Feature Story: HRE sales are picking up. Here’s why.

InterFace panel cites more capital, lower rates and higher occupancies

By John B. Mugford

Amid a growing sense that healthcare real estate (HRE) investment activity is picking up, a group of HRE professionals who were part of a recent panel discussion said that they feel quite positive about the sector’s near-term prospects, and they explained why they believe things are moving in the right direction.

“Even last year, when it was a soft year, we had a stellar year, and now we’re seeing more and more activity,” said Ted Barr, principal with Cleveland-based Woodside Health, which focuses on acquiring medical outpatient buildings (MOBs). “I’m seeing more people who want to transact, seeing more people asking brokers’ opinions of values.

“I think what you’re really seeing in the market now is pent-up desire to buy, pent-up desire to sell, all of which is being led by interest rates that are expected to come down and, in reality, are coming down. And, tied to that, lenders are back in the market, and they are wanting to lend and the spreads coming in.”

Mr. Barr, who said his firm has acquired 21 properties in the past 19 months or so, was part of an investment-focused panel at the recent 16th annual InterFace Healthcare Real Estate Conference, which was held at the Hilton Dallas Lincoln Centre. The event was presented by Atlanta-based France Media’s InterFace Conference Group.

Steve Leathers, senior managing director of Healthcare Capital Markets with Houston-based Transwestern, moderated the session, which was titled, “The Investment Market is Back! What to Look for in Q4 and 2026.” He noted at the outset that although “investment sales have been down when you look at historic standards … as a panel, we’re pretty optimistic (moving forward).”

In addition to Mr. Barr, the panelists comprised:
■ Ben Appel, vice chairman and co-head of the U.S Healthcare Capital Markets team with Newmark Group Inc. (Nasdaq: NMRK);
■ Chris Morgan, director of acquisitions with Dallas-based Big Sky Medical; and
■ Justin Shea, principal with Milwaukee-based Hammes Partners.

As Mr. Barr further outlined why he believes the HRE investment market is rebounding, he noted, “It’s a little easier when sellers have seen movement in pricing and say, ‘I’ll take a little less than I really want.’ And buyers are saying, ‘With where the interest rates are now, I can still hit my returns on my money, so I can bid a little bit more.’

“So, you combine that with (a slowdown in) development, meaning their occupancy got a little stronger, and maybe some rental increases kicked in, the NOI (net operating income) got stronger, and now that bid-spread is getting closer and closer.

“And, as a result, I’m seeing a lot more activity, and I’m seeing more transactions, and it’s my belief that … it will get much stronger over the next year.”

Mr. Appel of Newmark noted that even as the MOB sales market lagged during the past couple of years, “The demand has always been there. It’s just that we’ve all been waiting for the math to start working again, and it’s getting there now.”

During the lull in HRE sales, many investors turned to acquiring value-add properties in “deals that can grow the NOI out of the negative leverage. But, what we’ve found in the past several months is that as indexes have come down and spreads have come down, the core-plus, cash-on-cash math is starting to work again, and so (some investors) have launched their next fund to focus on assets like that.”

Mr. Morgan of Big Sky Medical said that as the market comes off what he calls a “three-year run away, where folks were under-allocated to medical office for (several reasons), we’re seeing a massive amount of capital, coupled with fundraising kicking up, the public markets being at all-time highs … and relative allocation to medical office is really driving a lot of transaction volume.”

He noted that larger deals, including portfolio transactions, are becoming more prevalent, in large part because “when you add onto that the availability and desire for lenders to lend in medical office, that’s what’s driving a growth or shift in dependency on single-asset transactions to grow into portfolio trades.”

Commenting on Mr. Barr’s remarks about increasingly active sellers, Mr. Morgan noted, “We had been at a point in time where it was very difficult to sell and hit returns for two- to three-year periods. But, I think we’ve gotten past that and we’re seeing much larger transactions clear the market.”

Mr. Shea of Hammes Partners said that his firm is seeing a lot of “interest in the space from the capital side… Our limited partners want more capital deployed in medical office and in the outpatient sector, and lenders are more willing to play ball at this point.

“So, couple that with more interesting product that’s being brought out by (Mr. Leathers and Mr. Appel), and it all just kind of leads to a lot more activity.”

Where are borrowing rates?

As the panelists delved more into the reasons why they believe the sales market is on an upward trend, Mr. Leathers of Transwestern asked about current lending rates.

