The Appetite is Growing for Medical Net Lease Properties

by | 05 December 2022

In 2021, single-tenant net lease (STNL) saw a record volume of $100 billion in completed deals, and in Q3 of last year, cap rates compressed to 5.95%.

The STNL space continued this strong performance in the first half of 2022, hitting an all-time high of $40.1 billion in investment sales, according to the latest findings from Colliers.

Since then, STNL activity has faltered from these historic highs across most sectors, with volume in Q2 falling 35% from Q1 and 17% from last year. In the medical sector, however, demand remains strong despite the pace of sales easing.

Factors Contributing to Growing Demand

To understand why net lease has grown so significantly, it’s important to recognize its key advantages. A recent GlobeSt. article highlights benefits such as predictable cash flows and the price range on assets. This appeals to both institutional and private investors looking to optimize and diversity their portfolio holdings to include more net lease medical assets. The current buyer pool is also still abundant with 1031 exchange buyers, who continue to be the most aggressive buyer group in the market.

Another factor driving the activity around net lease medical assets has been COVID-19. Pandemic investors flocked to the medical office sector for its perception as a safe, interest- resistant and now pandemic-resistant asset. During the pandemic, investors were eager to snatch up anything medical-related regardless of lease term, credit, and location.

Net lease has also risen due to the ongoing supply chain disruptions, slowing the delivery of new product. This has pushed more healthcare tenants to consider alternative space solutions like the adaptive reuse of traditional office or retail properties. These pipeline delays have created an imbalance between supply and demand and a compression in cap rates.

What’s Changed this Year in Capital Markets

Despite there still being a healthy demand for healthcare net lease properties, the 2022 marketplace is different than the previous year. Mounting inflation starting in Q1, rising rates, normalizing underwriting standards and general economic instability have whittled a more scrutinous buyer pool.

While capital is still being deployed, investors are no longer scooping up just anything that’s healthcare assets. Buyers are now taking a closer look at credit, lease terms and location. With inflation looming in everyone’s mind, assets that have strong rent increases are experiencing stronger activity.

To bridge the gap for investors that are feeling the burden of this rising interest rate environment, many developers and sellers are starting to shift pricing, which is creeping back toward pre-pandemic standards.

2023 Capital Markets Outlook

Following a very strong 2021, and good start to 2022, next year will continue its current trajectory, swinging back toward a normal pre-pandemic level of activity in the market. Overall, 2023 won’t be as robust, but for attractive assets, there is still an active buyer pool out there.

For developers and sellers, negotiation around rent increases with tenants will be more important than ever. On top of rent increases, good lease terms and credit will also be critical moving forward, more so than they have been in the last couple years. During the height of the pandemic, only one of these elements was needed to sell a property, but today’s market conditions necessitate all three factors carrying equal importance when appealing to investors.

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