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WEALTH MANAGEMENT

Investing in healthcare properties

Investing in healthcare properties

Healthcare property is one of the types with the greatest potential in the long-term

August 29, 2016

Yulia Kozhevnikova

Healthcare property is one of the investment property types with the most potential over terms of a decade or more. One of the reasons is the growing number of people who spend more time on their health and personal care, as well as of senior citizens in the US and the EU.

In the US, the number of people over 65 will double between 2012 and 2050, while in Europe, by 2020 one in five will be older than that. At the same time, life expectancy will increase in the advanced economies. In Sweden, for instance, it will grow to 89 for women and 85 for men by 2060 (from 84 and 80, respectively, as of 2016). In the UK, the average life expectancy will reach 99 years by 2064.

As reported by Forbes, LetterOne – a company owned by Russian billionaires Alexey Kuzmichev, Mikhail Fridman and German Khan – is going to invest $2–3 billion in healthcare properties via its US branch, L1 Health. According to L1 Health, global healthcare costs will grow by 5.2% over 2014–2018. In the US, healthcare costs will reach 18% of GDP by 2018.

What kind of property is this?

Healthcare properties are known as an alternative class of assets. Primarily, the foundations that want to diversify their portfolios invest in them, and such investments comprise 10–15 % of the market's total.

Healthcare properties are of a borderline type: medical office buildings (MOBs) are simply office buildings occupied by medics. Therefore, you can buy an office and convert it into a medical centre or vice versa. Healthcare institutions frequently become tenants in the properties of such major retail chains as Target and Walmart in the US. This trend has been labeled "retailing of healthcare". For instance, the Tranio catalogue has a shopping mall in Florida, rented by restaurant keepers, a church and a healthcare services provider, along with retailers. Medical centres are often located in multi-purpose complexes alongside shops and offices.

The main types of healthcare properties:

— Outpatient care centres

— Acute care facilities, or long-term acute care hospitals (LTACHs)

— Post-acute care facilities

— Free-standing emergency departments/centres (FEDs)

— Specialty hospitals

— Medical and diagnostic labs

— Offices of physicians and dentists

— Medical and surgical hospitals

— Psych & substance abuse hospitals

— Nursing care facilities or skilled-nursing facilities (SNFs)

— Wellness centers

In the case of clinics, post-acute and nursing care facilities, investing in properties featuring not a complex of separate buildings, but a single building with at least 150 beds and several wings is recommended. The advantages also include compliance with the operational standards of four-star hotels, availability of open public spaces, modern security systems and infrastructure (e.g. pharmacies, cafés, swimming pools, car parks and lots, etc.). The optimal percentage of one-bed wards is 95%, the rooms should be over 16 sq m (to make a two-bed ward of a one-bed one if required). Having bathrooms and balconies in the wards is recommended. The minimum occupancy rate is 80%.

When investing in medical offices located in shopping malls, it is advisable to have a convertible facility so that you can rent it out to retailers or other service providers if the healthcare service operator moves out. If the facility is designed to accommodate a particular tenant and this tenant moves out or goes bankrupt unexpectedly, there is a risk that adapting the property for a new tenant will be too expensive and the rental rates will fall significantly. On the other hand, this risk is counterbalanced by potential growth in the number of healthcare clients and the industry’s general growth potential, as well as an increase in the number and welfare of tenants.

When choosing a property, it is advisable to pay attention to the following:

— The demographic situation in the market (i.e. the growing number of senior citizens in the location)

— The amount of similar successfully-operating institutions and the ratio between the profitability of the property you buy and that of your competitors' organisations

— The percentage of clients who receive treatment under insurance or public programme coverage

— The term of the contract between the insurance company and the medical institution

You can obtain this and other kinds of information about the property during due diligence (i.e. comprehensive property examination), which involves lawyers.

The investment nuances

The main problem for those who invest in healthcare properties is the lack of information about the operator and the industry in general. Unfortunately, this property sector is not as transparent as the office or retail property sectors; this transparency disparity is conspicuous whenever it is crucial to learn as much as you can about the investment particulars.

The market entry threshold

In Germany, the existing healthcare properties sell at a price of €1,500–2,000 per sq m while the newly-built ones sell at €2,600–3,100 per sq m. The average price per square metre in the US is $2,900.

Individual medical offices sell for under €1M. For instance, in Montenegro a medical office of 100 sq m is listed at €650,000.

The prices for small hospitals in non-central locations start at €2.5M, for hospitals of higher quality – at €10M. For example, in Berlin a renovated plastic surgery centre, rented out to a major tenant for 10 years with a possible agreement extension for another 10 years, is selling for €16M. The yield rate is 5.57%, and the absolute annual return is about €900,000.

