American medical property bucks the downturn

Commercial property in America is in bad shape. But one property sector is profiting nicely from the US's ageing population, says Eoin Gleeson.

Just as in Britain, commercial property in America is in bad shape. First the cranes came down. Then the financing dried up. And now delinquencies on commercial property loans for everything from shopping centres to skyscrapers are soaring. But one type of commercial property is not being left to the squatters medical property.

The ageing American population spends more than $2trn on healthcare a year more than double the amount spent on food. Backed by both the government and private insurers, demand for healthcare services doesn't suffer in a recession like demand for speedboats and ski holidays. Spending in the sector will exceed $3trn by 2013 as a glut of greying baby boomers seek out medical care, according to research group Marcus & Millichap.

That's a captive market like no other, which will require medical offices, laboratories and nursing homes nationwide to cater to their needs. Another 8,000 primary care doctors will be needed to cater for the newly insured under President Barack Obama's reform plans, reckon Marcus & Millichap. Even if just half that number were taken on, that would equate to an extra seven million square feet of demand for medical office space.

That's why medical real estate investment trusts (Reits) firms that pool money to purchase, renovate and manage these properties have had more luck securing finance during the downturn. In September, GE Capital's Healthcare Financial Services business reported it had loaned out almost $1bn across 45 deals in the first six months of the year to allow borrowers to refinance debt and support working capital.

There are good reasons medical property is more creditworthy than the average office. Tenants stay put for longer. Doctors tend to form strong bonds with local hospitals and patients. And changing locations can be difficult for physicians with pricey medical equipment installed in their units. So while the average office lease is three to five years, medical office leases routinely last for eight to ten years. The vacancy rate for medical offices is set to end the year at 12.4%, compared to general office vacancies of more than 17%, say Real Capital Analytics. This is despite the fact that more than 14.1 million square feet of new space is slated for completion this year, according to National Real Estate Investor's Sibly Fleming.

The most interesting area in the sector is research. Big pharma firms have long struggled with the costs of their research pipelines. By farming out the tasks of researching and testing drugs to specialists, big pharma can offload some of the hassle and expense of bringing a new drug to market. Contract research groups have already taken on around $18bn of the $70bn market for research work in the industry.

And while banks have starved biotechs of credit during the meltdown, big pharma has stepped in as a significant source of capital to sustain the industry. In the second quarter, for example, biotech financing and partnering jumped to $12.3bn, excluding merger activity, up from $9.8bn in the first quarter.

BioMed Realty Trust (NYSE:BMR) is in the business of acquiring, developing and operating laboratory and office space for pharmaceuticals, biotech and research groups. The Reit currently owns, or has interests in, 69 properties, with around 10.5 million square feet of laboratory and office space. Biotech firms comprise 44% of annualised base rents. This is a niche business, "it's not like somebody that does apartments is going to start building life science", as Jerry L Doctorow of banking group Stifel Nicolaus points out. In the second quarter, occupancy stood at 92.3%. As of June, the group had a debt to total assets ratio of 41.2%, healthy by the standards of the sector. The $1.32bn firm also recently raised $166m in equity and competed two financings totalling $368m. It's valued on a forward p/e of 10.2 and pays a 3.3% dividend.

A smaller, more risky but potentially more rewarding bet might be the Medical Properties Trust (NYSE:MPW), which has grown its assets to $1bn in less than five years. The group owns 51 healthcare facilities, including acute care hospitals (72% of its portfolio), heart surgery centres and medical office buildings. It has $8m in cash and around $71m available under existing credit facilities. It trades on a forward p/e of 9.6, a discount to its peers, and has a 9.4% dividend yield.

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