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Healthcare Trust Of America: The Best Way To Play Healthcare Trends

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While there is no question the demand outlook looks robust, the supply side of the equation remains a rough one for many property types.

Does that make many healthcare REITs uninvestable? No, but it could never justify pulling the trigger at current valuations.

When it comes to medical office buildings, however, there is a defensible moat here on an operational level and just as many, if not more, of the trends in healthcare benefit the industry. As the largest and most pure play on these assets, Healthcare Trust of America (HTA) trades at a clear discount to its intrinsic value. While not a home run type of purchase today, hitting singles and doubles never hurt anyone.

Overview of Healthcare, Medical Office Building Outlook

Everyone knows the bull thesis for healthcare. The Office of the Actuary for the Centers for Medicare and Medicaid Services (“CMS”) recently projected that national health spending will rise 5.5% annually from 2018 to 2027. That means that, once again, healthcare spend will outstrip likely GDP growth for the next ten years. Within the “buckets” of healthcare spend, no matter the category (hospital care, physicians, prescription drugs, nursing) cost inflation is on the rise.

Part of that is economic (inflation, higher wages, more demand) and part of that is demographic (Baby Boomers). No question that healthcare is and will be one of the fastest growing areas of the market. Who or what captures the economic value from that growth has profound implications across the industry, real estate included.

Investors will not find a healthcare REIT not citing rising spend and aging demographics as a bull catalyst. However, there is criticism of the supply side of the equation in recent years, including bearish calls on plays like New Senior (SNR), Ventas (VTR), or some skilled/assisted nursing home operators themselves like Senior Care Centers. Depending on the asset type, there is often very few barriers to entry – particularly in the senior housing whether it be skilled nursing or assisted living. As much as the industry tries to talk about “viable infill” opportunities in certain markets, even strong locales eventually reach operational parity as competition moves in. Bad markets just cannot be fixed.

Medical office buildings (“MOBs”) are an exception. Unlike other areas of the healthcare real estate market, there are actual barriers to entry. Location matters. On-campus and near-site off campus buildings within high demand medical areas have seen immense value growth. Cap rates have contracted by 400bps since the Great Recession and steadily improved even in recent years which is slightly unusual. All else equal, that implies a 70% increase of property values even on flat net operating income (“NOI”). In actuality, comps have been healthy (low to mid single digits) which has created riches for owners which often has been the hospitals and health systems themselves.

These assets also benefit from a litany of trends in the American healthcare system, the most important of these is the increasing move towards outpatient services. Readers already know procedures are just nutty expensive nowadays. The only way for service providers to somewhat constrain costs is by reducing patient time spent under medical care. Avoiding an overnight hospital stay can save thousands of dollars per patient, often without any change in complication or readmission rates. Insurers are more than willing to allow hospitals to capture higher incremental profits to encourage outpatient work. MOBs, by their nature, rent to tenants providing these kinds of procedures.

As the entire healthcare industry continues to consolidate, health systems will inevitably target expansion within the core areas of their network. Heavy capital investment and infrastructure build-out leads to adjacent MOBs seeing growth. Hospitals, who still remain the majority owners of MOBs, are also highly incentivized to sell. Whenever a hospital is the landlord and rents space to physicians, they run greater risk of violating the Anti-Kickback Statute which bans any type of payment for referrals. Selling to a REIT like Healthcare Trust of America frees up capital while also avoiding any potential allegations of favorable rent treatment.

Healthcare Trust of America

MOBs are the Healthcare Trust of America bread and butter. Nearly the entire portfolio (94% of gross leasable area) is in this type of asset. The company owns 23.2mm square feet, making it the largest publicly-traded pure play in this space. Assets owned are primarily located in major metropolitan markets like Dallas, Houston, Atlanta, and Boston. This has taken quite a bit of hard work and time. Operating a bit under the radar, management has been high-grading the locations of its assets over the past five years. Acquisitions have leaned towards more dense urban areas and there has been some decent efforts made in cutting underperforming properties, including $300mm worth of dispositions last year alone.

While major healthcare REIT players like Welltower (WELL) and Ventas (VTR) have significant MOB portfolios, it isn’t their primary business. On a comparable basis, Healthcare Trust of America has spent more acquiring and developing in this space than anyone else. It shows through the results. Funds from operations (“FFO”) per share has grown at a 5.2% clip since 2014, outstripping the peer group significantly which has struggled to see any material change. The largest contributor to that has been same store sales growth which has run well above average.

Management is very efficient with its capital spend, runs a solid investment grade balance sheet with lower than average leverage, and has still managed to outgrow comps. No wonder shareholder returns have eclipsed other healthcare players as well – and I’d argue that as far as the stock price goes it should have done better.

CEO Scott Peters believes the business can generate substantially similar FFO growth going forward to the rates it has earned in the past. Contributing factors to that remain the same: low single digit same store revenue growth, marginal annual expense savings, and a touch of occupancy rate improvement. The expense growth target an admirable one in particular. Unlike many other REITs in this sector, same store expenses has actually shrunk over the past few years as the portfolio has grown, something most REITs do not accomplish. Tie the cost focus together with acquisition and development and management believes that execution can deliver 8-12% annual shareholder return potential even assuming no multiple contraction over the medium term. This does not rely on further cap rate compression which could also boost the market’s outlook.

Takeaways

Is the dividend exciting? No, 4.5% isn’t anything to write home about. Is this a deep value opportunity or something that might make you rich overnight? No, this is not one of my usual deep value contrarian plays. Is it an investment grade player with long term contracted cash flows, making a dividend cut is incredibly remote? That it is. Using my usual REIT framework, does it trade at a discount to net asset value (“NAV”)? Arguably, yes. With projected $450mm in 2019 NOI and valuing the business at a conservative 5% cap rate, there is about 15% upside to reach NAV.

