Many physicians who own their ASC and MOB real estate may be considering a sale-leaseback of their ASC/MOB real estate to take advantage of the increase in value of medical real estate.
Due to the long-term success and profitability of ASCs, excellent credit history and rent coverage, and the likelihood that the ASC will remain in the same location for many years to come, ASC (and MOB) real estate has become very attractive to real estate investors. This is reflected in the current competition to buy and leaseback ASC real estate and the high multiples of 14X to 20X rent being offered. Sellers can realize high selling prices, no change in rent, and retention of control through NNN leases.
2022 Outlook for selling ASC & MOB real estate
In 2021, over $16 Billion in medical investment real estate properties closed, a record number and a dramatic 75%increase from the previous year. Several portfolio transactions of ASCs, surgical hospitals and MOB real estate closed at historically low CAP rates and high prices per square foot. This has been led by investment companies entering the healthcare real estate sector and their willingness to pay above market values to achieve immediate scale. These portfolio acquisitions have created new comps that are benefiting ASC/MOB owners and increasing sale prices.
2022 is expected to see continue growth in medical real estate sales volume. As medical real estate buyers have become more competitive in bidding against each other, they have looked at ways to make a sale more attractive to physicians. Buyers are becoming more flexible in the terms they are offering physicians owners for the sale-leaseback of medical real estate. Some buyers have offered capital improvements and upgrades on top of paying high valuations for medical office-buildings. A greater percentage of buyers are also willing to pay for building expansions and renovations as part of a transaction.
An increasing number of buyers are also offering the physicians the ability to co-invest as part of a sale-leaseback. This has included tax deferred participation and equity back into the property as well as an “UPREIT” where physicians receive REIT stock. The ability to sell real estate at a top of the market number and retain minority ownership in the property with a world class ASC/MOB real estate operator is very appealing to some physician groups. We believe that this will lead to continued ASC/MOB sales growth.
A major potential counteraction to the growth in ASC/MOB sale volume is the impending rise in interest rates. Historically, major increases in interest rates have negatively impacted the value of medical ASC/MOB real estate. This has the potential of causing an inflection point where CAP rates increase instead of contracting.
Increase in interest rates
The U.S. Federal Reserve is expected to raise interest rates six times this year for a total of 150 basis points (1.5%), a faster increase than previously predicted, according to research reports. Major investment banks have been penciling in an increasingly strong run of interest rate hikes for 2022 after higher-than-expected inflation data ramped up pressure on the Fed to take a firmer stand against soaring prices.”
When interest rates increase, the cost of borrowing rises. Since most commercial real estate transactions are funded with borrowed money, the increased cost of capital is likely to be reflected in lowered purchase prices for medical property.
While global uncertainty does have the potential of reducing the number of interest rate hikes, several interest rate hikes are still expected in 2022 to reduce inflation and this is expected to reduce the positive impact of the new comps.
This increase in borrower costs is expected to be reflected in lower prices offered to sellers later in the year. With the potential for higher rates approaching, and the current historically low interest rates, the best time to sell would be now.
In summary, ASC, surgical hospital and MOB owners have an opportunity to take advantage of the historically strong market prior to significant changes in market conditions.
Seven common mistakes made by sellers of ASC/MOB real estate
Here are 7 common mistakes made by sellers of ASC/MOB real estate and some tips for maximizing the value of your real estate:
- Rent is too low. ASC/MOB owners often charge themselves below-market rent in order to maximize the EBITDA of the ASC business. Rent is a primary factor in determining the value of ASC real estate. Fair market NNN rent for ASCs averages $30 to $40 per sf, or sometimes more, depending on location. The multiples for the sale of real estate are significantly higher than the multiples for the sale of the ASC business. With a CAP rate of 6% the buyer is paying a ASC business. With a CAP rate of 6% the buyer is paying a16.6X multiple. Increasing the rent to fair market value will result in an increase in total value of ASC assets.
Rent is too high. The opposite side of the coin is charging yourself rent that is above fair market value (FMV). While this may show a high value for the real estate on paper, when it comes to selling an interest in the ASC business toa strategic partner, rent that is above FMV can negatively impact the strategic deal. Most buyers of the ASC business will require that the rent be within the FMV range.
- Selling ASC business before improving your lease. ASC owners should modify the ASC lease prior to soliciting offers to sell a controlling interest in their ASC business as they most likely will not be able to alter the terms of the lease after the strategic sale. Prior to marketing their ASC business, owners should ensure that the rent is FMV. The lease term should be 10-to-15 years plus renewal options and be triple-net (NNN) to maximize the real estate value.
- Using an inexperienced or local broker. Local brokers. Local brokers who do not specialize in ASC/MOB real estate typically lack the knowledge to be able to advise on a lease that will both maximize the value of the ASC real estate sales price and the ASC business. In addition, they usually market to local buyers. Most often there are few local buyers who are educated on the value that ASC real estate represents. Brokers who have a network of well-funded national buyers will bring in higher offers in less time. Sellers should engage a broker who already has buyers for your ASC property.
- Not obtaining competitive bids. Some ASC management companies and private equity companies will not allow leases of more than 5 or 7 years. This will greatly reduce the number of buyers interested in the ASC real estate and will lower the value of the real estate. In extreme cases, the ASC real estate may not be saleable.
- Partnering with a strategic partner that will not agree to along-term lease. Some ASC management companies and private equity companies will not allow leases of morethan 5 or 7 years. This will greatly reduce the number ofbuyers interested in the ASC real estate and will lower thevalue of the real estate. In extreme cases, the ASC realestate may not be saleable.
- Not reading or understanding the sales contract and/orbuyer’s lease. Often there will be onerous terms in the sales contract or lease that create significant difficulties for the sellers after the sale, such as frequent reporting requirements, restrictions on how distributions are made, or controls on what benefits and expenses the sellers may incur. It is important that the sellers utilize a broker who will advise them on terms of the sales contract and lease that should be removed or negotiated.
- Waiting until too late to sell the real estate. Timing the sale of both the ASC business and the ASC real estate is critically important. The sales should be made when the physician-owners are still young enough to have 10 or so years left to practice. Otherwise the buyers will begin to discount the cases the physicians will bring as they approach retirement. At a certain point, unless there are succession and recruiting plans in place, the value of both the ASC business and the ASC real estate will decline.
ASC physician-owners can obtain fair market value rents, ASC physician-owners can obtain fair market value rents, current cap rates, and valuations for their ASC business and real estate by contacting ASCs Inc. at 760-751-0250 or JH Winokur Inc. at 914-216-3574.