Feature Story: Strategy, patience and relationships

Jarrod Daddis shares NexCore’s formula for succeeding in tough times

By John B. Mugford

Whenever times have been tough in the market or deals have not necessarily gone as planned – which can happen to any organization – the professionals at NexCore Group LLC have rolled up their sleeves and relied on the creativity and fortitude that has allowed them to not only survive, but thrive, since the firm’s founding in 2004.

Today’s market, with rising interest rates, inflation, slower deal volumes and hard-to-obtain debt, is one of those times.

So when asked for some advice on how NexCore and other firms can navigate the current market, Jarrod Daddis, the firm’s president and managing partner, and an early-stage investor, noted that the healthcare real estate (HRE) sector is a “relationship business.

“And, so, on the capital side, the client side, the tenant side, the resident side, our architects, our contractors and lawyers – everyone we work with – we really need to come together to optimize” current market conditions and opportunities.

It’s that approach that has enabled NexCore to perennially rank at or near the top of Revista annual list of the largest HRE developers. The Denver-based firm, which has developed and acquired more than 16 million square feet of medical office buildings (MOBs), seniors housing facilities and life sciences buildings in its history, indeed relies on what it has learned over the years.

Mr. Daddis made his comments and discussed the state of the market, as well as the history of and the strategic approach taken by NexCore, during a one-on-one interview at the recent Connect Healthcare Real Estate Conference at the VEA | Newport Beach Marriott in Newport Beach, Calif.

Interviewing Mr. Daddis during the “Fireside Chat” session was Murray W. Wolf, publisher and founding editor of Healthcare Real Estate Insights (HREI), which was launched about the same time as NexCore, in 2003, as the first and still only national media organization entirely dedicated to covering HRE development, financing and investment.

Mr. Daddis added that although learning to be patient in the HRE sector has always been important, current market conditions make it even more so.

“Patience (is) something that we’ve had for a long time … I think it’s hard for some real estate professionals, especially on the transaction side, to understand that,” he said. “Sometimes deals take years, as we all know. To do a good, high-quality healthcare deal, it might take two, three, four years. In our senior business, it’s going to take us 18 to 24 months to build a community and another three to four years to stabilize it, sometimes a little faster.

“The same is true on the life sciences and tech side, which is a completely different animal,” he added. “So, I think it’s about being strategic, it’s about being patient, it’s about valuing relationships, continuing to find value at the client level, the capital level and the developer level to make it all work.”

He noted that any firm that takes a “merchant-developer” approach to the HRE sector – particularly a company that is new to the space – probably isn’t going to last very long. “But if you have a mid-to long-perspective, and you’re well capitalized, I think you’ll be fine and make it through.”

Shortly after NexCore was started by its founding principals, which included current CEO Greg Venn, the firm’s philosophy was to “figure out how to create value for our clients and take care of our investors. We’ve had a wonderful stable of investors on the institutional and private side over the years. So, for us, we’ve always thought about the business from a strategic and business perspective first and real estate and capital solutions perspective second.”

He continued, “This is a tough business. All elements of our business are more complicated today. We just decided to do very strategic deals that were congruent with what our clients and capital partners wanted, and that has served us well.”

When Mr. Wolf asked him about the current market, including the state of acquisitions, which NexCore does periodically, Mr. Daddis said: “Our core business is development, as acquisitions has been a product line and a service that we’ve provided on behalf of many of our capital partners, or our clients.

“We’ve done a lot of relationship deals where we do a project for a client; they’re a tenant in a building we’ve developed, and then they want to sell a few assets,” he said. “We’ve done a number of those types of opportunities and we’ve grown that steadily over the years.

“But this year, I don’t think we’re going to do any acquisitions. We just don’t see the right opportunities. The pricing doesn’t make sense. Over the long run, we’ll continue to do acquisitions but, for us, it will be about $100 million (annually) or so a year depending on the opportunities. But not this year.”

As for development, Mr. Daddis noted that there’s quite a dichotomy in the market, as health systems need to expand their ambulatory footprints while many continue to struggle with margins. The seniors housing side is seeing plenty of opportunities, with demand for such facilities continuing to grow.

NexCore is quite busy, he noted, with about a dozen projects currently under construction.

“Certain markets are pretty robust … Texas seems to be hot, Florida’s still hot, Colorado’s hot, and we see a lot of activity in California,” Mr. Daddis said. “Most of the opportunities are in markets with growing populations and places where people desire to live.

“Even so, there remain opportunities in some sleeper markets where care is needed,” he added. “And so, the question is, ‘How do you make those transactions work, too?’ I don’t know for sure, as we’re not tracking it at that level to say, ‘Let’s stay out of certain markets,’ or ‘What’s going on in a particular market in comparison to another?’ But… construction prices are going up in most markets that are hot and popular, and there’s a reason for that.”

Navigating an ‘odd’ market

As the discussion turned from NexCore’s long-term strategies, Mr. Wolf asked about current market conditions.

“I keep trying to figure out how to characterize the market we’re in right now, and I can’t really come up with a good word for it, other than to say it’s just an odd market,” Mr. Wolf said. “If you look at the data … there’s still development, but it’s definitely dropped off over the past year or so, in general, across the marketplace.”

“This has been an odd year,” Mr. Daddis agreed. “I think that’s a good way to frame it up.

“There are two competing issues – interest rates being one of those – and that leads to the (difficult issues) we’re challenged with right now in this environment.”

He gave an example of a project transaction that NexCore is currently working on with a hospital system that has “roughly 18 acute care and specialty hospitals. They don’t necessarily have an ambulatory strategy, and I think a lot of you in the room know the data, but healthcare systems are struggling.”

