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Industry Pulse: Healthcare real estate demand like to remain strong in 2019

Experts still upbeat about HRE despite stock volatility and recession talk 

The “Deal Flow Drivers” panel featured (from left to right), moderator Stefan Oh of American Healthcare Investors, Caroline Chiodo of HTA, Trisha Talbot of Newmark Knight Frank, Darryl Freling of MedProperties Realty Advisors and Eric Tellefson of Capital One. (HREI photo)

SCOTTSDALE, Ariz. – As the domestic and global stock markets continue to show plenty of volatility, with an economic slowdown potentially on the horizon, investors continue to look for safe places to put their money.

One such place is healthcare real estate (HRE), particularly medical office buildings (MOBs), according to panelists at the RealShare Healthcare Real Estate conference held Dec. 5-6 at the JW Marriott Camelback Inn in Scottsdale.

“(Investors) are looking for places to put their money that will be safe and produce returns during a potential downturn, and more and more they are looking to healthcare (real estate),” said Darryl Freling, managing principal with Dallas-based MedProperties Realty Advisors LLC, which has been investing in healthcare facilities for more than a decade.

“We are an alternative investment vehicle, and we invest in long-term assets in the space, and they have performed well during good economic times as well as during the last recession.’

Mr. Freling was part of a panel session titled, “Deal Flow Drivers: Dissecting Demand & Capital Flow in 2019.” Other panels during the conference focused on the economy, the viability of long-term healthcare facilities, the impact of technology on healthcare, repurposing retail spaces for healthcare, and others.

Besides Mr. Freling, the panel included:

■ Caroline Chiodo, senior VP, finance, Healthcare Trust of America Inc. (NYSE: HTA);

■ Trisha Talbot, managing director and broker, Newmark Knight Frank (NYSE: NMRK); and

■ Erik Tellefson, managing director, medical properties, Capital One.

The moderator of the panel was Stefan Oh, executive VP, acquisitions for American Healthcare Investors.

Down but still plenty of demand

Demand for MOBs has soared in recent years because of the reliable cash flow resulting from the stability of medical tenants, and large institutional investors have discovered the space.

This demand, panelists noted, has driven prices high and capitalization (cap) rates, or first-year estimated returns, to record lows.

However, Mr. Oh noted, “If you look at the MOB transactions this year, we’re on pace with where we were in 2014, ‘15, ‘16. But we’re down from 2017.

“I don’t know if it’s necessarily a result of demand being down or if that’s a result of 2017 just being an extremely great year.”

(Editor’s note: The panelists didn’t know it at the time because the data was not yet available, but 2018 MOB sales volume was about $11.2 billion, according to the real estate research firms Revista and Real Capital Analytics Inc. (RCA). That compared with the record volume of $12.87 billion in 2017.)

Mr. Freling noted that if one were to exclude the 2017 sale of Duke Realty Corporation’s (NYSE: DRE) MOB portfolio for about $2.75 billion, 2018 sales volume would be asimilar.

Ms. Chiodo of HTA, which bought most of the Duke Realty portfolio, said demand was still healthy in 2018. The difference, she said, is that many of the most desirable portfolios have already traded.

“I don’t think the demand’s down, I think that the properties that are 50,000 square feet and above with 10-year-plus leases, completely stabilized – I think those have traded,” she said.

So although the remaining MOB assets from 20,000 square feet to 50,000 square feet are still strong, she said, investing in “the next wave” of MOBs will require buyers to accept a little more risk.

“The demand is certainly there, and will continue to be, with a lot of capital raises taking place for this investment type.”

The only potential hindrance for the MOB investment market is a lack of product on the market, she said. “Demand is there, it’s just more a function of deal flow.”

Mr. Freling added that rising construction costs could keep HRE development numbers low, creating even more demand for the market’s existing properties.

He also noted that there was already supply and demand imbalance in the MOB market, which has been exacerbated by a “tremendous amount of new capital, non-traditional buyers.”

Those kinds of buyers tend to look for “chunkier” deals, he added, meaning that they seek larger portfolios of product. That is leading to portfolio premiums and upward pressure on pricing.

Mr. Oh asked how these newer entrants are behaving differently than the might have five years ago.

Mr. Tellefson said, “On the lending side, the entrants really have been institutional equity… They do look for the larger, more diverse portfolios. They skew more toward core assets.”

And while these investors were not major players in the space a couple of years ago, he added, “and now they’re ready to pull the trigger and buy assets.”

To date, Mr. Tellefson said, these newer entrants have usually partnered with a national or regional MOB developer and investor.

Ms. Talbot of NKF said most of the newer investors have partnered because owning HRE facilities can be more complex than owning other property types.

However, Mr. Tellefson said, “At this point, they may be willing to do it on their own.”

Although interest rates have been rising, cap rates for MOBs have not fallen much, if at all, because of the strong and ongoing demand, according to Mr. Oh.

The panelists agreed that demand should remain strong for HRE facilities and MOBs throughout the next year, even with a potential economic slowdown.

More from RealShare

Other highlights from the conference included:

■ People’s overall health is becoming increasingly important, as employers are more interested in hiring healthy individuals. As a result, there is likely to be more capital invested in wellness programs and infrastructure that promotes healthier lifestyles, noted keynote speaker Mark Stapp, a professor of real estate at Arizona State University’s W.P. Carey School of Business.

■ Mr. Stapp added that the future of locating sites for new facilities, including healthcare, is likely to be focused on the use of psychographics, which gauges people’s attitudes, aspirations, and other psychological criteria, instead of just demographics.

■ Vacant retail spaces will continue to be repurposed into medical facilities, but only if such spaces can be retrofitted for less than what it costs to build new MOBs. Also, Matt Bear, founder of Bear Real Estate Advisors, said that while retail mall owners might be seeking medical tenants to fill vacant spaces, other retailers might not want such users. “Once a retail mix goes to 25 percent to 30 percent non-retail, that facility is lost,” he said.

■ Even though many healthcare systems believe they can develop and operate outpatient facilities more economically than third-party, professional real estate firms focused on healthcare, that is not necessarily the case.

“Even though they can currently borrow at, say 4.5 percent, their capital, when everything is taken into account of owning such facilities, is not as efficient as the best owners of healthcare real estate,” said Shane Seitz, senior VP with the U.S. Healthcare Capital Markets team at CBRE Group Inc. (NYSE: CBG). ❏

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