Jay Gangwal of IRA Capital speaks at InterFace Health

The Feb. 1 InterFace Healthcare Real Estate West “Investment Market Update” panel discussion included (from left to right): Elliott Sellers of Anchor Health Properties, Jay Gangwal of IRA Capital, Jon Sajeski of Sila Realty Trust, Joe Dominguez of Dominguez Capital Advisory and moderator Travis Ives of Cushman & Wakefield.

InterFace panelists say there's still a lot of capital flowing into the MOB space.

What a difference a year can make.At the InterFace Healthcare Real Estate (HRE) West conference in Los Angeles in February 2022, a panel discussion devoted to HRE investing was titled, “Who’s Buying, Who’s Selling and Transaction Trends in the Red-Hot Investment Sales Market.”And rightfully so. The HRE sector was indeed “red-hot” at the time, as sales of medical office buildings (MOBs) had totaled a record $18.6 billion in 2021, according to data from Arnold, Md.-based Revista. Fourth quarter (Q4) 2021 MOB sales of $7.4 billion set another a record – the greatest total ever for a single quarter.But “hot” changed to “not” last year. By the end of 2022, interest rates were on the rise, debt was more difficult to obtain, and a large gap existed between sellers’ asking prices and what buyers wanted to pay. MOB sales volume dropped to $2.2 billion in Q4 – the lowest volume for any Q4 since Revista began tracking MOB sales in 2015.As a result, the tone was a bit different at this year’s InterFace HRE West. The investment panel discussion was titled “Investment Market Update: Are We at the Bottom? When and How Will the Market Snap Back?”“The situation has changed quite a bit, and today’s investment sales market is not necessarily red-hot,” Rich Kelley, senior VP of the InterFace Conference Group, acknowledged during his introduction of the panel discussion. “But it’s certainly a lot stronger than in many other asset classes in commercial real estate, and there remains a lot of room for optimism.”And optimism there was. Despite the plunge in MOB sales volume during the second half of 2022, the panelists generally said that their firms, as well as many other investors in the space, are still looking to acquire properties and build portfolios.Moderating the investment panel was Travis Ives, co-leader of the Healthcare Capital Markets team with Chicago-based Cushman & Wakefield (NYSE: CWK). The panelists were:■ Joe Dominguez, president of Dallas-based Dominguez Capital Advisory;■ Jay Gangwal, principal with Irving, Calif.-based IRA Capital LLC;■ Jon Sajeski, chief investment officer with Tampa, Fla.-based Sila Realty Trust Inc., a non-traded real estate investment trust (REIT); and■ Elliott Sellers, VP of investments and partner with Media, Pa.-based Anchor Health Properties.Mr. Sellers of Anchor said the firm made acquisitions totaling nearly $620 million in 2022, making it “roughly, the third-most-acquisitive buyer by volume.“Looking ahead to 2023, (our) investment philosophy at Anchor has always been the same, which is, we’re investing for long-term merit and are not as focused on short-term performance. Interest rates and inflation are top of mind for every single investor … in the sector, but we’re trying to not let that be the primary driver behind either doing or not doing a deal.“If you look historically at this sector, investors that have been able to build thematic portfolios have been consistently rewarded over time. And I think a lot of the folks in this room feel that way. And it is certainly our attitude as well, which means we’re remaining active in the sector.“You know, the big missing piece right now is portfolio transactions. But we think that will come back here in the not-too-distant future.”Mr. Gangwal of IRA Capital said the firm, which made acquisitions totaling about $250 million in 2022 and has already made investments totaling about $100 million in 2023, will continue to look for and acquire “institutional quality assets” when “good opportunities” arise.“By doing so, we’re going to create a lot of shareholder value and returns for our investors,” he added. “But we always look to the capital markets where we can continue to extract value. And so, I think we’re going to always do that.”Any acquisitions IRA or other investors make in the near future probably won’t include large portfolio deals, however.“Portfolio deals are not happening today because of the debt capital markets issues that we’re all facing,” Mr. Gangwal said. “But having said that, I think there are still going to be opportunities. And from our standpoint, we’re always going to look to the capital markets for those opportunities. In fact, I think the inverse could be the case today, whereas maybe you would see portfolio premiums being paid in the past, maybe 12, 24 or 36 months ago, today you can get that portfolio at a discount.“And so, I think from our standpoint we are very active. It’s a challenging market for sure, but we think there’s a tremendous opportunity going forward.”Mr. Dominguez spent the past two years leading acquisitions for one of the sector’s most prolific recent buyers, Dallas-based Big Sky Medical Fund. The firm was founded by veteran HRE entrepreneur Jason L. Signor and makes its acquisitions in partnership with Bahrain-based GFH Financial Group.He noted that while portfolio deals are currently “not in favor,” in large part because getting larger loans is more difficult, “package deals” will probably be in favor in the not-too-distant future. But when that happens, he said, the portfolios that will be in demand will be the ones in which the sellers, or those that accumulated the portfolios, did so “with a theme” and didn’t just put together a group of properties piecemeal.He noted that Big Sky was “fortunate to have a good capital partner that helped us facilitate our growth.”