While healthcare real estate has proven to be an increasingly attractive investment in recent years, mergers and acquisitions deal volume in 2023 may fail to reach last year’s record.
“We believe that overall volume will be healthy given the continued demand for healthcare real estate, but will be lower than previous years’ historic highs,” said Cornerstone Companies senior vice president of investments Ted Baker.
His company’s holdings include approximately 55 medical office buildings and surgery centers with an aggregate value above $500 million.
“My guess is that we see less of [the] larger trades and more single-asset deals [and] lower overall volumes,” Baker said.
There were 120 deals involving five target subsectors – medical office buildings, ambulatory surgery centers, healthcare real estate (consisting of multi-property portfolios), urgent care locations and life science buildings – that had disclosed prices in 2022 from a total of 268, according to data captured in the LevinPro HC database. The total amount for those transactions was $24.4 billion for an average of $203.2 million per deal. The transactions included 383 locations for an average of $63.7 million per facility.
Dollar volume statistics were skewed significantly last year when Healthcare Realty Trust, a real estate investment trust focusing on health care, acquired Healthcare Trust of America, Inc. for $18 billion. Healthcare Trust of America was described as an owner/operator of medical office buildings in the U.S. with approximately 25.3 million square feet of gross leasable area and $7.5 billion invested primarily in medical office buildings.
In 2021, there were 84 deals with prices that were revealed involving the five categories, from a total of 202 transactions. The total dollar amount for the purchases was $5.22 billion for an average of $62.1 million. There were 53 transactions that included prices in 2020 (out of 103 total deals) for a total of $4.1 billion and an average of $77.2 million. The numbers for 2019 were 26 deals with prices (from 44 total transactions), a total of $2.5 billion and an average of $97.1 million.
“Volume will likely be down this year because of less interest in portfolio sales,” said Collin Hart, managing director of ERE Healthcare Real Estate Advisors in Newport Beach, California. “Over the last several years, the market has been highly active with large portfolio transactions.”
Borrowing Costs to Limit Deal Volume
A consistent theme mentioned by industry experts that is expected to impact M&A volume this year is the macroeconomic environment dominated by rising interest rates.
“There is likely to be a damper on these [large portfolio transactions] because of interest rates and the resulting pricing slump,” Hart said. “Many physicians are exiting their healthcare real estate investments as a way to capitalize on what they’ve built.
“We prefer and focus on healthcare real estate owned by physicians, then assist in transitioning them to third-party ownership. We’re a conduit between the physician and the institutional real estate investment world.”
JLL’s 2023 “Healthcare Investor Survey and Trends Outlook,” which featured responses from 129 professionals who specialize in the healthcare space, stated that “many large domestic banks have temporarily slowed down lending activity and higher capital reserves imposed by the Fed on large banks is hindering lending.”
Federal Reserve Chairman Jerome Powell on March 7 said borrowing costs are likely to head higher than central bank policymakers had anticipated. The Fed has increased interest rates eight times during the past year.
However, the outlook for pushing borrowing costs higher this month became less certain after bank failures moved equity markets lower.
UBS agreed to buy Credit Suisse after turmoil rattled the U.S. banking system. First Republic Bank obtained $30 billion from 11 banks to avoid a possible collapse. Silicon Valley Bank fell into receivership after massive losses on its investments. The FDIC announced that a subsidiary of New York Community Bancorp agreed to acquire parts of Signature Bank, which has been placed in FDIC receivership.
The Fed’s attempt to reduce the rate of inflation with interest-rate hikes has led to some economists predicting that the U.S. will enter a recession this year.
The U.S. central bank will issue its next interest-rate decision on March 22.
The JLL survey also showed that only 30% of respondents believe we have endured the worst and expect market valuations and transaction activity to improve in the next 12 months. The JLL survey revealed that market participants were asked to identify their No. 1 concern about changes that could negatively impact the healthcare market during the next 12 months. Interest rates and capital markets were cited by 66% of respondents, followed by development costs (13%).
“As a company, we expect volume to be down similarly,” Baker said. “Interest rates have clearly impacted our underwriting model and I do not think we have seen prices move enough to match. The demand for healthcare real estate is still as strong as ever and with a lower supply. Deals are very competitive, which is potentially keeping prices elevated. We will look to do [$100 million]-plus between our funds, and will be highly selective of the deals we aggressively pursue.”
A whitepaper from ERE Healthcare Real Estate Advisors mentioned that approximately 81% of physician practices have multiple partners, “further limiting liquidity.” Commonly, ownership shares can’t be sold independently of one another, except to an incoming partner or existing partner, creating “undue expense and significantly limiting the buyer pool.”
“Although real estate is likely the most valuable asset in a practice, it’s ancillary to the operation, the business itself and the
providers,” according to the whitepaper. “If a retiring physician can’t find someone to buy his real estate at an acceptable price, he can simply keep it, continuing to receive the rental income as a source of passive cash flow. But that income is only viable if the practice and incoming partners are willing to continue paying the same rent.”
