Healthcare real estate is a segment of the real estate industry encompassing hospitals, offices, and other campuses specifically designed for and leased to professionals in the healthcare industry. These buildings can be owned by private investors, health systems, REITs, and others. More importantly, these buildings are exhibiting strong fundamentals and drawing attention from the investment community because of the economic and demographic shifts currently taking place in the U.S. One REIT in particular, Healthcare Trust of America, is a great pick for long-term gains. This article will give a macro-level view and analysis on why healthcare real estate is an income-generating opportunity, and why investors need to consider HTA or other healthcare REITs as portfolio additions.
There are multiple economic shifts happening in favor of the healthcare real estate market. To begin, let’s examine nationwide spending and a few other key background information statistics. In 2017, total healthcare expenditure was $3.5 trillion. Analysts project spending growth of 5.5% annually through the year 2026, where it will reach $5.7 trillion and nearly 20% of total U.S. GDP. The main pieces underling these growth projections: elevated levels of employment in the U.S. the employer-based insurance system, rising healthcare consumption due to the ACA, and an aging U.S. population.
In 2010, approximately 50 million Americans had no health insurance. When the Affordable Care Act was introduced, that number fell to 28.1 million just six years later. Why does this matter for healthcare real estate? Access to health insurance has resulted in more physician office visits and overall usage of healthcare services. When people visit their doctors more frequently, there’s more payments, and less risk of default on rents & debt for property owners.
One of the strongest indicators for rising health service demand is the growing and aging U.S. population. The U.S. is projected to add 2.3 million people yearly to the national population through the year 2030. By 2060, the population is projected to grow by 79 million people. On top of this, people are living longer. The segment of Americans considered to be seniors (65+ years old) is expected to nearly double in the same time frame, with that age segment rising from 50 million people to 95 million people. The 85+ age segment is projected to triple (6.5 million people to 19 million people) as well. The reason the aging population is so crucial for healthcare real estate and REIT investors is seniors spend an average of five times more on healthcare and health services than younger people. A growing and aging population will directly affect demand and revenue growth for the healthcare industry. More physician visits means more spending, more revenues, and more stable commercial assets.
One thing worth mentioning here - health building construction is not keeping pace with demand. While the health care and service industries are showing productivity and efficiency increases, higher employment is pushing demand for building space above supply. With a lack of premier space for physicians, property owners can raise rents and generate more income from their tenants. Additionally, hiring in healthcare and related industries is projected to increase 18% by 2026 to meet the older demographic demand, and there has been 1.88% YOY growth in medical school enrollment since 2010. The entrance of these new employees into the healthcare world will support demand for medical space and push to meet staffing needs.
Demand for healthcare varies by region. Bigger metropolitan areas with warm weather and tech hubs are pulling both young people entering the labor force and retirees to their cities. These areas are going to require higher need for health industry services because of the high volume of in-migration. The top markets for population growth through 2023 are Austin, Orlando, Raleigh, Las Vegas, and Dallas.
One thing we will explore moving forward is the medical office building segment of commercial real estate. In 2018, there was over $1.2 trillion worth of healthcare real estate in the market. Historically, that value has been dominated by hospitals as a one-stop-shop for all your medical needs. Growth in hospital market share, however, has slowed more than other segments of the industry over the last 25 years. Now, 39% of all U.S. healthcare real estate market value is considered outpatient facilities (MOBs) while only 31% is considered hospitals. It is important to note that this shift is largely due to the new and growing demand for a more patient-centered healthcare model. Efficiency and convenience are important to patients, and the healthcare industry is starting to move medical services into patients’ nearby communities to accommodate these desires. Outpatient visitations have risen 25% over the past 10 years, showing how there is a clear wish to circumvent the dizzying and often annoying hospital layout.
Technologically speaking, there have been numerous advances in operations and surgical procedures that now allow for outpatient treatment after historically needing inpatient treatment. One example is laparoscopy, which is a type of surgery using a small tool with a video camera at the end. This camera lets the surgeon get a better picture of what’s going on inside a body, so the incisions they make can be much smaller than with other tools.
The Centers for Medicare and Medicaid Services assesses a list of medical procedures each year that are categorized as “inpatient only.” Technological advances are increasing the quantity of these procedures that are removed from this list and allowed to be completed on outpatient campuses. Last year, six procedures were taken off the list. A few more examples of surgical advancements:
- Spine surgery – laser technology now allows for safer procedures and outpatient designation.
- Coronary artery disease – high-quality radial access and new disposable products allow for safer surgery.
- Mucus membranes – “dropless surgery” is a safety improvement in cataract surgery that now allows many of these procedures to be performed on outpatient sites.
As medical technology pushes forward, we should see more procedures designated as off-campus permitted. This will push occupancies and demand higher for medical office buildings as patients will not have to trek to a distant hospital to receive certain services.
