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Although the US Fed Funds rate is close to a 15-year peak, long-term interest rate trends are more important for property investors. Five-year US Treasuries at the time of writing were at 3.8%, and 10-year Treasuries are lower, indicating the market expects rates will fall over the medium term. US inflation has fallen from above 9% to just over 4% and is expected to fall to the targeted 2% from 2025 onwards.
Besides the macro environment, several tailwinds in the US medical office building (MOB) sector drive positive long-term investor returns.
The first driver is the switch from inpatient (hospital stays) to outpatient care. In 1994, 70% of patient spending was in the hospital systems and 30% in outpatient facilities; by 2019, the ratio was almost 50:50. This is partly because of the cost of overnight hospital stays and the drive by insurance companies to control the costs of healthcare, and partly because of advances in technology. Today, patients can walk out of a day hospital (Ambulatory Surgical Centre), after having a procedure that would once have required a lengthy hospital stay. It’s not only laparoscopic surgery that is now performed in Ambulatory Surgical Centres, but more acute procedures like knee and hip replacements that are now taking place without the need to stay over for observation.
The second trend is the ageing American population. By 2030, more than 60% of Americans will be over 65. Orbvest targets states with the most concentrated ageing US population, e.g., Florida, Texas, Arizona, New Mexico, and Georgia. Older Americans are moving away from states with higher taxes and colder climates to those with lower taxes and warmer weather.
The third trend is that people aged 65 and older spend about $19 100/year on medical procedures against about $4 300/year spent by those under 65. Older people need more healthcare. In 1980 the US spent about 10% of GDP or $2 trillion on health care. It is about 18% of GDP, or over $4 trillion. By 2030, healthcare spending is forecast to be about 30% of GDP.
Fourthly, although returns from US office properties – like those of most other developed countries – are under significant pressure as more people are working from home post-Covid, the average occupancy of MOBs has stayed at just under 92% since 2019. Medical professionals generally prefer to remain in a synergistic environment where they benefit from referrals of patients within the same campus or building or where complimentary services, including imaging (X-ray) and laboratories, enhance the patient experience. Medical offices also have additional requirements, including extra parking allocations, backup generation, special waste treatment, and oxygen provision. Some states even require a certificate of need that stays with the building and a portico to cover patients arriving and departing.
The fifth driver for MOB returns is that, since Q2 2021, demand for medical office buildings has exceeded supply, which means medical rentals are likely to increase. The impact of inflation on construction costs will also positively impact rentals because developers of new facilities need to make returns on their investments. A new MOB’s average land and construction cost is about $501/SF, but most of the buildings that OrbVest buys are priced at $200-300/SF. When building a competing medical office costs more, rentals for new and older properties will rise. Average rentals for triple net (NNN) leases, where tenants pay all the running costs, were rising at 2% p.a. two years ago, but by Q4 2022 were rising at a rate of between 2.5% and 3% p.a.
Since 2015, MOB cap rates (reflecting the rate of return from a property if purchased all cash) have reduced steadily as investors have sought out assets that are not correlated to the equity markets and provide long-term steady income. Cap rates have compressed from 6.8% in Q4 2015 to 5.9% by Q3 2022 during the low-interest rate environment. But the impact of the higher interest rate cycle has reversed these wins, and buildings that trade in today’s market have moved to the 7% range. This means sellers will not realize the anticipated prices and will hold onto properties longer. Positively, investors with good-quality property delivering a consistent income stream at interest rates fixed when rates were lower are under no pressure to sell. But there are opportunities for buyers to obtain competitive financing to acquire buildings relatively cheaply compared to a year ago.
OrbVest generally uses 50% to 60% debt and 40% to 50% equity when we acquire new medical office buildings. Expecting that interest rates will fall, we secure fixed-term debt with no cancellation penalties and will refinance the debt at a lower interest rate when rates drop off to enhance returns.
Our advice to South Africans concerned about rand/dollar depreciation is that it is difficult to anticipate exchange rate volatility and rather move money offshore at regular intervals to diversify into a hard currency asset that delivers regular dividends over the medium term.
Our diversified portfolio has consistently paid no less than 7% dividends since inception, underpinned by leases from over 100 physicians and healthcare providers.
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About OrbVest:
OrbVest is a growing real estate company focusing on the US healthcare sector. Visit www.orbvest.com. OrbVest is an authorised Financial Services Provider. The article’s content is for information purposes only and should not be construed, under any circumstances, by implication or otherwise, as advice of any kind or nature or as an offer to sell or a solicitation to buy or sell or to invest in any securities. Past performance does not guarantee future performance.
Returns are taxable and will be taxed as dividends from a foreign source, ordinary income or capital gains, depending on your tax residency. OrbVest is not a tax and/or legal advisor. Investors must consult their financial and/or tax advisor or attorney before investing.
Investment is made via www.orbvest.com, where the particulars of the investment are outlined in the property supplement, a private placement memorandum or a subscription agreement. The proposed investor should read these in their entirety before investing and obtaining independent advice.