Health Care Properties Offer Investors Exceptional Performance

Health Care Properties Offer Investors Exceptional Performance

Commercial real estate’s status as a desired institutional investment class is on the rise, with investors increasingly broadening the scope of their portfolios. While office and multifamily assets continue to garner the lion’s share of capital, formerly “niche” sectors like health care properties are gaining momentum and drawing an increasing swath of buyers.

Health care real estate, for example, offers solid returns due to its higher tenant retention rates and less volatile rental rates—which translates into less risk, in many cases. And the fervor for medical office properties in 2014 is proof positive that investors are paying attention. For the third consecutive year, medical office building (MOB) sales were at peak levels, topping $5.0 billion. This new high-water mark is a function of greater familiarity with and acceptance of the asset class, as well as an unprecedented amount of capital allocated to health care among institutional real estate investors.

The heated acquisition environment and the limited supply of investment product has fueled sales while containing momentum, and JLL expects the continued interest in health care properties to persist in 2015. Institutional, REIT and private equity buyers, including new entrants, will compete for precious little new property. The universe of U.S. medical office property is now estimated at a total value of $315 billion across more than 51,000 properties, according to the medical real estate research firm Revista Medical.

The heightened competition for MOB acquisitions has accelerated pricing for comparable medical office properties and surpassed all prior records. Revista says that in 2014, the average medical office property sale was $286 per sq. ft. That’s 36 percent higher than the pricing of $210 per sq. ft. just five years earlier in 2009. For REITs, in particular, health care provided a 34 percent return on investment—the best performance of any sector in commercial real estate. The perfect storm for MOB pricing is supported by the strong credit environment, offering attractive borrowing terms and low interest rates. Fears concerning the impact of health care reform and key provisions of the Affordable Care Act of 2010, that became effective last year, appear to have subsided.

New development opportunities will soak up capital at the same rate as they materialize; certain REIT investors have shifted to control the development pipeline by entering into “loan-to-own” structures, whereby they provide construction financing to developers and take title upon completion, rather than the property going through a common disposition process.

JLL expects the peak in interest in MOBs to continue in 2015, assuming the key features of the investment environment—such as low interest rates and capital raise for real estate and health care properties—are in place. Cap rates will remain under pressure as investors accept lower returns to deploy capital for high-quality, stable income-producing properties.

In addition, the underwriting of smaller buildings and tertiary market locations will be more common and acceptable to fill acquisition pipelines. Finally, M&A activity and portfolio listings on a stock exchange are likely to continue, particularly for non-listed REITs that have successfully deployed their equity raise.

Health care properties may represent a small percentage of overall investment into commercial real estate, but its ability to generate impressive returns makes it an asset class to watch.

John Gates is CEO of JLL's Markets, Americas division, and is based in Dallas.

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