“They (GFH) were on board with a hedging strategy that allowed us to maintain a decent cost of capital on the debt side as the markets were getting upset,” Mr. Dominguez noted. “But I would also say that our acquisitiveness was also partially driven by the fact that we were a new entrant. And those things all play together.”When it comes to a lack of portfolio sales in the current marketplace, Mr. Dominguez said “there is certainly a disruption to that right now and I think you know, looking forward, it makes sense that there would be a portfolio premium to some extent. I think the difference is going to be sort of what portfolios are most favored and it plays into the debt themes that we’ve talked about, where smaller pieces of debt are easier to execute. And, you know, the $500 million transactions may not be as popular as the $150 million transactions.”On the current state of lendingWhen asked about the current state of the debt markets, Mr. Sellers said Anchor is “fortunate to have really excellent, local market partners and lending relationships. You know, I think the sector has created a reliance on the largest lender in the sector, which is Capital One.“In the second half of last year, when you saw Capital One pull back on lending efforts, that really caused a ripple effect throughout the sector,” he added. “However, the firms that had six or seven different lending relationships, especially within regional banks as well, were able to continue to get transactions done. You know, some of the buyers in the sector were able to rely on pre-existing programmatic facilities.”Anchor has worked hard, Mr. Sellers said, to build relationships with “local and regional lenders. And you know, I think that’s really going to be the name of the game here for 2023. It’s going to be a year of a lot of one-off asset financings, and less reliance on programmatic portfolio debt facilities.”Mr. Ives added that with a lack of “available debt, as well as the increased cost of debt and the impact on the market throughout 2022, do we think there is a wave of debt coming in 2023 and ‘24?“And, will there be any sort of distress in the marketplace, with motivated sellers being pushed by debt maturities? Is that going to have a meaningful impact in healthcare real estate? It is certainly starting to have a meaningful impact in other product types, as office is probably feeling the most pain there.”However, in the HRE sector, he noted, “leasing fundamentals are very strong, and lenders may not be as likely to make a push there. What are your thoughts in terms of, you know, debt maturities over the next few years and how that might impact the market?”Mr. Dominguez noted, “historically, we haven’t seen a lot of real distress in the MOB space with respect to debt, and so I wouldn’t anticipate that it’s a huge motivating factor.”“I think for the most part, like you said, MOBs have been performing well, to the extent that there’s debt maturities … the values should still hold up there… But there’s always a component of that in decision making. But, I don’t think it’s a primary driver for volume in 2023.”Mr. Sajeski said that with the health of the HRE and MOB product types, and the fact that there’s still a lot of capital flowing into the space, there shouldn’t be much distress in the near future.However, he did add that he has heard “there will be some large portfolios put on the market that maybe were transacted a year or two ago that essentially have one- or two-year loans while they try to find partners for the real estate. So I do think there will be some opportunities that will come out of that.“Or, if it’s a smaller – call it a position owner that has debt rolling and is facing some challenges, particularly in the value-add space – there could be more activity, we’ll see.”He added that because there is still plenty of “liquidity in the debt fund markets, this could mean that while debt is currently more expensive, an owner with debt maturities coming due could buy themselves some time.”Mr. Ives told the audience that he was having “this same conversation with a representative of a large lender in the healthcare space right before this panel. And he was asking me essentially the same question – as in: ‘Are you seeing any of this?’ – concerning what are his peers’ shops doing when they have debt maturities.”He noted that “a handful of lenders” dominate in the HRE space. So if most investors believe this will be a short-lived recession, “a blip in the radar in the long upward trend of healthcare real estate,” we’re probably not going to see “a very hard push, if there is distress…” Under those circumstances, he said, it is unlikely lenders would “ask an owner to take part in a forced sale or do anything dramatic for fear that it’s going to erode some of those relationships that they’re reluctant to lose…“So if there’s a way to solve around that and sort of kick that can down the road, most likely, that’s what’s going to happen.”With interest rates seemingly stabilizing, Mr. Ives added, “it’s unlikely there will be a wave of distressed sellers of any significance in the marketplace, and then it feels as though we’re, you know, at a point in time where people can start to kind of dip their toes back in the water and we can get these transaction volumes back to where they ought to be, you know, at maybe $4 billion a quarter and end up at $12 billion or more annually and, eventually back to the $20 billion mark where we’d like to be.”Who has a buying advantage?Mr. Ives noted that the panel was also going to include Daniel Turley, managing director of business development with Toledo, Ohio-based Welltower Inc. (NYSE: WELL), a publicly traded REIT. Mr. Turley, however, could not make it to Los Angeles due to a snow storm that did not allow him to travel.“We were going to engage in a conversation there about, you know, the difference in the cost of capital and the ability to execute acquisitions from the private side versus the public REIT side,” Mr. Ives said. “Any comments from the panelists here? I mean, we have a private REIT in Jon Sajeski with Sila.“Just curious what your thoughts are concerning the public REITs versus the private equity in 2023 and the expectations.”“I’d say we’re very fortunate to have a credit facility right now,” Mr. Sellers of Anchor responded. “We’re very low levered, so we can draw upon that. We don’t have financing contingencies, you know, so being, really, an all-cash buyer to sellers is an absolute huge selling point right now.“On the flip side of that, that doesn’t mean we’re going to buy everything that gets sent our way because I have a lot of those conversations daily,” he added. “But I do think it gives us a great competitive advantage in this environment, because I can’t tell you how many re-traded deals or we have broken deals that come our coming way now, even deals that … we had put in a bid at a price where we thought the market was at and we got outbid… But then a month, 45 days later those same groups are calling, asking us for the equity, or to help sponsor a JV with them.”Mr. Sajeski noted, “just to clarify, that we are a public, non-traded REIT, which actually works quite nice right now, because we don’t have the same pressures of being obviously a publicly traded company. We sit in a very fortunate position to kind of strategically decide where to place our capital right now, which is definitely a big benefit in the current environment. Because the traded REITs, as it was mentioned, obviously, have a different kind of pressure on the equity side.”Are there opportunities to convert office to medical?As the panel talked about the acquisitions markets further, Mr. Ives wanted to know if the panelists were considering acquiring general office buildings – where occupancies are on the rise – and converting them to Mobs.“Are you looking at that potential distress in the office market as a potential pipeline of acquisition opportunities?” he asked. “Are you thinking this is (a product type that( you can acquire at a very reasonable basis and sort of take advantage of that situation?”Mr. Sellers noted that while there “are certainly a number of entrepreneurial groups out there that may be looking at that as an opportunity, our commercial office conversions have, historically, been highly selective and we will continue to be highly selective in that regard,” he said. “It all depends on the micro market in which such facilities are located.”Anchor Health Properties, he noted in recent years acquired a general office building in the San Diego market that it converted to medical.That project, Mr. Sellers noted, is “off to a good start. But, you know, I wouldn’t expect us to do materially more of those over the course of time.”The reason the firm will continue to be “selective” when it comes to such project, Mr. Sellers added, is because converting office buildings to medical is not always easy, nor as cost-effective as it might seem.“I’ve seen plenty of failed office conversions where someone gets into it thinking it’s going to be a cheaper way to enter a market, and as they get in there,” he said, “and they quickly find out that the costs to convert to a medical building are not as low as they expected. It’s a tough business.”Mr. Gangwal of IRA Capital agreed, noting that “most medical buildings are typically in the 30,000 to 50,000 square feet range when it comes to size… When you look at the landscape of office buildings that could be converted to medical, assuming you’ve got adequate parking and the right floor plate sizes and everything else that will be needed … (conversions) don’t always work. We don’t think there’s going to be tremendous opportunity in this regard. But we think, selectively, there could be some and we don’t think that that shadow market will have a huge impact on us, either.”Mr. Ives noted that, in some circumstances, when a conversion project does make sense, “the discount-to-replacement is a compelling theme, right? We heard (an earlier panel) talking about the cost of MOB construction and, you know, that rents that the rents that need to be achieved for new construction in most markets are well above where the average market rent is in that market.