Earnings Update: Healthcare REITs (Q3 2024)
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Earnings Update: Healthcare REITs (Q3 2024)
The recent murder of UnitedHealth Group (UNH) CEO Brian Thompson put the American healthcare system back into the public eye.
Here in the States, we have a uniquely complex healthcare system that has pros and cons.
As demonstrated by the murder of the health insurance CEO, many are dissatisfied with the high cost, opaque pricing, and spotty insurance coverage of the American healthcare system. But at the same time, the American system is undeniably the most innovative in the world, acting as the world's engine of advancement in medical technologies.
For all its flaws, the US system looks unlikely to be fundamentally overhauled anytime soon.
Could the new Republican government taking power in 2025 tinker around the edges and change some aspects of the system? Of course.
But the nearly 17% of GDP that the US spends on healthcare (more than any other developed nation by 4-6 percentage points) looks likely to stay and even grow for the foreseeable future.
We are highly bullish on healthcare real estate as a long-term investment, especially the senior housing/care and medical outpatient sub-sectors.
Let's explain why.
The core thesis for healthcare real estate is that the US population, like every other developed nation's population, is aging. Healthcare needs compound rapidly as people enter old age.
Older people require more healthcare. Thus, as the population ages, spending on healthcare will necessarily rise.
While this coming "silver tsunami" has been known about for a long time, it has only just begun to arrive. In the post-Great Financial Crisis period of 2010-2023, the population of 80+ Americans grew by 1.5% annually. But from now through the end of the decade, that growth is expected to surge to 4.5% annually.
The wave of growth in this age group has already begun. Hence why absorption of senior housing units (chart on the right above) has soared in the post-pandemic period up to today.
Of course, the biggest competitor to senior housing/care facilities is home healthcare, which can be significantly cheaper if family members are available and willing to provide supplemental care.
However, the demographic situation in the coming decades looks increasingly unamenable to familiar caregiving, as the ratio of middle-aged family members (usually children) to older people is projected to decline rapidly.
For much of human history, it has been the tacit agreement that parents care for their children, and their kids in turn care for their parents when they reach old age.
The sharp decline in the birth rate during the 20th century makes this traditional situation increasingly untenable.
That makes growing demand for senior housing/care facilities virtually inevitable for the foreseeable future.
What about the supply of such facilities?
While there was an oversupply situation in the late 2010s as developers got ahead of their skis, building too much supply before the demand surge had arrived, the pendulum is now swinging in the other direction.
As the 80+ population rapidly grows, high construction and capital costs has dramatically compressed the amount of construction starts in this space.
In fact, if we zoom out all the way to 2010, we find that senior housing construction starts are the lowest they have been in at least 15 years.
What could change this situation?
Either senior housing rent rates would have to meaningfully grow, or interest rates and/or construction costs would have to meaningfully come down.
In all likelihood, rents will rise and interest rates will come down somewhat from here, although construction costs will likely remain elevated.
As for outpatient medical buildings, one must keep in mind that patients and providers have both trended away from inpatient and to outpatient services in order to cut costs and increase convenience.
If anything, COVID-19 only accelerated this longstanding trend.
As a result, medical office buildings have seen continuously falling vacancy rates, while their traditional office cousins have suffered higher and higher vacancies.
As the older population grows and healthcare demand rises, we expect MOB occupancy rates to continue creeping up.
But what about all that empty traditional office space? Could it be converted into medical use and begin to compete with MOBs?
In some limited cases, yes, traditional office is convertible into medical office, and some office landlords are doing so. For example, Sutter Health recently announced their intent to transform 1 million square feet of office space into a health campus in Santa Clara, California. However, this redevelopment project won't be cheap. The estimate price tag of converting these offices for medical use stands at $800 million.
Turning a vanilla shell office space or building into a usable space for medical tenants is an expensive prospect.
To quote Nuveen:
From a physical standpoint, medical outpatient buildings require a substantially different buildout, including increased plumbing, higher floor load capacity, ample parking ratios, differentiated HVAC/electrical loads, biohazardous waste removal, and different floorplan.
On top of all that, most medical tenants want to be clustered around each other for the beneficial network effects. Hence why the largest MOBs are located on or directly adjacent to hospital campuses.
Let's now turn to the Q3 2024 earnings results of our four healthcare REITs:
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