There has been a narrowing of the gap between cap rates of various healthcare property types. World capital markets and the lack of available products are driving this change. Institutional investors have moved towards real estate and see medical real estate as a stable alternative.
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If you look at cap rates in the United States, the average is still around 7% with plenty trading higher, but some investors are dealing with rates in the 5% range. Rising interest rates will affect cap rates. If rates are raised today, it will affect the short-term yield, though not so much the long-term yield. Real estate is cyclical. Rates will always change. It is easy to find a strong health system’s hospital at a 6% cap rate for a 20-year hospital lease. This is priced at a cheaper value than, for instance, a trophy office building at 4.5%. However, some opinions are that the hospital would decline more in value than a mid-town high-quality office building, due to the march of obsolescence.
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There are many predictions that cap rates will go up a bit. There is still plenty of money being thrown at the investments, but it is slowing slightly. We are facing total uncertainty and an unknown revenue stream in the healthcare industry. The government has become the majority payer in the industry, and it is expected that they don’t plan on taking on more payments under the new Affordable Care Act plan.
One developer’s viewpoint was that campus-driven deals two to three years ago were in the eight-caps. Now, an off-campus property with a good-credit tenant lease or a health system would demand cap rates in the sixes or lower. Developers are experiencing lower teens or single-digit internal rate of return now; their debt cost is higher than yield in some cases. They underwrite based on the dividend yield if the property were held for ten years. Renewal probabilities are a big factor. Developers are finding that an 80% chance of lease renewals doesn’t work any longer because doctors are moving to new buildings with newer systems more often.
Cap rates are just one small part of healthcare real estate. The questions on everyone’s minds are: What’s going to be the Uber in healthcare real estate? What will be the disruptive innovation? Who’s going to benefit from the increased demand of about 15 million more people through the ACA? Who will come up with a new kind of clinic that can provide service at a price that will work for that group of patients?
Stand by. Answers are coming, one way or the other.
Beth (CCIM, LEED AP) is a healthcare real estate advisor to health systems with a specialty in the sale of investment properties including hospitals, surgery centers and medical office buildings. She was a former pilot, professional pianist, and dance instructor who co-owned a 25-thousand acre ranch in Wyoming before flipping Texas real estate to fund her early brokerage career.