Summary
- Healthcare REITs own a variety of healthcare facilities including medical office buildings, senior’s housing, skilled nursing facilities and hospitals.
- Healthcare REITs outperformed all other REIT subsectors the last 3 years with an average total return of 44.14%. (NAREIT, 2019)
- 18 healthcare REITs are publicly traded on US markets with an average dividend yield of 6.13% and a total market cap of $110.6B. (NAREIT, 2019)
- Healthcare makes up 20% of GDP and is growing at a pace that exceeds GDP growth by 1.4% annually.
- 1 million baby boomers will turn 75 each year for the next five years.
What is a Healthcare REIT?
Healthcare REITs invest in several different types of healthcare related facilities:
Medical Office Buildings – MOB’s are building’s that are designed specifically for outpatient medical use and are occupied predominantly by healthcare providers. Facilities vary in size, location and use, however, fundamentally derive value through strategic significance to tenants and healthcare providers. MOBs have fewer tenant defaults and lower turnover than traditional office buildings. Physician’s and health systems are usually good credits, and don’t move frequently due to high tenant improvement costs involved in medical space. MOBs trade at cap rates ranging between 5%-7.5% depending on the quality of the asset.
Senior Living Facilities – are facilities for the elderly and include varying levels of care such as memory care, assisted living and independent living. REITs typically engage in two types of ownership, NNN and RIDEA. RIDEA allows the REIT to participate in the ownership of the operating company, as well as the real estate. NNN assets tend to have long term leases with fixed annual escalations. REITs tend to strategically align with a select group of operating partners and identify markets with high barriers to entry. Cap rates currently range between 6%-8%.
Skilled Nursing Facilities – (SNF) Often referred to as “sniffs”, skilled nursing facilities provide medical services to patients that require on going care. SNFs provide care under the supervision of a physician, nurses are available 24 hours a day and rehabilitative therapists treat patients on site. These assets are subject to higher regulatory exposure due to a high concentration of Medicare payments, and are perceived to be higher risk investments. Cap rates range between 10%-13% for stabilized SNF assets. (NREI, 2019)
Acute Care Hospitals – are facilities that provide short term care for patients with an immediate need for treatment. These are traditional hospitals where most patients go to receive acute medical care. Acute care facilities are typically owned or aligned with a health system, leases are traditionally NNN with fixed annual escalations and have terms of 20 years or more. Strategic alignment with leading operators is especially important in the ownership of acute care hospitals, because the value of the asset is so strongly correlated with the operator’s market position and creditworthiness.
Life Science Facilities – are buildings that house research facilities and laboratories. These facilities are usually located near universities or large pharmaceutical companies, concentrated primarily in Boston and San Francisco currently, with emerging growth in a few markets including Chicago, Houston, San Diego and New York. Landlords and tenants invest a great deal of money into improving life science space due to the nature of research projects. Yet life science leases tend to have shorter terms due to the unpredictable nature of research and funding, which results in higher rents. Cap rates for Life Science facilities are currently trending in the 6%-7% range.
Performance of Healthcare REITs
Healthcare REITs have outperformed all other subsectors of REITs consistently the last 3 years with a total return of 44.14%, and 35.03% over the last 12 months. (NAREIT, 2019) Since 1994, healthcare REITs have also outperformed the FTSE equity REIT average by 160 bps per year, as well as the S&P 500.
Currently, however, same store NOI is running below the REIT sector average with a 1% annualized growth rate. RIDEA assets are most susceptible to general economic conditions and have been underperforming due to higher labor costs and downward pressure on rates. The trend is expected to be temporary as more than a million seniors turn 75 each year. However, the senior’s housing development pipeline in 4Q18 set a record at $2.8B in new supply and shows no signs of slowing. Absorption has started to improve, but the slowdown in NOI growth will most likely continue trending downward in the short term. (NAREIT, 2019)
Skilled nursing has also struggled to sustain following policy changes resulting in lower occupancy and lower reimbursement rates. Operators have struggled to remain afloat, and in some instances,
REITs have provided rent concessions to operators to help them stabilize. Cap rates for these assets are reflective of the added risk at 10%+. There is virtually no new development of SNFs, and, in some cases, facilities are being converted to other uses. As intended by the regulatory changes, people are turning to lower cost alternatives to SNFs such as home health care.
Pros and Cons of Healthcare REITs
Pros
- Healthcare spending accounts for nearly 20% of the US economy and is outpacing GDP growth by 1.4% annually.
- Growth of the 75+ population is expected to exceed 20% over the next 5 years, resulting in greater demand for healthcare facilities. (NAREIT, 2019)
- Healthcare is not as sensitive to recessionary periods as other sectors of the economy.
- A strong pipeline of potential acquisitions still exists for the sector, and the resulting significant growth, as ownership continues to trend from operators to REITs.
Cons
- An abundance of new senior’s housing development has saturated some markets, resulting in downward pressure on rental rates.
- Healthcare, in general, has significant regulatory exposure.
- Exposure to third party operators also adds a layer of risk, particularly for SNFs, senior’s housing and acute care hospitals.
- Higher labor costs have hampered senior’s housing RIDEA returns.
2019 Outlook for Healthcare REITs
Healthcare REITs are expected to continue to perform favorably over the next 12 months, with performance more balanced in total returns and dividends than they have been over the last year. Dividends will likely continue to trend consistently in the 5% range. Total returns across the REIT sector are expected to grow 4%-5% in 2019, which healthcare REITs will likely exceed. (Lazard, 2019)
Growth of the 75+ population is expected to exceed 20% over the next 5 years, resulting in greater demand for healthcare facilities; this equates to roughly 1 million people per year. However, growth in supply, namely in senior’s housing, will take time for the market to absorb. The ongoing labor shortage and rising operating expenses will continue to put pressure on RIDEA portfolios. Skilled nursing operators will continue to adapt to regulatory changes. The larger REITs with diversified portfolios will be able to manage the strain of higher costs and greater supply in the short term, REITs focused solely on senior’s housing and skilled nursing will likely have a more difficult time.
Broader market trends are in favor of REITs as investors shift a greater allocation of investments to real estate. Favorable changes in tax treatment of REIT dividends and an expectation that interest rates will remain relatively stable in the short term are also favorable. Among nontraditional assets, investors preferred data centers and healthcare over other asset classes including student housing, cell towers and single-family investments. (Deloitte, 2019)