Over the past ten years, there has been significant investment in specialty hospitals across the United States. These smaller, freestanding facilities differ from larger general medical center hospitals. Valuing specialty hospitals is complex, requiring investors to consider the physical asset, tenant, and tenant financial performance.

Types of Specialty Hospitals

There are several different types of specialty hospitals, however, there are four that are most popular from an investment standpoint.

1. Surgical hospitals are similar to ambulatory surgery centers (ASCs) in that they are freestanding healthcare facilities (often physician-owned and led) that specialize in providing surgical care. Surgical hospitals, however, go above the outpatient surgical offerings of an ASC and also provide inpatient surgery options for certain medical needs and conditions, such as cardiovascular or orthopaedic specialty hospitals.
2. Inpatient rehabilitation facilities (IRFs or Rehab Hospitals) are freestanding rehabilitation hospitals and rehabilitation units in acute care hospitals. These facilities are more focused on shorter term rehabilitation after a major physical injury or surgery. They provide occupational, speech and physical therapies in a more intensive inpatient setting.
3. Psychiatric hospitals, or behavioral health hospitals, are primarily engaged in providing psychiatric services for the diagnosis and treatment of mentally ill individuals.
4. Long‑term care hospitals (LTCHs or LTACHs) are certified as acute‑care hospitals, but LTCHs focus on patients who, on average, stay more than 25 days. Many patients in LTCHs are transferred from an intensive or critical care unit. LTCHs specialize in treating patients who may have more than one serious condition, but who may improve with time and care, and return home. LTCHs generally provide services like respiratory therapy, head trauma treatment, and pain management.

Investment Considerations

From an investment standpoint, surgical hospitals are one of the most desirable specialty hospitals, followed by IRFs, psychiatric hospitals, and LTCHs. Surgical hospitals are often fully or partially physician-owned, which drives utilization and control for the physicians. Joint ventures with health systems are especially attractive for their efficiency and growth prospects, with capitalization rates generally ranging from the low-to-high 6%, and rents in the range of $30 to $40+ per square foot. These assets provide the referrals, accompanying utilization, and efficiencies of larger health systems, as well as name recognition. Health system joint venture facilities also often have a succession plan for retiring physicians, and long-term growth and sustainability prospects, making the asset more desirable from an investment perspective.

In contrast, IRFs are typically not physician-owned and are operated by existing major players or new entrants in the market. Their capitalization rates range from mid-6 % to mid-7 %, with rents similar to those of surgical hospitals.

Psychiatric hospitals are becoming more popular due to the trend of purpose-built assets and improved financial performance. These hospitals often have smaller, regional operators, with capitalization rates ranging from 7% to 9%.

LTCHs remain the most challenging type of specialty hospital from an investment perspective. They are difficult to price, due to historical financial struggles and a limited buyer pool. Their capitalization rates range from 8% to 10%, with rents in the teens to high $20s per square foot, although there are some exceptions for facilities that have rates closer to the rehab and surgical hospital levels. 

Financial Health and Coverage Ratios

A crucial factor in pricing all specialty hospitals is the EBITDAR (Earnings Before Interest Taxes Depreciation Amortization and Facility Rent) coverage ratio. This ratio ensures that the operator can afford their rent and continue operating. Reported coverage ratios by investors vary from Medical Properties Trust at 2.3x (Q4 2023) for general acute care hospitals, Ventas at 2.5x for health systems, and Welltower previously reported 2.27x for health systems. Investors typically seek coverage ratios of 2.0x or above for specialty hospitals to ensure financial health and investment appeal.

Impact of Inflation

Inflation remains a major challenge in the healthcare sector, significantly impacting construction costs across the specialty hospital asset class. While there are numerous estimates regarding how much costs have increased, newer facilities are requiring rents between $60 to $120 per square foot. These rents are typically calculated based upon the required rental yield on construction costs. 

To put this in perspective, if a facility with a healthy EBITDAR coverage of 2.50x at a $40 PSF rent, a new facility with a $60 PSF rent would have a coverage of 1.67x, deterring many investors. New facilities can take up to 3 years to stabilize. If they achieve a 2.0x coverage ratio, they will likely attract buyers, setting a new market per square foot price point, often higher than existing space. While there will be exceptions, the broader market will likely wait on the sidelines until there is a proven performance track record at those rental price points and valuations.

Investing in these specialized assets requires careful consideration of the type of specialty hospital, its financial performance, and broader economic factors such as inflation. Each specialty hospital has its unique investment characteristics. Understanding these nuances can help investors make informed decisions in this complex market.