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Time for a check-up? Healthcare REITs under the microscope

Healthcare real estate can offer investors strong demand fundamentals – especially in accommodating ageing populations – and stable, long-term income .

Healthcare real estate can offer investors strong demand fundamentals – especially in accommodating ageing populations – and stable, long-term income .

  • Healthcare real estate – a growth market in the US, Europe and Asia – can offer investors returns that are typically higher than those from the broader real estate sector
  • A diverse segment, with particularly strong growth potential due to ageing populations’ needs
  • Supply-demand imbalances can vary significantly across geographies and over relatively short periods, so it is wise to ‘keep a finger on the pulse’

The pent-up demand for healthcare real estate, and especially housing for “senior people”, in markets across the world is neatly illustrated by two news articles in late January. The one concerned a BBC story about Japanese pensioners bizarrely choosing a life of crime and punishment to get locked up and enjoy free housing and healthcare at the state’s expense.[1] On the same day, Dutch daily Financieel Dagblad published a story about the boom in investor interest in healthcare property.[2]

The slightly odd BBC anecdote illustrates how demand is growing across the spectrum of healthcare needs driven by fundamental demographic change and rising living standards and how this is impacting the provision of real estate. The stories prompted us to take a look at demand for healthcare across the markets we invest in and the implications for listed healthcare real estate owners.

Healthcare real estate is a major sector in public commercial property portfolios in the US: it comprises about 13% of the US REIT[3] sector by market capitalisation. It is also growing in Europe and Asia. Besides strong demand fundamentals, it is seen as offering investors in both public and private markets stable long-term income which is typically higher than that of REITs more broadly. The conviction has grown that there is a shortage of suitable real estate to meet the healthcare needs of an ageing population. This has also begun to whet the appetite of Dutch property investors.

Healthcare: a diverse and growing sector

Healthcare is one of the economy’s biggest sectors accounting for about 10% of expenditure in the Netherlands and 17% of US GDP.[4] There are 33 healthcare REITs globally, with a total market capitalisation exceeding USD 127 billion, 90% of which are in the US.

The sector features a number of property sub-segments classified according to the medical specialism of their tenants including

  • senior housing
  • skilled nursing facilities
  • medical office buildings
  • hospitals
  • post-acute care facilities
  • science and medical laboratory facilities.

Senior housing provides housing and medical services for older households, from independent to assisted living and “memory care”. REITs usually own these properties and lease them to operators on a triple-net-basis or alternatively own the properties and engage an operating company to run them.

Another important sub-segment is medical office buildings. These house medical practioners in leased facilities. Medical office buildings and hospitals are the largest healthcare property sectors in the US, accounting for over 70% of property assets by value. REITs have historically had a roughly 33% exposure to medical offices, while 46% of REIT assets are in the senior housing sector.

The demographic dividend: growing demand for healthcare

Demand for healthcare is being substantially driven by ageing populations in developed economies and increasingly in emerging markets. Older people require more care and as they become more frail, specialist or senior housing. In the Netherlands, for example, the population aged 65 plus is forecast to increase by 40% by 2050 (source: CBS 2018). In the US, the number is forecast to grow by more than 50% (US Census Bureau, 2017).

The need for healthcare services in economies such as the Netherlands and the US is already high and a growing population of older people should lift demand for medical facilities. The trend has not been overlooked in the Dutch market: it saw a 35% increase in healthcare real estate transactions in 2018 from an assortment of capital sources. Investment volumes grew from EUR 100 million in 2009 to EUR 1 billion in 2018.[5]

Exhibit 1: Selected heathcare REITs; averages per country

Source: Bloomberg, FTSE EPRA NAREIT, 11/02/2019

Dividend performance is a key metric for the REIT sector. The dividend yields paid out by healthcare REITs are higher on average than those of companies in the broader global real estate index as shown in the table below.

Exhibit 2: Healthcare real estate operating companies and REITs in the FTSE EPRA NAREIT Developed index

Source: FTSE EPRA NAREIT, 11/2/2019. The above-mentioned securities are for illustrative purpose only, are not intended as solicitation of the purchase of such securities, and does not constitute any investment advice or recommendation. The value of your investments may fluctuate. Past performance is no guarantee for future returns.

A number of real estate investors see healthcare property as recession proof because it tends to be one of the better performing real estate sectors during a downturn. Healthcare is characteristically a non-cyclical investment: people consume medical services irrespective of the state of the economy. Moreover, in the aftermath of the 2008 financial crisis, the sector outperformed the broader US REIT index and while many REITs slashed their dividends, the largest healthcare REITs left theirs intact.

Reimbursement, regulation and supply risks to the healthy outlook

In most developed economies, healthcare sub-sectors are vulnerable to changes in government reimbursement policy. In the US, government payments account for nearly half of healthcare spending (source: Green Street). The ongoing political conflict about the Affordable Care Act is typical of the political risk facing healthcare services providers and healthcare property owners. Interestingly, US REITs’ senior housing portfolios are one of the least susceptible to changes in healthcare policy: fees are paid out of residents’ own pockets.

The ability to pay is currently a low risk factor in the US for REITs’ senior housing portfolios, but it will be a key determinant of investability in other countries. The more reliant residents are on public funding or insurance-based systems for rental payments, the more sensitive these will be to regulatory change and the greater the longer-term risk for investors.

Although the fundamentals plainly support healthcare real estate demand, there are concerns in markets across the US over excess supply in the senior housing sector. There has been a surge in supply since 2015 with developers anticipating the rising population of older households and adding property at a rate of more than 5% to the existing stock, damping the “demographic dividend” of an ageing population (source: Green Street Advisors, November 2018). Investor return expectations were damaged as the vacancy rate rose from 2015 onwards. The risks of a similar event in markets elsewhere such as the Netherlands cannot be discounted.

Keeping a finger on the pulse

The backdrop for REITs specialising in healthcare real estate is likely to remain positive for investors, helped by the benefits of long-term demand drivers. The healthcare sector, and senior housing in particular, thus has a number of clear attractions for investors, including relatively high dividend payments and a reputation for being more defensive than other REIT sectors in downturns, but still needs careful consideration given the challenges it faces.

Evidence from the US suggests that the investment opportunity presented by healthcare is nuanced, especially in senior housing. The supply-demand imbalances can vary significantly across geographies and over relatively short periods. And the regulatory and reimbursement frameworks that underpin the sector are extremely complex and subject to political whims.

[1] Why some Japanese pensioners want to go to jail, 31/01/2019

[2] “Vergrijzing trekt beleggers aan in het zorgvastgoed” Financieel Dagblad, 31/1/2019

[3] Real estate investment trusts

[4] OECD Health Statistics OECD, 11/02/2019

[5] In 2018 bijna 1 miljard euro geïnvesteerd in zorgvastgoed, Capital Value, 31/1/2019

For more articles by Shaun Stevens, click here > For more articles on real estate investment trusts (REITs), click here >

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