Feature Story: Investors are being more cautious

InterFace conference panelists discuss their strategies in a volatile market

By John B. Mugford

A recession might be looming (if it’s not already here), interest rates are on the rise and landing debt financing for making acquisitions in the healthcare real estate (HRE) space is perhaps as difficult as it’s been for a number of years.

Because of these factors – and a widespread belief that sellers have not necessarily responded by appropriately reducing their asking prices – a good share, but not all, of the investors involved in acquiring medical office buildings (MOBs) and other types of HRE facilities are perhaps being a bit more cautious.

A panel of HRE experts discussed that question and more during a panel discussion titled “In the Face of Rising Rates and a Potential Recession, is it Pencils Down or Full Steam Ahead for the Investment Market?” at the InterFace Healthcare Real Estate Conference in Dallas Sept. 8.

In summing up the main question to the panel, the moderator, Andy Dow, said: “So the topic of this panel is – I think very descriptive in the face of rising rates and potential recession – is ‘Is it pencils down or full steam ahead?’ As one of our panelists said when we had our pre-call, ‘It may not be pencils down, but the pencils are moving a little more slowly.’ And I think that’s consistent with what … you’re going to hear from this panel.”

Mr. Dow is an attorney and the chair of the Real Estate Industry Group with law firm Winstead PC in Dallas.

For the most part, the panelists, which included an HRE broker as well as investment professionals from a variety of firms, agreed that they are currently active but showing some caution.

“Every time I talk to a broker I haven’t talked to in a while, you know, the first question I get is, ‘Are you active?’” said Mervyn Alphonso, executive VP and partner with Charlottesville, Va.-based Anchor Health Properties, one of the sector’s most-active private HRE investors and developers in recent years.

“And I say, ‘If we weren’t active, I’d be in Belize right now.’ … We are still active. But I would say that, across the board and with our peers as well, we are being selective.”

He noted that Anchor made acquisitions totaling about $900 million in 2021, a record-setting year for the firm.

“We will not do $900 million this year, but … we’ll still have a solid year,” Mr. Alphonso added. “We do have the benefit of having, I think, a myriad of diverse capital, so we have the ability to align capital with specific deal profiles. But even with our capital, of course, we’re being very selective and careful, with the biggest challenge certainly being the debt markets … and just the uncertainty, which makes it very difficult to plan around acquisitions and investments… You can’t predict the future and we don’t know what the Fed (U.S. Federal Reserve Bank) is going to do in the next month or the next 90 days. But we can try to solve and try to protect the downside, and that’s what we focus on.”

Others on the panel echoed somewhat similar responses, with variations of how active they will be for the remainder of 2022 and into next year.

Those other panelists included:
■ Mindy Berman, senior managing director, Capital Markets, with Jones Lang LaSalle Inc. (NYSE: JLL) in Boston;
■ Erin Bremen, senior VP of investments with Chicago-based Remedy Medical Properties;
■ Ryan Crowley, senior VP of investments with Nashville, Tenn.-based Healthcare Realty Trust Inc. (NYSE: HR); and
■ Joe Dominguez, managing director of investments with Dallas-based Big Sky Medical Real Estate.

Ms. Berman, a longtime HRE facilities sales broker and advisor, said that although, for the most part, the MOB sales velocity has slowed in recent months, the total volume for 2022 will end up being very strong. And, she added, the MOB and HRE facilities sector, despite some of the current headwinds facing the economy, remains a good business to be in.

“I take a positive view on things, and I’m going to tell you what I really like about the environment and why you feel good about being in this space,” she said. “Number one … there are a ton of new faces in this room, a lot of people I don’t know. So, there’s a lot of new capital chasing the sector, exploring the sector – whether you’re refugees from other property classes, medical office and healthcare is the ‘Steady Eddie’ So that’s a positive.”

The fundamentals “are really sound,” she continued. “We have really strong and consistent occupancy. We’ve had rent growth that we’ve never seen before, great absorption of new construction. We have sales volume, actual debt volume is off the charts, historically. There was about $20 billion of sales last year (2021), and we’re on pace with that, in the first half we had $9 billion of sales versus $5 billion the year before, which (saw sales come on very strong in the second half of the year)… And whether you think there’s a recession looming or not, we’re going to have predictable cash flows as we have the strongest fundamentals we’ve ever seen in medical office today.”