The statistics compiled in the LevinPro HC database during recent years, which coincided with rock-bottom borrowing costs, have seen investor interest on the rise.
Record-Breaking Total
The number of transactions targeting medical office buildings, ambulatory surgery centers, healthcare real estate, urgent care locations and life science buildings has been on an upward trajectory. After the total reached 44 in 2019, it more than doubled to 103 in 2020. It nearly doubled the following year to 202 and totaled a record-breaking 268 in 2022.
However, the deal total in 2023 was at 54 as of March 16. This compares with 63 transactions posted between January 1, 2022, and March 16, 2022, representing a 14% decrease. The annualized total for 2023 stands at 259 transactions.
Also, overall deal volume in all sectors so far this year has fallen off last year’s pace.
There were 2,406 deals posted in 2022, the most ever recorded in a year. Last year through March 16, there were 556 transactions recorded compared to 445 deals posted during the same period in 2023, representing a 20% decline.
Despite the upward momentum in recent years, Hart is forecasting a downward trend in 2023.
“Volume will be down because of increased interest rates, [resulting in] reduced pricing power, combined with continued volatility and uncertainty in the economy overall,” Hart said. “Investment demand remains strong, but investors seem to be more cautious. This is attributable to interest rates moving quickly but deals moving slowly.”
Baker noted that interest rates will continue to be a major factor regarding his firm’s investments this year.
“Our existing portfolio has been appropriately hedged, so we are not worried about our position there,” Baker said. “It will be more of a factor on new deals. The velocity of the increase in debt costs has made it harder to model out new acquisitions that fit within our and our investors’ criteria. We continue to monitor every deal to gauge where pricing is and where pricing is going.
“Sales prices have visibly decreased from the market highs in 2021 and early 2022. Deals that were put under contract in the latter half of 2022 seem to be taking longer to close and many seem to have closed under different terms. The ongoing volatility in the interest rates requires changes to underwriting models on a daily basis, causing constant evaluation through the lifecycle of a deal. We expect further stabilization in pricing over the next quarter which will allow us to confidently put more money to work in the latter half of the year.”
Baker said “mission-critical” medical office buildings and ambulatory surgery centers remain the primary target in his firm’s portfolio. He also mentioned demand for behavioral health facilities, both inpatient and outpatient.
“Changes in reimbursement and what seems to be a fading stigma have led to material growth in this subsector,” Baker said.
Despite the headwinds, some industry professionals are expressing a bullish outlook on the sector for 2023.
‘Overweight for Investors’
“There continues to be capital interested in health care and medical office buildings, especially in the current environment where the normal outlook for traditional multi-tenant office is quite tepid [and will] continue to be in a bearish market for the next two to three years,” said Allan Swaringen, president and CEO of Chicago-based JLL Income Property Trust, which is a non-traded REIT. “I think healthcare-oriented real estate could be an overweight for investors, and so you might see transaction activity increase low double digits year over year.”
His firm has approximately $600 million of its $7.1 billion fund, or about 9%, allocated to healthcare real estate. The capital is allocated between medical office buildings and life science/lab science facilities.
“We would be quite happy to grow that allocation to 10% to 15%, so that’s an increase of $300 million to $600 million [and] a 30% to 50% increase in terms of the healthcare allocation,” Swaringen said. “That’s our strategy.”
JLL’s investor survey stated that rental rate growth for medical office buildings is projected between 2% and 4%. Medical office asking rent has been increasing 2.29% on average for the last two years. This is in contrast to overall office market rents, which have grown 1.9% on average in the same period. While the traditional office market is adjusting to hybrid work expectations, in-person visits account for 90% of all healthcare appointments with telehealth declining from a peak of 52% during the COVID-19 pandemic to 10% of all visits. An aging U.S. population will continue to drive demand for healthcare services as the 65-plus population accounts for 36% of healthcare expenditures.
The survey placed medical office occupancy at 92.3% in the fourth quarter of 2022, adding that because of the high cost to build out a medical office space and proximity to patients, medical office tenants tend to remain in the same space for longer, providing stable occupancy.
JLL’s survey revealed that medical office buildings were seen as the greatest opportunity for investment by 66% of respondents, followed by ambulatory surgery centers (20%) and behavioral/psychiatric, eating disorder (12%).
“Most of the medical office we do, the building is 100% medical office,” Swaringen said. “It’s not 50% medical, or a few doctors in a building. The whole building was designed, built and occupied by doctors and doctor practice groups.”
Montecito Medical Real Estate has clearly embraced an aggressive approach when it comes to acquisition volume.
Montecito dominated the LevinPro acquisition numbers last year with 43 deals that included 61 facilities. All but one of the transactions had square footage reported for a total of 1,352,889 square feet. Based on the 42 deals that had square footage posted, the average per transaction was 32,212 square feet.