At the same time, the outpatient care model continues to grow, as it has for decades, he said.

“And, when we look at the data, projections show a 25 percent increase in outpatient growth over the next five years,” Mr. Daddis continued. “You put that in combination with the aging demographic and there are a lot of reasons why the development pipeline continues to grow.

“This project that we’re working on is a really important project, as we’re building a 100,000 square foot comprehensive outpatient center. The system is dealing with a lot of the same challenges that all of these systems are facing right now.

“You have to feel for all of these executives who are trying to navigate the space, because as their margins have been either neutral or have gone negative, a lot of (them) have paused … as they look to right-size their financial situation and then figure out how to grow. Because that’s where systems are going to grow today, in the outpatient environment.

“Consumers want outpatient, payers want outpatient. and … that’s where the opportunity is for everybody in this room because there’s so much demand that’s out there.”

Yet, although there is strong demand on the outpatient side, “there are capital issues facing everybody, what with interest rates and the economy … and that is impairing the development volume.”

NexCore, he told the audience, “closed a (development) deal this morning, and I have to tell you … what with interest rate expenses being two-and-a-half times higher than they were a year ago, or a year-and-a-half ago, all the capital costs are up, all development costs are up, and most of the systems are trying to figure out how to maintain the very aggressive expenses side of the equation.”

Although demand for projects remains strong, Mr. Daddis noted that the lending environment is difficult.

“(This market) is tough to deal with today, and I understand why deals are tougher, as they’re running into right-size limits on loans today. It’s just a different environment, different than we’ve ever seen.”

Are systems looking for fee-for service?

When asked by an audience member, Travis Ives, executive director and co-lead of the U.S. Healthcare Capital Markets team with Cushman & Wakefield (NYSE: CWK), whether health systems currently want developers to do more fee-for-service projects, or whether they are looking for HRE firms to develop and own projects for them, Mr. Daddis responded that many health systems are looking for “optionality.”

“They want to know if we’d be willing to do a fee transaction, or would we be willing to own it, or would we be able to create another joint venture type of structure,” he said.

For the most part, Mr. Daddis noted that the ownership question of a project can depend on a market, the strategy of a particular health system, or both.

“Maybe it’s a market where the providers are independent and we can provide ownership to a physician group,” he added. “We are seeing more and more cases where health systems want to see creativity, they want optionality. So for us, as a core developer and preferring to be more on the ownership side, we do need to pivot in some instances and say, ‘Okay, when does it make sense for us to be a fee-for-services developer? And, when does that make sense?’

“It really can come down to a system’s current balance sheet or capital capacity,” Mr. Daddis continued. “But it can also come down to being in a market that’s really different, where they want … us to help them look at different scenarios.”

Demand is rising in senior housing, life sciences

When talking about the development market in senior housing, Mr. Daddis said, “There’s a huge demand right now – huge demand.”

Data shows that the number of “new units coming online today are up to 80 percent of what they were at their peak, but those deals, too, are also really tough to get done.”

On the operational side of the seniors housing business, he said, “We’re looking at capital stacks completely differently than we have in the past, as the leverage on those deals are down.

If there’s a problem facing the seniors housing sector, he said, “it’s that it’s hard finding good, quality staff to take care of our residents.”

On the life sciences side, where NexCore has a development partnership with Irvine, Calif.-based HATCHspaces, “we’re bullish about the sector. “But, deals structures, again, have changed… It’s virtually impossible to finance in today’s market unless you have strong pre-leasing available. But still, there’s huge demand. And, if you look at the dollar flows that are coming into the industry, like here in Orange County, there is, I think, roughly a billion dollars here to date that’s come into this marketplace to fund up companies.”

He noted that capital is still flowing into most of the top life sciences markets, such as Boston, San Francisco and San Diego. And, you look outside of those markets, at the next tier of markets, there’s also a lot of capital flowing in as well. So, there is opportunity.”

The sector’s current mantra: Survive ‘til ‘25

Mr. Wolf noted that the MOB sales volume has dropped quite dramatically in 2023, with a total volume of about $3 billion in the first half of the year.

That’s about “a third of what there was in the same period a year ago,” Mr. Wolf added. “So, things are definitely pretty quiet, which of course begs the question, how long is this going to continue?

“I know you don’t have a crystal ball, but I know you’re a very strategic company and you have a lot of good planning meetings. What are you all saying to each other around the table these days?”

“Yeah, when is it going to end?” Mr. Daddis asked, rhetorically. “Nobody knows. We don’t know. We have some theories, and our basic theory is that rates are going to be high for a longer time.

“So, what does that mean? We still think the development demand is going to continue and so we need to figure out how to get those deals capitalized and out of the ground.”

He noted that 2023 has been a “tough year,” and that it is likely that 2024 will also be a “tough year.”

Although he said NexCore is confident about its long-term prospects, Mr. Daddis noted that he’s been hearing others in the sector saying as kind of a mantra, “Stay alive ‘til ’25.” And that could be a challenge for some, he acknowledged.

“We just don’t see rates coming down for a bit. That’s in the short term. Mid- to long-term, we have a different assessment.”

Mr. Wolf added that the “financial markets hate uncertainty, right? And, of course, we’ve got a lot of uncertainty about the economy. We’ve got an election coming up, and heaven knows what that’s going to bring, so we may see some of that situation where potential clients and investors are going to be staying on the sidelines.

“But, you know, healthcare real estate’s been through it before. You and I have both been in the business about 20 years, and have been through the Great Recession, we’ve been through COVID, and you know healthcare real estate thankfully continues to be one of the best performing asset classes and just that resiliency gives you hope, even when times are a little slow.”