Ms. Berman added: “Obviously, the velocity is down this year. But, Ryan (of Healthcare Realty Trust), thank you very much for a merger.”

Ms. Berman was commenting on the merger of two of the sector’s largest publicly traded real estate investment trusts (REITs) that saw Healthcare Realty Trust (NYSE: HR) acquire Healthcare Trust of America (HTA). The merger includes HR’s acquisition of about $11 billion worth of MOBs from HTA. In addition, HR is in the process of selling more than $1 billion worth of MOBs to fund the purchase of HTA.

Investors are active, but strategic

In answering Mr. Dow’s question about whether Healthcare Realty Trust remains an active buyer, Mr. Crowley said, “over the last eight quarters or so, we’ve been investing and doing acquisitions at a pace of roughly $200 million per quarter. That’s a pretty robust pace.”

However, he noted, HR will be “decelerating to roughly half that pace, about $100 million per quarter, based on the current quarter as well as for the fourth quarter of this year. That being said, we will end the year in line with our acquisitions guidance that we started the year with, and that is in the range of $500 million to $750 million.”

Mr. Crowley explained that the publicly traded REITs such as HR “are always going to be active, our team especially. Where some buyers, traditional buyers, private buyers can potentially be opportunistic, we’re more strategic. And we’re not going to be paying attention to those short-term IRRs (internal rates of return), those levered returns. We are going to be sensitive to building in cap rates, and for us, it’s all about finding the right properties. We spend an exorbitant amount of time looking at our target markets, looking at our core-plus markets, our core clusters of properties.

“And we sharpshoot,” he added. “We know the buildings we want to own in all of these outperforming markets and we go after them.

“So, for us to let a strategic acquisition pass us by because of volatility in the capital markets doesn’t do us any good in the long term. We have a very long-term investment horizon, and so for us, the operational games you get by buying properties that complement other properties you own in a sub-market are going to be what drives us and it’s going to keep us constantly being active in the market.”

Mr. Dominguez of Big Sky Medical Real Estate, which was launched in 2021 and has formed an investing partnership with Bahrain-based GFH Financial Group, said the firm still has a “strong appetite” for HRE acquisitions. In previous articles in HREI™, Big Sky’s founder, Jason L. Signor, has said the company plans to make about $1 billion of investments in 2022.

“I still think that’s achievable,” Mr. Dominquez said during the discussion. “There’s clearly a little bit of a slowdown in Q3, but we anticipate a very active Q4 and there’s still things to get done here in Q3, so we’re excited about that.

He did note that the firm is approaching the market with some “caution,” even though “when you look at this sector,” even if there is a recession, “it proves itself, time and time again. We feel great about the underlying fundamentals, we’re happy to be here and we’re excited to continue our activity.”

Ms. Bremen of Remedy Medical Properties, which made acquisitions totaling about $1 billion in 2021, said that while the firm’s investment “volume compared to this time last year has gone down bit, we’re on pace to do about the same volume compared to all of last year at about $1 billion in new acquisitions.”

She noted that because “the debt markets are impacting everyone’s pro formas, we’re trying to really sharpen our pencils on the due diligence side, making sure that we are being very thorough, particularly as it relates to any capital investment you might need to make when you don’t have absolute net leases. We’re sending (local) consultants … out to give us opinions on actual costs. And we’re no longer relying on those allowance per square foot numbers that come from our consultants. So we’re kind of taking the extra steps needed to feel really good about finalizing our pro formas, particularly now when … it takes a while to get deals done.”

Taking those additional steps, Mr. Bremen said, is “paying off, and fortunately we have … expertise in-house, so we’ve been doing things like taking our … leasing team and property management team, our consulting groups and really having them (dig) into every transaction and make sure that we have full convictions on what we’re buying.”

Is the bid-ask gap closing?

One of the next biggest questions in the current acquisitions market centers on seller expectations – or, more specifically, the gap is closing between what sellers are asking for their properties and what investors are willing to pay, especially with debt more difficult to come by and more expensive with interest rates on the rise.

“Are you seeing compaction in pricing?” Mr. Dow asked. “Are we getting closer? Are the sellers … hanging on to those returns that they heard people were getting … and that they’re still trying to get. And, are buyers being disciplined and … underwriting by today’s standards, at least in their minds?

“So are we getting closer to that degree of equilibrium where we’re going to see some more transaction volume?”

Mr. Crowley of HR, responded: “I think it’s a mixed bag.

