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By Martin Freeman*
The most striking feature of the recent Building Owners and Managers Association (BOMA) International conference in Texas earlier this month was the exponential and dramatic interest in medical real estate (MRE) in the US.
This conference brings together some of the key roleplayers in the MRE sector, specifically construction firms, building managers, buyers and sellers. It is one of two annual conferences in the US that provide insights on the industry. The other is the Revista Medical Real Estate Investment Forum, which is attended by healthcare professionals, investors and property managers, and will be held in March 2022.
Over the years that I have been attending the BOMA Conference, I’ve noticed how the numbers have grown, and, given that MRE is a niche sector, this is now a pretty sizeable event.
One of the reasons is that the interest of larger private equity firms and REITs has grown on the back of the good performance delivered by medical real estate and its resilience through the COVID-19 pandemic.
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Another reason for the interest is that the two other popular real estate niches in the US, industrial property and multi-family units, have seen cap rates plummet – a reflection of rising prices – which means yields have dropped. Investors are now looking around for higher-yielding property assets. Property is also attracting investors who are switching from equities after the recent liquidity-fuelled rally, amid fears of a correction and to diversify their portfolios.
Trends evident in US medical real estate
Some key themes emerged from this conference.
Firstly, there was strong consensus that MRE prices will increase. That means that if you buy medical property now, it is highly likely to become more valuable in the next 2-3 years, irrespective of interest rate increases or rising inflation.
For companies like OrbVest, which are dedicated to sourcing medical properties for global investors, it has become more important than ever to source deals off-market or through networks, because property acquisitions are becoming more competitive. We’ve now been operating in this sector for almost eight years and have forged valuable relationships. I spent a lot of time in 2021 building up the OrbVest brand and the results are now clear: the industry likes our story and wants to do business with us.
If we target ten deals a year, we only need to do one deal per year with each of our partners, which is attainable. New entrants are likely to struggle to secure good assets or will tend to overpay for them.
Secondly, the conference showed that developers are keen to complete medical office buildings as quickly as possible, but there are significant bottlenecks in the construction sector. After a halt to activity in 2020 during the peak of the COVID-19 pandemic, building firms are trying to catch up on 2020 work as well as resume normal activity in 2021. Speakers at the conference raised concerns over the rising price of new construction, which is making it harder for developers to achieve budgets and making existing buildings more valuable.
What is likely to happen now is that costlier new buildings will need to charge higher rentals, which will also cause rentals in older buildings to rise over time. We currently have long contractual leases in place that vary from 2-3% escalation across the portfolio. We have seen lease escalation trending higher, on new leases, in markets where construction has not yet caught up with demand, and as result the landlord can pass through the inflationary pressures.
A third theme that emerged from the BOMA conference was that there are fewer speculative developments in this sector. Most MRE developers will only start construction once the building is at least 50% leased in advance, unlike residential apartments, where there is still a lot of speculative building.
MRE, which was once an “orphan” in US real estate, has never been stronger.
How will OrbVest respond to these trends?
All this means that OrbVest will have to respond more rapidly than before when deals come up. We’ve already found our relationship partners need a fast “yes” or “no” on a deal and that we have to be able to close on a deal timeously.
It also makes good sense to grow OrbVest’s pipeline rapidly on the back of this wave. We still see plenty of opportunity and as a smaller player we can move quickly. We are in a position to buy buildings that are too small to interest the bigger players, aggregate them into a portfolio and then (having done the hard work) sell that portfolio onto a larger player.
OrbVest’s commitment to its investors is long-term sustainable wealth creation, with an expectation of delivering 7-8% cash on cash dividends per annum and double-digit returns in US dollars. Although we are not speculative investors, this does not preclude us from selling before the standard five-year term, if a sufficiently attractive offer comes up.
For example, we are currently busy with negotiations on two buildings where we might sell sooner than expected. On one building, instead of a total IRR of 12-13%, investors could realise 15-17% in dollars. On the other, the total IRR could be more than 20%. We are confident of concluding these deals, as there is more than one potential buyer.
As we cash out of some investments, we will ensure that we are able to offer new opportunities. We will maintain our policy of considering only acquisitions that meet the criteria of our Investment Committee and offer attractive fundamentals.
US medical real estate remains a great long-term investment
Businesses change, strategies change, but we believe strongly in healthcare niche and as long as it continues to generate returns for our investors, we will stick to it. We believe that, for the time being, we can continue to source deals, build on our reputation and create a $1 billion portfolio, perhaps faster than we originally expected.
- Martin Freeman is the CEO of OrbVest.
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