‘Foreign Investors, New Players’
“[Medical real estate] is still very attractive as an investment option,” said Bryan Brown, senior vice president of acquisitions at Montecito Medical Real Estate. “[It] is growing with foreign investors and new players in the space. [They] see the sector as a long-term, secure investment option.
“Overall, we are projecting fewer total dollars in transaction volume, but a larger number of transactions. We tend to create our future and volume. We should be over 2022 volume by 10% to 15%.”
He went on to describe healthcare real estate as a “great investment” in any environment.
“Typically, medical real estate has annual rental increases where other categories do not, and leases are typically longer-term, to solidify the future cash flow,” said Brown. “With institutional investors, none [are] leaving and more [are] coming in. An individual fund may need to monetize assets for various reasons. But, overall, once you’re in the space, groups tend to stay.”
Another significant player in the market was Anchor Health, which accounted for 15 transactions in 2022 featuring 17 facilities. The deals amounted to 754,964 square feet for an average of 50,331 square feet per deal.
Total annual square footage involved in deals strengthened in recent years. Based on 29 transactions with reported square footage in 2019, the total was 7,208,558 square feet. For the following years, the numbers were: 2020, 76 transactions had square footage reported for a total of 7,824,732 square feet; 2021, 163 deals with square footage posted for a total of 14,938,594 square feet; and 2022 when there were 217 transactions with square footage specified for a total of 44,491,878 square feet.
There were 78 deals posted last year involving more than one facility. One of the more notable transactions was announced on January 4, 2022, when Nashville-based HCA Healthcare acquired West Palm Beach, Florida-based MD Now Urgent Care, which had 59 urgent care centers, for $594 million.
“Healthcare real estate provides a strong hedge against inflation given the customary annual rental increases,” Hart said. “The same cannot be said for all other asset classes, like retail and professional office. Multi-tenant medical office buildings, along with ambulatory surgical centers and specialty clinics, both of which are often single-tenant, tend to be the target assets of most of the funds and REITs we transact with.”
Swaringen is not daunted by the headwinds facing investors.
“I go back to the global financial crisis of 2007 to 2009, the largest recession in the history of the U.S. since the Great Depression, when 9.5 million people lost their jobs,” Swaringen said. “The only sector in that time period that generated positive job growth, and essentially economic growth, was the healthcare sector.
“If you can invest in a high-quality medical office building and get a 7% to 9% [internal rate of return], that’s quite attractive. That’s why medical office and healthcare-oriented real estate will continue to attract capital.”
One trend in recent years that has remained constant is that REITs and real estate investment firms have been the acquirer types that have dominated this space.
In 2023, real estate investment firms have so far been the acquirer in 26 transactions, accounting for 48% of the deals with the five subsectors as targets, with REITs involved in six deals (11%). Private equity (PE) has been involved in five transactions (9%).
Last year, the numbers were real estate investment firms (135 deals; 50%), REITs (50 transactions; 19%) and PE (27 deals; 10%). In 2021, the statistics included real estate investment firms (71 transactions; 35%), REITs (46 deals; 23%) and PE (27 transactions; 13%).
Brown commented on the lagging deal totals involving REITs.
‘Dilute the Returns’
“REITs will not be acquiring a lot of real estate in the near-term due to the higher interest rates,” Brown said. “When interest rates go up, as in today’s environment, acquisitions with higher interest rates dilute the returns to the stockholders and [are] avoided.
“[Return on investment] is a key metric and if [interest rates] are high, some deals will not get done. Sellers still have some expectations that the pricing in the 3% [interest-rate] world is the same as in a 5.75% [interest-rate] world.”
Brown added that REITs “tend to still like on-campus assets” despite the fact that a shift to off-campus locations is taking place.
“[There’s] a lot of movement away from a hospital campus to newer and retail/convenience-type locations,” Brown said. “Insurance companies and reimbursements [are] driving the shift away from the traditional hospital as [the] hub of all health care.
“There will be lots of new construction of medical real estate with convenience [for the] consumer as a driver, very near large neighborhoods [with] more retail placement.”
Medical office buildings have been overwhelmingly dominant among the target sectors.
“Medical office buildings have been around the longest and there are just more of them,” Brown said.
So far this year medical office buildings have been involved in 46 deals while ambulatory surgery centers accounted for six transactions with two life sciences building deals. In 2022, the transaction targets included medical office buildings (213 deals), ambulatory surgery centers (28) and urgent care facilities (23). The numbers in 2021 included medical office buildings (160), ambulatory surgery centers (28) and urgent care facilities (11).
Professionals in the healthcare M&A space are aware that conditions well beyond their control will present a challenge regarding deal-making for the rest of the year.
“It’s not as easy as it looks,” Brown said. “We review roughly $17 billion every year to find the diamonds.”
The challenges presented by rising interest rates as well as buyers and sellers agreeing on acceptable terms were among the challenges in the healthcare M&A space at the start of the year. Now you can add the uncertainty in the banking sector that may limit the availability of capital that is often needed to make such deals a reality.