“Chris (Morgan), you referenced spreads coming in during last year … and banks obviously have the index, whether it’s five-year SOFR (Secured Overnight Financing Rate) or five-year (U.S.) Treasuries, and then they add on their spread. What was that at the end of last year, and what do you think it generally is now for, for example, a core-plus stabilized high-quality project?”

Mr. Morgan of Big Sky Medical responded, “It was mid-200s a year ago, and, well, we signed up a little refinance deal this summer at 180. So it’s 50-ish bps tighter on the spread side.”

Mr. Leathers noted, “50 to 75 basis points, Treasuries, obviously oscillate, dance, but they’re generally down maybe 25 to 50 (basis points), and there are different peaks.”

Mr. Morgan added, “We’ve seen good movement in swap rates recently, too, which is another way to obviously put together your cost of debt.”

For Big Sky Medical, the recent slowdown in MOB sales and the significant drop in portfolio sales forced the firm to “get more active in different parts of the capital stack, as everyone had to morph how they spent their time every single day,” Mr. Morgan said.

He added that the firm now capitalizes “every part of the capital stack. We’re placing debt, we’re placing equity, both LP (limited partnership) and GP (general partnership) equity. We’re involved in sale transactions on the single asset and the portfolio side of the market.”

‘The maths math again’

After the panelists noted that sellers seem to be more motivated to put assets on the market today than in the past two years or more, Mr. Leathers asked the panelists, “What’s driving the sellers’ ethos? What are the top few reasons you see owners of real estate selling nowadays? Things are getting better, right? Do they ride the wave and hold on? What’s pushing things outside the nest there?”

“It varies between private and public sellers,” Mr. Appel of Newmark responded. “We’re seeing a lot of long-dated funds that have probably been at a point where they’re ready to sell an asset or a portfolio for, call it, a year to three years now.

“Until now, the capital markets were not super accommodative, (but) we’re at a point now where, like Chris (Morgan) said, the math maths again. As a result, we’re seeing a lot of volume come to market. The good news is that the demand is at least as great, if not better, than the availability of quality product that’s out there.

“And so, I think that’s what we’re seeing on the fund side. We’re seeing, generally speaking, REITs (real estate investment trusts) becoming net sellers. We’re seeing private investors – and I mean purely private, in sort of a joint venture format that may be outside of a fund – that are looking at maybe not as great of a return or as big of a price tag as they might have seen in 2021. But they are interested enough to be a seller.

“So, I think it varies, depending on who it is that we’re talking about. But, we’re definitely in a much more accommodative environment where capital demand, at least I would say, exceeds quality of product.”

How much does geography matter?

When it comes to choosing where to invest in a property or properties, the healthcare provider matters, according to Mr. Shea of Hammes. He’d been asked by the moderator, Mr. Leathers: “What about geography?”

Mr. Shea responded that Hammes has holdings in “36 states, at this point. We are, first and foremost, an operational company. So, (we are) a strategic consultant to healthcare systems, both on where to put buildings from a development perspective but also where to build large greenfield hospital campuses. And so, the investment platform that we started 12 or 13 years ago is one of … being an operator, and that continues today, as we like to think of ourselves as underwriting operational footprints.

“That could mean a secondary or tertiary market. We closed on a deal in El Paso, Texas, last week. We generally think of wrapping the real estate around all of that other work. So, it does allow us to go into smaller markets and maybe markets that others may not necessarily play in, particularly if they’re just focused on the Sunbelt or, you know, very rapidly growing markets. We, of course, invest in those as well, but a little bit broader investment mandate.”

Mr. Morgan of Big Sky Medical said the firm is “hyper-focused on the geography, especially on the value-add side. We talked about this, as it’s very hard to pitch a value-add lease-up deal in a market where the population is declining. So, sort of our first check is, is the population growing and is it dense enough to support our business plan on a value-add deal? On the core-plus side, it’s a lot more tenant-driven – not that the tenant’s not important on the value-add side as well. But it’s more tenant-driven on the core-plus stabilized side, and like everybody here says, we like to be in the Southeast and in states like Texas, where populations are growing. That’s kind of our first check.”

Mr. Appel of Newmark said, “Everyone everywhere needs healthcare at the end of the day, right? In looking at Hammes and Woodside, they have two different strategies, doing more value-add in specific markets, generally sort of high-population growth markets, where you look at the writing on the wall of the market fundamentals and say, ‘With my operational prowess, is that going to help me execute business plan,’ versus more operating fundamentals: the tenant performance, etc., right?

