient care delivery will see 30% growth over next 10 years or less because every hospital system is faced with how it can simultaneously reduce the cost of care while at the same time improving patient access and quality of care, Lillibridge responded. As more independent doctors join health systems and occupy more on-campus tax-exempt space, health systems have less of an incentive to sell their property to for-profit enterprises and lease it back.
Hospitals and health systems probably won’t revisit monetization through sale of their MOBs until after the full breath of health care reform begins in 2014, Lillibridge said. After that, aging facilities will again prompt health systems to reevaluate their capital needs and reconsider sale-leasebacks.
Hinds agreed that despite the importance of real estate to the balance sheets, real estate concerns for now have been pushed down on the priority lists of health-care executives, who are focused on growth through mergers and acquisitions in the new era of reform, which will require both cost control and the need to expand to accommodate new physicians and IT infrastructure improvements.
Randyll Drummer, Costar Group