“If you had a seller who was laser-focused on price but they were kind of a discretionary seller, if they were seeking opportunity and they timed their sale perfectly, they were a market participant,” he said. “If the market went against them, then they were not a market participant. That’s why I think there’s a little bit of a dearth of deals on the market currently.”

He noted that he believes Q3 2022 is a “period of price discovery. I think maybe you’ll see more deals come to market in the fourth quarter.”

Mr. Alphonso of Anchor Health Properties said that he agrees with what Mr. Crowley said, adding that getting deals done during a time when the “bid-ask” gap is somewhat wide “depends on the buyer.”

He continued: “I’m always under the assumption that we all have the same information, whether you’re a buyer or seller,” he said. “However, there’s a different perspective that buyers will have, particularly physician groups. Physicians tend to mark their price to what their friend’s price was six months ago, not so much on what the market actually is at the time.

“I don’t know if that means they’re just being optimistic or where the market price really is,” Mr. Alphonso continued. “But if it’s a more seasoned buyer or seller, someone who’s been in the market for the while, they understand where the capital markets are and I think in those cases it will be easier to negotiate price. But then again, I think as Ryan mentioned, it’s the profile of the seller that matters.”

Mr. Dominguez of Big Sky Medical said he thinks there is currently a “bifurcation between sorts of what I would call professional investors and those who are maybe doing sale-leasebacks, or that are transacting sort of every month, or every year.

“To a great extent, we rely on the advisors … you know, Mindy and her peers, to help educate sellers who might not be as active (in informing them) that there’s just a little bit of a different reality about where we are today versus where we were six months ago.”

Other topics covered

During the discussion, the panelists tackled a variety of other topics, including:

■ A variety of new capital sources, including institutional capital, continues to enter, or is looking for ways to enter, the HRE market. “With the rise in cap rates,” Ms. Berman of JLL noted, “it’s attracted some different capital that’s been sniffing around the space. They’re becoming more earnest players or actually closing deals and these are good institutional pension fund types, sovereign wealth types that we’ve completed deals with.” She added that a rise of “50 basis points of return for a pension fund makes a big difference. Investing today (is more attractive to them from) where cap rates were when they were just way too low for their taste. My job as an advisor to sellers is to really identify the stream of capital coming in. I’ve got to say that it is currently very dynamic and … we have at JLL have the benefit of a very large platform and wide relationships in the market.” As far as Ms. Berman is concerned, “I commend everyone here being very artful in terms of their access to deals and meeting the risk profile that suits them today … being more disciplined.” She concluded by saying that how the “public REITs versus private capital play, they’re all playing, they’re playing in different segments, and they’re moving around.”

■ So far in 2021, the volume of portfolio deals is down, but it could rebound soon. “I think pretty much everybody would agree that the portfolio transaction volume is down from what we’ve seen in recent years,” Mr. Dow said, noting that the volume of large portfolio recapitalizations has also decreased. He asked the panelists their opinions on why this has happened.

Ms. Bremen of Remedy said that she believes “the debt markets are further impairing those portfolio transactions. I mean, I know we’ve seen that on our side. “We certainly still would love to do more portfolio acquisitions, but my husband’s actually a lender out of Chicago … and I was picking his brain earlier this week about this point in particular, that a lender can’t necessarily hold larger loans in its balance sheet when they’re having to syndicate. You know that further impacts pricing because … if that individual bank doesn’t know the sponsor, the borrower, as well as the lead lender, and the pricing needs to go up. But time will tell. I mean, maybe in a couple of quarters we may see more volume on the portfolio side. But in the meantime, we’re still seeing a lot of opportunity with standalone deals and we’re able to aggregate a nice portfolio.”

Ms. Berman of JLL added that while portfolio volume is certainly down in 2022, people must remember that the portfolio volume of about $8 billion in 2021 was “extraordinary, a record year. And it was characterized by things that were very positive about the sector in terms of its maturity and institutionalization, recapitalization of existing operators, developers that the new capital needs to piggyback on their expertise. So this was creating more liquidity In the space. There were many discretionary deals, as about half the portfolios went to new entrants, and about half of the portfolio deals were recaps, meaning that the seller was reinvesting back into the venture and continuing operations in most cases.” She added that 2022 will still be a “very strong year for portfolio sales, so don’t count portfolios out. We are active today, closing two credit facilities, or portfolios, of $200 million to $300 million.” ❏