Why Net Lease Medical Cap Rates Are Compressing

Only 27 percent of the medical property sector supply was leased to investment grade-rated tenants during the third quarter of 2019, explains Randy Blankstein of The Boulder Group.
Randy Blankstein, president of The Boulder Group
Randy Blankstein  Image courtesy of The Boulder Group

Cap rates in the third quarter of 2019 in the single-tenant net lease medical sector decreased by 2 basis points to 6.45 percent when compared to the previous year. The overall net lease market in this time period remained relatively stable, decreasing by only 3 basis points. The supply of net lease medical properties continues to grow as larger hospital systems acquire smaller healthcare groups and one-off physician groups in order to expand their off-campus patient facilities. In the third quarter of 2019, the supply of single tenant medical properties increased by more than 17 percent.

The single-tenant medical sector continues to be in demand with private and institutional investors. However, private investors are more drawn to credit-backed tenants (i.e. Fresenius and hospital system backed leases). Institutional investors are more actively pursuing properties where leases are backed by physician groups, which allow for higher cap rates. Regardless of the strong demand across the board from investors, net lease medical properties were priced at a 10 basis point discount to the overall net lease market. This is primarily attributed to the limited amount of investment-grade tenants in the sector. Only 27 percent of the medical property sector supply was leased to investment grade-rated tenants during the third quarter of 2019.

The medical sector is still one that consumers and service providers typically meet in a face-to-face setting, making this sector largely e-commerce resistant. Additionally, single tenant medical leases frequently possess strong rental escalations throughout the term providing investors with an inflationary hedge.

The single-tenant net lease medical sector will remain active as investors are attracted to the long–term outlook for healthcare related properties. The sector’s resistance to e-commerce and the country’s aging demographic will keep investor demand high. Investors across all profile types will continue to acquire net lease medical properties as cap rates remain attractive when compared to the overall net lease sector.

Randy Blankstein is president of net lease advisory firm The Boulder Group.