Demand for Healthcare Property Remains Vibrant…The Problem is Finding New Properties, Thanks ObamaCare!
It is March 21, 2010, and after a year of contentious debate, backroom deals, hardline negotiating, and outright confusion of what the bill really contained, the Patient Protection and Affordable Care Act was passed by the House by a vote of 219-212. Welcome Obamacare!
Say all the good or evil you want about Obamacare and the provisions the new law contains, but one thing is for certain: the capital markets hate uncertainty! During the prior 12-18 months, the financing of new healthcare-related facilities that relied in part or in whole on Medicare / Medicaid reimbursements (particularly hospitals, assisted living facilities, and dementia care facilities), all but came to a complete halt! Since no one really knew what would happen or what provisions the bill might contain, no financing or development strategy could be formulated that would be impervious to any outcome. There were simply too many variables.
As someone who lived through this period of time and had several new hospital construction projects in the middle of financing when things came to a screeching halt, I can tell you, no one was happier than me that at least an outcome had been reached so that life could resume (whether I agreed with the outcome is irrelevant for this point). What happened afterward was such a flood of new construction financings for healthcare related facilities that you could hardly believe that we were at the bottom of one of the worst recessions in U.S. history.
Outside of my little paradigm, the healthcare REIT’s, fully mobilized after raising over $18 billion of new capital, were embarking on one of their most active periods of acquisitions and M&A activity fueled by rising stock prices, access to relatively cheap capital, and armed with a relatively new opportunity to enhance returns through the new RIDEA (REIT Investment, Diversification and Empowerment Act) structure passed in 2007, which allows a REIT’s taxable subsidiary to own a portion of the business operating out of the real estate owned by the REIT. With the healthcare REIT’s leading the charge, there was over $27 billion of senior housing acquisitions during the last quarter of 2010 and the first quarter of 2011, and a near record $27.8 billion during all 2011.
After two years of such rampant activity, broadly improving fundamentals due to the rapid increase in people reaching the age of 65, and just generally a ton of good feeling about the healthcare sector, you would expect that new construction starts are increasing. The surprising facts is that new constructions starts leveled off in 2011 and are expected to be down in 2012. Why? Well, blame it on the conventional lending community. Yeah, sure, some REIT’s have experimented with plugging the gap and taking some development risk by financing some ground-up projects, but that is not really the best place for them to alleviate their withdrawal symptoms from the past two years activity. The sector’s acquisition market is becoming more competitive and supply-restricted leading to cap rate compression, which is great if you are a seller of a healthcare property.
I expect the improving fundamentals in rental rates and occupancy, cap rate compression, and continued demand improvements from the aging population to cause developers to push harder on new construction opportunities. The question is: will the conventional financing be there to accommodate this new demand for construction starts? I think it will be, but not in the volume demanded until 2013. I see the healthcare sector thrust back into a state of uncertainty until the 2012 election cycle is over. Compound the elections with the forthcoming Supreme Court ruling on the constitutionality of the previously discussed Obamacare, and I can see 2013 being the Second Act for the very pleasant performance that we watched in healthcare during 2010 and 2011.