Medical Office Buildings
These assets are the up-and-coming assets - the real money-makers. A medical office building is a space used by physicians to conduct health service procedures and checkups off-campus. MOBs account for approximately 10% of the office building sector in commercial real estate. These buildings continue to perform well even with changing political landscapes and regulations. Rents are up 1.5% YOY since 2010, and NOI growth has been positive for ten straight years except for two negative quarters during the Great Recession. Occupancy for these buildings has bounced between 92% and 92.5% since 2015 and hasn’t been below 91% since 2009. Tenant retention rates average 81% - which is the highest tenant retention rate across all commercial sectors. Pricing for MOBs have grown 50% over the last five years and are currently averaging around $327 per square foot. There’s no wonder why investors are flocking towards these buildings as a way to generate stable income.
MOBs have historically offered a 2% spread or greater in cap rate or yield over the past five years as compared to similar benchmarks. According to JLL research, medical office yield has been above the S&P 500 dividend yield and 10-year treasury yield since 2008. Last year, the MOB cap rate sat at 6.7% while the S&P 500 dividend yield was 2.0%, the office cap rate was 4.2%, and the 10-year treasury yield was 3.0%. Again, I re-iterate the desirable upside of these assets given their strong outlook and the economic indicators discussed above.
Healthcare REIT Performance
Cushman & Wakefield tracked 8 MOB-heavy REITs (HCP, HR, VTR, HCN, SNH, HTA, DOC, and MPW) over the last ten years. Using their data as a proxy, we can see the performance for MOB REITs and make a few predictions. In 2009, MOB-heavy REITs were priced at a low, then improved until mid-2013. When the ACA was enacted, five of these REITs saw stock prices rise 36% on average, while HTA and MPW rose nearly 50%. Since 2013, performance has varied as some shares have remained stagnant and some have slightly risen in value.
Some of these REITs have also made it clear that they intend to move more towards senior housing investments. In fact, many REIT spokespeople have been vocal in their intent to do this. Debra Cafaro, chairman of Ventas, recently came and said that senior housing is “a great business and there’s going to be very powerful upside, and we’re starting to see the leading indicators of that.” On the surface, this seems true. Population data and age factors seem to clearly indicate a probable rise in demand for senior living. However, other data seem to point in a different direction. As senior housing and care costs rise, it will become harder and harder for middle-income seniors to afford annual out-of-pocket costs. In fact, by 2029, only about 46% of middle-income seniors will be able to afford the anticipated $60,000 annual cost of living for housing. The size of this group is expected to be 14.4 million people in 2029, so this is a considerable chunk of the senior population that is projected to need (or want) alternative housing methods. This presents another problem – overspending. If the high-cost problem isn’t solved, the middle-income senior population may spend down their financial reserves until they become eligible for Medicaid. This could put massive financial pressures on the federal government and economy to support an aging population, and drive down occupancies for REITs owning assets with large volumes of senior housing. So while some big senior housing REITs like Welltower and Ventas may choose to push their investments in that real estate segment, I’m steering clear. Medical office building fundamentals are clearly stronger and have a more concrete future.
Markets & REIT Suggestions
My top three housing markets for future economic growth are Orlando, Phoenix, and Atlanta. All three have high 5-year population growth projections above the national average (1.94%, 2.14%, and 1.42% respectively), and each of the markets has 5-year household income growth projections above 3.8%. These markets are ripe for medical economic growth because of the in-migration from retirees and new workers.
Now comes the fun part. My favorite REIT today – the one I believe has the best growth prospects and current value – is Healthcare Trust of America. HTA is one of the largest pure MOB players in the market. Their portfolio consists of assets located primarily in demographically favorable markets (like the three previously mentioned) where HTA (and I) believe economic and technological changes will make a favorable economic difference. GreenStreet Advisors projects FFO/share to be $1.60 this year and grow to $1.66 in 2020. AFFO/share expected at $1.24 this year and $1.29 in 2020. Same-property NOI growth for HTA is projected to grow at 2.3% CAGR through 2022. This is stable growth that investors can expect to be maintained in the future as MOB demand grows.
HTA has also shown strong historical growth. The company has a 13% CAGR in NOI since 2014, a 16.3% CAGR in FFO since 2014, and a 1.2% CAGR in dividends/share since 2014. Because of their consistent growth and the locations of their high-quality assets, HTA stands out as compared to other REITs with MOB holdings like WELL or CHCT. HTA is a clear long-run winner.
Because political regimes can be so quickly replaced, there’s always the risk that new policies limit the ways physicians can provide and distribute care. This can affect where physicians would like to do business, thereby affecting occupancy, rents, and new construction. Telemedicine is also a rather new technology of which many real estate investors are aware. If telemedicine were to become more popular/advanced, it could affect care delivery systems as well. Personally, I do not fear drastic healthcare policy change in the coming years, nor the rise of telemedicine. The healthcare and health system delivery system basics will remain intact.
Strong economic and technological fundamentals are pointing in the right direction for healthcare real estate – specifically outpatient/medical office buildings. HTA is poised to capitalize and grow as strong indicators point in favor of healthcare real estate assets. Investors should consider healthcare REITs as portfolio additions.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.