Not every investment needs to have 30, 50, or 100% projected upside to make sense. This one just works. Investors have seen quite a lot of dividend cuts over the past year.

 

Source: Seeking Alpha

How ASCs Play A Role In Medical Office Transactions — 3 Insights From An Investment Director

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An influx of medical office investors is good news for ASC operators, according to John Nero, a director of the healthcare-focused investment banking firm Hammond Hanlon Camp.

Mr. Nero told Becker’s ASC Review how ASCs could be affected by medical office transactions — and play a role in them.

Question: What should ASC operators know about the medical office building market and activity right now?

John Nero: The medical office market continues to see an influx of new capital providers regularly, including private equity, institutional and offshore capital. These investors continue to create a market imbalance where capital outweighs the supply of quality medical office and ASC product, which bodes well for ASC operators that own their facilities and may want to evaluate opportunities to partner or sell in a favorable market environment.

Question: Every week, there are new transactions involving medical office buildings that have ASCs. Why do you think we see these kinds of facilities changing hands? Is it normal or noteworthy?

John Nero: Medical office buildings with ASCs tend to be viewed favorably, particularly when dealing with facilities located within certificate of need states, where the ability for the tenant to move the ASC is limited and the development of new competitive product is often restricted. While ASCs are specialized uses that cost a landlord more tenant improvement dollars compared with a more traditional medical office user, they also generate higher rents and have higher renewal probabilities upon lease expiration. Having an ASC in a multi-tenant building may also help attract physicians who perform cases to lease their office space there.

Question: What do medical office building operators prioritize when selecting a strategic capital partner?

John Nero: The top three factors medical office building operators look for when selecting a strategic capital partner are:

1. Alignment On Scale Expectations —This may be the most important element of creating a successful joint-venture partnership within any real estate sector, but in healthcare, it is particularly important. Some institutional capital providers can have unrealistic expectations of scale and capital deployment in this space. Most operating partners want to align with capital partners that are fairly well-educated on the nuances of the outpatient facilities sector, so that both sides understand what level of scale is realistic within the established investment strategy and defined timeframe.
2. Competitive Advantage — Every investor is seeking a competitive advantage, and this goes for both operators and capital providers. Operators are obviously looking for competitive economics in their joint-venture structures, whether it’s a favorable promote structure or eliminating requirements on crossing multiple investments within a program. They may also seek a sourcing advantage from their capital, as many private equity capital providers also have strategic investments in healthcare operating businesses (such as ASCs) that may surface off-market real estate opportunities.
3. Speed And Efficiency — Most medical office building operators see a tremendous amount of deals on a regular basis. As such, they need to be aligned with a capital partner that can respond quickly on whether or not to pursue opportunities in today’s competitive marketplace. The old mantra that “A fast ‘no’ is the next best answer to a ‘yes'” rings true here. Most new arrangements we’re advising on have some type of “three strikes” policy, whereby the capital partner can decline up to three opportunities that fit predefined criteria before the operator can pursue the transaction through another capital vehicle.

 

Source: Becker’s ASC Review

Why Medical Office Could Be The Safest Asset Class During A Recession

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The potential of a looming economic downturn has investors looking for safe places to put their money, and one top investment manager says medical office could be the best bet.

LaSalle Investment Management Head of U.S. Healthcare Real Estate Steve Bolen, speaking at Bisnow’s National Healthcare Mid-Atlantic event last week at the Washington Marriott Georgetown, said the two safest asset classes in commercial real estate are multifamily and medical office.

“Apartment owners are able to maintain occupancy during a downturn by lowering rents, and they have the flexibility to bring them back up with the economy improves,” Bolen said.

Medical office space has the benefit of being occupied by an industry, healthcare, that typically does not suffer the same job loss as other sectors during a downturn. During the Great Recession, Bolen said the overall U.S. employment base was shrinking by more than 6%, but the healthcare employment base was still able to grow by more than 2%.

“There is no better sector of our U.S. economy in terms of job growth during downturns in the economy than healthcare,” Bolen said. “Astute institutional investors have come over to medical office and view medical office as a key component of a well-diversified commercial real estate portfolio.”

Another benefit of medical office, Bolen said, is tenant retention. LaSalle has made about $2.5B of medical office investments, he said, and the overall retention rate for its medical office tenants is in the mid-80% range. In standard commercial office space, he said, retention is in the 60% to 70% range.

“So you’ve got excellent employment growth during downturns in the economy and very sticky tenants,” Bolen said. “Medical office has a lot of attributes investors view very favorably when investing for defense.”

The main challenge in investing in medical office today, Bolen said, is that so many investors are looking to put money into the asset class that there is not enough supply to satisfy the demand. The solution for this, he said, is to look in secondary and tertiary markets that investors might overlook. Medical office investors do not need to stick to the top 25 largest metropolitan areas as investors of commercial office do, he said, and they can instead find quality hospitals that create demand for medical office space in smaller markets.

“There’s just not enough to buy that’s good quality for the amount of capital that is seeking a home in this space,” Bolen said. “So you have to go where the deals are. You have to align yourselves with hospital systems in secondary and tertiary markets.”

Demand for medical office space is booming in part because health systems are moving many services away from traditional hospital campuses and into outpatient facilities. Over the last two years, the revenues that leading hospital systems make outside of the hospital have begun to equal the money they’re making inside the hospital, said Dr. Sunil Budhrani, CEO of Innovation Health, a partnership between Inova and Aetna.

“The world outside the walls of the hospital has become very important to us,” Budhrani said. “In some markets, you’ll see a reshaping toward ambulatory, outpatient [facilities] … We’re going to reshape how we’re delivering healthcare and how the hospital plays into that space.”

 

Source: Bisnow