Of the many hard lessons that were learned in 2020, perhaps one that has stuck with real estate professionals is that no industry and no asset class is entirely recession-proof. Back in 2008 when the bottom fell out of the economy, there was no mass closure of small businesses and offices like there were in the pandemic. In many ways, resilient real estate classes such as medical office and healthcare were impacted just like every other sector in the country’s economy.
However, the pain may not have been as severe.
But it’s the theme of stability and security that has drawn investors to the world of medical office properties, and there’s perhaps more interest than ever. There was certainly economic hardship brought about by the pandemic, but there’s also been other changes like an increase in telehealth and an emphasis on medical providers meeting their patients where they live versus having them come to a hospital campus.
“The phrase I like to use for COVID was that it was the unequal recession,” says Curt Pascoe, Director of Real Estate for Ryan Companies. “Certain segments of the population and of the economy were completely shut down — particularly in service and retail — but for the typical patient who has healthcare insurance provided by their work or through subsidies from the government, a lot of that work continues.”
In other words, the pandemic was a health emergency, and despite the fact that many medical providers and hospitals had to postpone or cancel the lucrative elective surgeries, there was as much of a need as ever on the healthcare system, particularly on the smaller-scale clinics found in regular communities.
While the pandemic-induced recession led to mass unemployment and a spike in the cost of raw materials, Ryan Companies and partner Compass Health pressed forward on the construction of a new 50,000-square-foot medical center in suburban Westmont. Set to open in the coming months, the building in the larger 18-acre Oakmont Point Westmont Office Complex will provide behavioral health and psychiatric care, a segment of healthcare that is growing exponentially.
Telehealth proved to be a huge success for outpatient care during the pandemic, but there’s still going to be a need for patients to meet with physicians in person, Pascoe suggests. This means that the demand for physical space will always be there — although technology is certainly impacting the way that these spaces are designed and programmed.
“I think the brick and mortar strategy for healthcare providers is going to become even more customer-centric,” Pascoe says. “We’ve heard from our providers that they saw a spike in telehealth in 2020, but those numbers have come back down from the spike, so the brick and mortar positions will continue to be really important.”
Additionally, the aging population and need for senior support is expected to continue as those in the Baby Boomer cohort move onto retirement and fixed incomes. So, not only is the demand on the healthcare industry going to grow, but so will the need for physical medical office space in the greater Chicagoland area.
Although the pandemic exposed the weak points of every and all real estate asset classes, the world of medical office still has a lot going for it. Even before the pandemic, there was increasing interest and competition among developers and investors for medical properties, but that trend is likely to continue in the post-pandemic years.
“There’s a tremendous demographic tailwind with the aging population and the size and scale of the healthcare industry in terms of GDP, in terms of employment, and in terms of the vast presence of real estate associated with it,” says Joe Magliochetti, Chief Investment Officer of healthcare real estate developer and landlord Remedy Medical Properties. “For a long time, it was really a niche sector, but more and more institutional investors were attracted to it because of what was perceived as an acyclical investment.”
Like many other small business owners, independent medical providers received PPP loans and worked with landlords on rent deferral arrangements. However, the healthcare industry has not had to endure the same level of hardship that landlords and tenants in traditional retail and commercial office have faced in the last 12 months.
“We went through some rent deferral agreements, but it was collected by the end of the year,” Magliochetti says of his company’s medical tenants that faced hardship last year. “In most cases, our rent collection level was 90-95% in the peak of the pandemic shutdown — it was just a minor bump, especially when compared to what owners of buildings in other asset classes experienced.”
Remedy, which Magliochetti says owns “a couple million square feet” of space in the Chicago area, still sees the market as a strong one and continues to pursue investments in the region. And with the tremendous flow of capital in commercial real estate at the moment, there will not only be increased competition, but appreciating value.
“The flow of capital is the single most influential factor in valuation,” Magliochetti explains. “So no matter what interest rates are doing, the flow of capital drives cap rate compression, and there’s plenty of that coming — both domestic and international capital.”
So how does the smaller guy stand up to the big REITs and institutional investors who are piling into the world of healthcare real estate? By identifying the opportunities and doing the work — like property management — yourself. This and also working with profitable, reliable tenants. At least, this is the strategy that Brian Howard of Stage Equity Partners utilizes.
“First and foremost, it’s our tenant that drives the opportunity,” Howard says of evaluating medical office property deals. “We want a well run, well-capitalized, experienced medical user, whether that’s a healthcare system or physician group, and once that is there, you’d like to have a building that ideally has lower capital requirements coming due.”
But the other big part of the strategy is just simply not competing directly with REITs and institutional investors. Similarly to industrial, which has seen REITs move into acquiring smaller scale and lower density assets in recent years, institutional investors are now more willing to spread out their capital over many properties instead of focusing on fewer, larger investments.
This means that investors like Howard have to think one step ahead.
“Our business model has always been geared more to what I would call the middle market, meaning we like to acquire buildings that are under the radar of what the institutions and REITs are looking at,” he says. “A few years ago, REITs and institutions weren’t particularly looking at sub-$10 million, and now they are, and that’s because everyone is looking to scale their portfolios.”
But it’s a combination of the desire to scale up a portfolio in an asset class that was previously more of a niche world, or at least one that had far fewer players and fewer available properties. Or as Howard puts it, “The world of $50 million standalone medical office buildings is not as large as other asset classes.”
And so it’s all bets are off when it comes to chasing opportunities and adhering to preconceived notions or trends.
“I’ve been buying medical office buildings for 13 years now, and I would say that medical office is as competitive and attractive of an asset class that I’ve seen since I started this business,” Howard says of the increasing interest in and profile of healthcare properties.
So as we enter the post-pandemic world, competition and demand — as well as the flow of capital — for medical office properties will only continue to increase. But will there continue to be room for everyone? When it comes to independent investors going up against REITs, it may be less of a David versus Goliath scenario and more of an “early bird gets the worm.”
This story also appears in the June 2021 issue of Illinois Real Estate Journal.