Foundations close major portfolio transactions (i.e. buy several properties at once) worth tens of millions in euros. For instance, the Blackstone Foundation sold a portfolio of three UK acute care centres to a private US investment enterprise for £30.4M.

Yield rates

In general, healthcare properties have higher yield rates in comparison with the office space, as the former have higher depreciation risks due to a more rapid deterioration. Super-prime facilities in the top locations of big cities yield 3.50–5.25% p.a., and prime properties yield 5.0–5.5% p.a. The yield rates of the lower-quality properties in peripheral locations can reach 7.0–9.0%.

The average yield rate of healthcare properties in the US is 6.72%, but can range between 4.0% and 7.0%. Facilities in prime office buildings yield about 4.5% p.a. on average, and less expensive hospitals rented out for 20 years yield approximately 6.0% p.a.

The average yield rate in the UK is 4.5–5.5%. Primary care centres and care homes yield 4.5% on average, hospitals – 5.0 % and specialist care centres – 5.5 %.

In Germany, the maximum initial yield rate for modern properties in a good location with a reliable operator runs to 7.5%.

Special aspects of management and rent

Many healthcare properties are constructed and managed by major international companies and are often built for particular tenants. The majority of funds are put into such projects by private investors while the state acts as a duty-bearer and observes the adherence to the loan and rental income payment agreements. This scheme enables the provision of medical assistance to the population wherever there is a lack of public funds.

There are medical centres rented out to one major tenant and properties rented out to many tenants: for example, half of the facilities may be rented out by the provider chain's employees, and the other half may be rented out by independent medical practitioners.

Such properties are often rented out to the medical institution operators. For instance, in Germany major post-acute care centre operators are Median Kliniken, RHM, Mediclin, Asklepios, Helios, Wicker-Gruppe and AHG Allgemeine Hospitalgesellschaft.

When choosing a healthcare property, obtaining the following information about the operator is important:

— The number of clinics managed

— The percentage of the rental income in the total revenue (13–22% recommended)

— The profit margin (i.e. the recommended ratio between the rental income and EBITDAR 1.5–2.0) and expenses (e.g. staff, compensations)

— Any long-term risks

The rental terms are 3–5 years for small facilities and 15–20 years (with an extension option) or indefinite for medical centres. In the UK, term contracts for over 100 years (leasehold) are common. For instance, in 2015 a care home was sold with a rental contract for 150 years. The yield rate is 3.4% p.a. with annual RPI uplifts of 0–4%. The buyer is the US Alpha Real Estate company.

What the future of healthcare properties will be like

The main developments pertaining to healthcare properties include advancements in telehealth, an increase in the number of outpatient institutions and the introduction of co-working spaces for medics.

Telehealth

Telehealth provides medical assistance remotely with the help of modern computer and telecommunication technologies. In the near future, this area of medicine will likely continue steadily in its development, especially in terms of diagnostics. Thus, a new kind of property – telehealth stations – may well appear. Several healthcare providers in the US, including Cleveland Clinic, Community Health and Kaiser, are already using telehealth platforms. Modern technologies will be used more and more often in the medical service market. Such mobile apps as ZocDoc are already helping patients to find medical workers in their local areas, learn the doctors' appointment hours, make appointments, read reviews and give ratings.

Shift from inpatient centres to outpatient centres

This trend has been observed in the US for more than a decade: the number of inpatient acute care institutions is shrinking, while the amount of outpatient centres is growing. At the same time, the clinics are moving out to the suburbs more frequently due to the higher cost of urban facilities.

The introduction of sharing centres

Property rent is becoming more expensive and many medical workers will want to save money and rent facilities on a timeshare or co-locating basis. A similar trend is observed in the office space market, where co-working spaces or community offices are spreading.

Private clinics growing in number

Due to heavy national debt and necessary social security programme cuts, some countries (e.g. Spain, Italy and France) will probably not be able to provide enough public clinics to satisfy the demand from the growing population aged 60+. Therefore, the demand for private clinics will be high in such countries. In addition, in Europe investing in healthcare properties located in affluent countries (e.g. Germany and France) is beneficial.

Where to invest?

When choosing, pay attention to the demographic situation and the demand for medical services, transport accessibility and the abundance of qualified personnel. It is advisable to choose properties far away from common sources of noise (e.g. railroads, highways, airports and factories ) and near quieter residential districts.

Yulia Kozhevnikova is a real estate expert for overseas property broker Tranio.com


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