Health-care act could be good Rx for commercial real estate

Commercial real estate investing is preparing a shot in the arm as a result of the shift in delivery of health-care services from the Affordable Care Act.

The new law is turning health care into a growth sector that real estate investors cannot ignore, managers say. Starting next year, the law is expected to extend health-care services to 30 million to 50 million more people, greatly increasing demand for medical office space and medical facilities, as well as certain types of senior housing and care facilities.

Health care's percentage of gross domestic product in the U.S. is expected to grow to 19.6% in 2021 from 17.8% now, according to a LaSalle Investment Management Inc. study quoting data from the Centers for Medicare and Medicaid Studies, part of the U.S. Department of Health & Human Services. The medical office sector continues to improve, with demand for buildings expected to exceed supply through 2014, LaSalle's study noted. What's more, medical office vacancy rates have been lower and more stable than the total office sector, averaging 10.3% between 2001 and 2012 compared with 14.4% for all offices over the same period, according to the study.

Equity real estate investment managers increasingly are moving into the sector, threatening to replace the health-care real estate investment trusts that have been dominant in winning properties. REITs accounted for $2 billion of the medical office market in 2012 compared with $572.4 million for equity real estate money managers, according to the LaSalle study, citing Real Capital Analytics data. In 2009, the year before the act was passed, equity real estate managers invested $38.2 million in the health-care sector.

The Affordable Care Act also is affecting the type and location of properties that will be required. In the past, the most highly prized properties in the sector were either on hospital campuses or nearby. Now, pushed by the law to cut costs, health-care systems are developing satellite offices, boosting the potential value of medical office buildings located in population growth centers retrofitted for medical groups to do provide everything from medical exams to lab work, imaging and out-patient surgery.

“It is the biggest medical reform since Medicare and it has huge ramifications on the (health-care real estate) sector,” said Tim Wang, director and head of investment research in the New York office of real estate money manager Clarion Partners LLC.

In addition, doctors are giving up their practices to join larger health-care organizations because of the increased pressure on costs. This trend makes offices set up for multiple individual practices less valuable, Mr. Wang said.

“We believe that the new ... act will likely accelerate the trend (of doctors selling their practices), which will in turn impact our investment strategies for medical offices,” Mr. Wang said.

Real estate money managers and investors are taking notice.

In June, Kayne Anderson Real Estate Advisors, the real estate arm of Los Angeles alternative investment firm Kayne Anderson Capital Advisors LP, closed its third fund after only three months of fundraising. Kayne Anderson Real Estate Partners III, which is the first of the firm's specialty funds to invest in the health-care sector, exceeded its $700 million target, closing at its hard cap of $750 million.

The fund, which also invests in senior and student housing, will invest in facilities not connected to hospital campuses that are a one-stop shop for patients, said David Selznick, chief investment officer of Boca Raton, Fla.-based Kayne Anderson Real Estate Advisors in an interview. The trend to off-campus health care had been in place already but recently the major players “are accepting reality and starting to build real estate — or contracting with developers to build the hospital system real estate — so the hospital system can deliver lower cost medicine” in line with the Affordable Care Act, Mr. Selznick said.

The new law “clearly pushes or expedites this process. Health-care delivery is more volume based and insurance companies and Medicare are working on hospital systems to lower their cost,” Mr. Selznick said. “When you lower costs, you want volume to operate a successful business.”

The Affordable Care Act assists real estate investors, he said, because “if 60 million more people use medical services that didn't before, then you need more medical office space to service those needs.”

Real estate money managers that have been investing in the sector for years are taking advantage of the trend and selling properties. In November, Seavest Healthcare Properties LLC, a real estate investment firm specializing in the medical office sector, sold the 14 properties from its first two funds to Duke Realty Corp. for $332 million. This was the largest non-real estate investment trust medical office portfolio sold in history.

William Maher, director of North American investment strategy in the Baltimore office of LaSalle Investment Management and a co-author of the study, said in an interview that demand for medical real estate is being affected by the shift in health-care delivery to medical office buildings from hospitals that is spurred by the Affordable Care Act.

Now, large systems are creating satellite facilities, creating demand for specialized office space that can accommodate them, Mr. Maher said. Before, stand-alone medical facilities were not highly valued because doctors were eager to be near a hospital, said Mr. Maher. “The Affordable Care Act is changing the way doctors practice,” he said.

Still, not everyone is sold on the idea of investing in medical offices miles away from hospitals.

“I think on-campus medical office or hospital real estate will be in higher demand (by investors) because pricing on campus or across the street or couple of blocks from a hospital demand higher pricing and rents and dollar per square foot,” Clarion Partners' Mr. Wang said. “We tend to observe higher occupancy in those locations as well. Medical offices miles from a hospital will be questionable.”

And there might be more buying opportunities for equity real estate managers. The stock market has been trading down lately, which — if it persists — could dampen the acquisition activity of REITs, which have been gobbling up health-care properties. Health care has been a growing REIT sector because REITs can issue stock at valuations that are much higher than they can buy medical properties, said Dan Pine, managing director and head of the portfolio management team at Forum Securities Ltd., a REIT investment management firm in Greenwich, Conn.

But stock market declines make the capital of the dominant players in the market — health-care REITs — more expensive, which changes dynamic, he said.

“If in fact the REITs do step back, and it looks like they will, ... there should be an increase in activity from other buyers to pick up the slack,” Mr. Pine said.