Private Equity Investors Shifting Focus to Healthcare
The U.S. boasts the world’s leading healthcare industry, consistently demonstrating remarkable stability as a CRE asset class. Today, healthcare compromises about 20% of the national gross domestic product (GDP) and continues to be one of the nation’s fastest growing industries. In the last 12 months, the demand for healthcare properties like medical offices and urgent care clinics has exploded.
Rising Demand
The rising demand for healthcare real estate is driven by the need for medical facilities to serve growing populations, advances in medical technology, and changes in healthcare delivery models. Additionally, the aging population in the U.S. has increased the demand for healthcare facilities, making healthcare real estate a significant and growing sector within the real estate market. By 2034, the 65-plus population will outnumber children for the first time in U.S. history. By 2060, nearly one in every four people in the U.S. will be 65 years old or older, according to the United States Census Bureau. Furthermore, the longer people live, the more medical assistance is required to maintain a good quality of life. Healthcare expenditure per individual for those aged 65 and older remains consistently five times greater than the amount spent per child and three times higher than the expenditure per working-age person.
So what does this mean? Markets will need to adapt to high rates of chronic health conditions, and costly expenses in technological adoption will continue to put the healthcare asset class on an upward trajectory.
Healthcare’s Resiliency
A significant contributor to the rising popularity of the healthcare sector is how well it has performed in times of economic uncertainty, specifically during the COVID-19 pandemic. Throughout the pandemic, vacancy rates and rent collections stayed solid in outpatient medical facilities and MOBs. Data from Revista LLC revealed that medical office landlords reported collection rates exceeding 95% even during the height of the pandemic. Omega Healthcare Investor, a national healthcare REIT, reported rent collections surpassing 99% and a healthy 7.07% dividend yield in H1 2021.
MOB rents remain stable, unlike other real estate assets that often experience significant fluctuations. These buildings offer a steady income stream with
modest annual rent increases averaging around 2% to 3%. In certain markets, particularly those experiencing high demand for healthcare real estate due to demographic shifts (such as the Sunbelt states), YOY rents have surged by 6% or more.
Sales volume in 2023 amounted to about $8.1 billion, according to RCA.
Healthcare By The Numbers | Last 3 Years
- Cap Rate: 9.4%
- Sale Price/SF: $156
- Average Sale Price: $7.6M
- Sales Volume: 34.9B
- Average SF: 50.5K
The Role of Private Equity in Healthcare
Private equity in healthcare is a type of for-profit ownership that reflects private investment in healthcare institutions. Generally, for-profit healthcare organizations can be classified as private or public.
Private equity firms gather funds from affluent individuals and institutional investors to purchase medical practices. One common approach involves acquiring a substantial physician practice, known as the “platform” practice, and obtaining smaller practices in the same specialty that are able to benefit from the aggregator’s provided infrastructure. This strategy aims to achieve economies of scale and scope, offer managerial expertise, introduce additional services, and enhance negotiating leverage with payers.
In Q3 2023 alone there were 23 private equity deals in the U.S. pharmaceutical industry, worth a total value of $4.1 billion. While private equity firms have been traditionally active in hospital, nursing home, and home care sectors, there has been a notable surge in acquisitions of physician practices, particularly in lucrative specialties such as dermatology, urology, gastroenterology, and cardiology. A joint project by the American Antitrust Institute, the Nicholas C. Petris Center on Healthcare Markets and Consumer Welfare, University of of California, Berkely, and the Washington Center for Equitable Growth found that private equity firms have been progressively obtaining physician practices in various specialties, increasing from 75 deals in 2012 to 484 deals in 2021, or more than a six-fold increase in only 10 years.
From 2012 to 2021, private equity acquisitions of physician practices in the U.S. increased sixfold, from 75 to 484.
Various factors have contributed to the increasing interest in private equity in healthcare in recent years. One factor is the low cost of capital due to reduced interest rates, attracting a wave of investors looking to participate in the $4 trillion healthcare economy. Another factor is the growing commercialization of healthcare, which has made it more acceptable for private investors to treat healthcare, traditionally a nonprofit sector, like other markets. Indeed, some nonprofit healthcare organizations have started resembling their for-profit counterparts. Nonprofits have pursued near-monopoly dominance in local markets through extensive mergers and acquisitions. Compensation for nonprofit executives has also surged, along with the accumulation of substantial capital reserves.
Enhancing Security: Private Equity In Healthcare Leases
The conglomeration of practices by private equity not only provides existing businesses with stability and additional resources but also helps strengthen the underlying real estate. When a smaller operator partners with or is acquired by a larger entity, the real estate becomes more desirable and benefits from the increased security of the larger organization. Oftentimes, after an existing practice is acquired and the in-force lease is assumed by the purchasing organization, investors will see an increase in their property value.
Strategic Sale-Leaseback For Doctors’ Property Transition
Doctors who own their own practice locations have a unique opportunity created by the recent surge of private equity in the healthcare industry. Prior to the sale of their business, doctors can facilitate a sale of their property by employing a strategy known as a sale-leaseback. In this process, the doctor sells their property to an outside buyer while simultaneously entering into a lease agreement so they can continue to use the space. By selling their property before the sale of their business, doctors are able to set the lease terms that maximize the value of their real estate. After selling their business, the purchasing business can assume the in-force lease, relieving the doctor of all tenant obligations.
Takeaways
Healthcare real estate continues to shine and shows strong signs of stability and resilience. The industry’s robust response to COVID-19, the growing aging population in the U.S., and increased private equity spending in the healthcare sector have all had a positive impact on the continued strong performance of healthcare real estate. As these factors continue to play a role, it can be expected that the healthcare asset class will continue to prosper as investors seek a safe haven for their capital.