“So, if you’re able to selectively acquire at a reasonable basis, even if there’s functional obsolescence that you’re having to fix, invest capital into the building, into a parking deck, or whatever that may be, it seems as though you can still be at a lower cost basis than building new … and probably a benefit from speed to market.”The panelists noted that such projects can indeed work when the circumstances are right, including, according to Mr. Sellers, when a project has a good sponsor behind it, such as a strong health system.Are alternative asset types selling?Mr. Ives led off a discussion on the current acquisition market for alternative HRE asset types, such as inpatient rehabilitation facilities (IRFs) long-term acute care hospitals LTACHs) and behavioral facilities, by addressing Mr. Sajeski of Sila.“Premiums are important,” Mr. Ives said, “and Jon, you’re a little bit different than maybe some of the other shops represented here on the panel in that you’ll go maybe a little further outside the box in terms of asset type within the healthcare space in that you will buy inpatient rehab facilities, primarily all based in more of like a single tenant, that kind of structure.”“Some of these types of facilities were already yielding higher rates than the more traditional MOB space to begin with and maybe, even still with where cost of debt is today, this puts you in positive leverage territory. Give us some perspective from that alternative asset type.”Mr. Sajeski noted that “there’s absolutely been movement,” on the pricing of alternative asset types, and “the problem is the data points. It’s the price discovery, which I think on the medical office side there is more transparency, as cap rates on MOBs have moved, and I think everybody’s in somewhat agreement here, has generally moved up from a 5 percent cap rate to, call it roughly, a 6 cap. So there’s been a 100 basis point movement there.When it comes to IRFs, on the other hand, Mr. Sajeski said, there’s “probably been similar movement, maybe even a little more.”However, he noted that with such a smaller pool of buyers in the IRF space, “you’re really not seeing transactions happen right now. There might be a lot of opportunities out there, but again you don’t have data points and if you’re especially a private buyer, which is a little different than our setup as a REIT, they can’t justify it to their partners making such a purchase because they don’t have the data set, they don’t have the comps (price comparisons) there.”For a buyer looking to acquire, for example, a portfolio of three IRFs, Mr. Sajeski said the price would probably top $100 million.“So now you’re getting into that larger transaction size, and then it … becomes much more challenging, I think, to get the debt together on those type of portfolios. I do think there’s probably a 100 or 150 basis points on the rehab side over the last year.”There does seem to be more buyers interested in acquired LTACHs, he noted, “which I’d say are higher risk, lower margin categories. Once you get over a seven cap, you start approaching that double-digit yield range, there seems to be a lot of groups that’ll come chase that kind of yield at that point.”When the others were asked about their interest in alternative HRE asset types, Mr. Gangwal of IRA Capital said the investment firm, LLC will continue to “look at all product types in the healthcare space, including inpatient rehab facilities, as historically they’ve traded a little bit wider for the reasons Jon mentioned. And during the last couple of years, they’ve really been compressed in terms of that cost of capital, just given where the debt markets have been.”The COVID-19 pandemic, Mr. Gangwal added, “highlighted the need for more patient beds and I think a lot of those inpatient rehab facilities are the net beneficiaries of that. I think that’s why you’re seeing a lot of their unit level numbers that are really, really through the roof in terms of coverages and their financial strength.”Mr. Sellers added that Anchor is “actively buying and developing in the IRF space,” adding that it believes strongly in the role such facilities play in “the continuum of care.“That being said, pricing for the property type is really all over the place, and it is difficult to comp to IRF transactions on both the investments and development side,” he continued. “At the end of the day, it comes down to the operator of the facility and the market positioning, and you have to ask whether there are other considerations, such as whether it’s a Certificate of Need (CON) state that has a material impact on pricing.“But you know, we’ve been acquiring and building IRFs for the last four or five years and we plan to continue to do so and to be a market buyer.”The panelists also noted that having health systems become more involved in providing care at, or partnering with other operators of IRFs and other types of alternative facilities has made them more valuable.“As long as a health system is behind the operator, or actually, the facility itself and driving patient flow to them and all the physician groups are aligned with the system, it has a good chance of being successful,” Mr. Gangwal said. “It has, absolutely, it’s changed the profile.”

Source: Wolf Media