“You can go into secondary markets and find amazing core assets that are very strategic, very mission-critical to that operator, to that use, to that patient base. And I think both can see really great success.”

From a “pricing perspective,” he added, “I would say we’re seeing core assets that would be in any market that are trading in, call it, mid-5s on a (capitalization) rate basis today. It’s got to check most boxes, but that’s what you’ll see, or single assets and select, very core portfolios, that are trading all the way up to, call it, low- to mid-6s, for assets that are a little bit more core-plus or maybe a little bit of a mixed bag.”

Other topics covered

During the discussion, the panelists talked about several other topics, including:

■ When it comes to the types of sellers and HRE property types currently in the market, Mr. Barr of Woodside said he’s “seeing the full spectrum, and we buy heavy value-add, light value-add, core-plus, and we buy hybrids of medical mixed with office or retail. I’m seeing a lot of deals from all places, direct and brokers. I would say that there’s so much that I’m seeing, but a lot is in trading or are getting closer to trading. People are kind of testing the waters, but it’s full spectrum.” He added that Woodside is “probably seeing more core-plus deals that actually get packaged and go to the market. And, I’m also seeing more value-add-ish plays that are testing the market and seeing if they’re close enough to getting to their numbers, and if they are, then it goes forward.” Mr. Appel said that, from his point of view, Mr. Barr’s assessment is “spot-on, and I think the growth in the value-add market, just percentage-wise, is much greater than core deals, because we’ve been in a risk-off environment for so long. But, the return of lenders to value-add lending is pretty meaningful, and so I think folks are just getting their feet under them on what that lending looks like, what terms look like and what the resulting pricing looks like. I think that’s why you’re seeing more testing of the water.”

■ As for the recent increase in market activity, Mr. Appel said, “We’re seeing a lot more portfolio transactions. And, when we look at the breakdown of pricing within portfolios, that’s what’s a lot more interesting than, ‘What’s a blended cap rate on a couple hundred million dollar portfolio?’ Because there’s a lot of stuff in there. We’re still seeing the core tranche of that portfolio pricing in the mid- to high-5s, and then everything else we have, call it somewhere in the 6s, blending today in the low 6s, roughly. So, thinking about how you price risk, that’s sort of our band of how we’re thinking about it today, what we’re seeing.”

■ In talking more about pricing for portfolios, as well as geographically strong areas, Mr. Barr of Woodside added that the firm is seeing “a number of portfolios, and they’ll come out with different pricing, and what we actually do is price every single asset, and one we might, you know, give a 5.5 percent cap rate, and the other we might give a 9. And, quite often the broker asks us, ‘Why?’ But there are so many factors that go into it. If you’re in the northern parts of Dallas … I have very little concern that if I lose a tenant, I can backfill it. I also am pretty comfortable that every time I renew the rent, it’s going to go up in those strong markets. You go into some of these smaller markets and you lose a tenant, and there is some concern that your building could stay vacant forever.”

■ On the development side of the HRE sector, Mr. Shea of Hammes said, “I don’t know that we’ve ever been busier. We’re finding ways to make deals pencil, particularly with healthcare system-sponsored, new construction projects, and so that’s kept us incredibly busy. I think we have five or six things that we have in the ground right now or are getting ready to be in the ground. So that’s kind of helped us as we’ve been a little bit softer on the acquisition side and a little more careful.” Mr. Leathers noted that even though some firms are quite busy with development projects, overall there has been a “slowdown, as we usually see upwards of even 20 million square feet of space delivered per year, but it’s been down to about 10 million square feet in some recent years when you look at year-over-year development.” He added that that as “the buy side of the market opens up, that should actually, in a way, help drive down that cost of capital and perhaps prompt more development, net-net.”

■ Mr. Leathers asked the panelists if they’ve noticed that cap rates, or expected first-year returns, have started to drop, adding, “Does that help developers to underwrite a little more aggressively, which maybe lowers yield on cost? Do you think that’s going to help push the market to build more?” Mr. Shea of Hammes responded: “I think so. I mean, we certainly take that into consideration as we’re putting together a development pro forma. And, we think that could monetize if it were open today. We’re not a merchant developer, as we’re more of a long-term holder. But, that’s certainly something we think about and try to understand, which is the current market value for a similar building.” ❏