The Impact of Interest Rates on Medical Real Estate
The Impact of Interest Rates on Medical Real Estate
Written By: Chase Jarrett | Director | ERE Healthcare Real Estate Advisors
The Federal Reserve announced last week a 75bps rate hike, along with continued balance sheet reduction; the largest rate hike since 1994.
What does that mean?
Raising interest rates is the Fed’s way of “fighting inflation”. CPI (“Consumer Price Index”) increased 8.58% last month year over year, a vast increase from the near 2% average from 2017-2021. The Federal Reserve, or “the Fed,” serves several functions, including the regulation and supervision of banks and other financial institutions, and supporting the stability of the US economy by exercising three levers: the reserve ratio, interest rates, and open market operations (i.e. buying and selling government securities).
Why does the Fed modify interest rates?
The Fed lowers interest rates to stimulate economic growth, as lower financing costs can encourage borrowing and investing. When the cost of money (interest rates) is inexpensive, inflation can occur, and the Fed can raise interest rates in order to stabilize price levels. Recently, inflation has reached levels not seen since the 1980’s, driven by a multitude of factors, including (1) sustained period of low borrowing rates, allowing investors to take on more exposure to higher risk assets due to the lower cost of attaining capital, (2) economic stimulus in the form of the government injecting/distributing trillions of dollars to the American populous and businesses, increased demand on consumer goods, higher cost of production and transportation across the supply chain, and (3) Regulation D reserve requirement exemption, all contributing to excessive leverage across financial markets.
In other words, the Fed has serious power to influence the economy of our country.
How does this impact Medical Real Estate?
Interest rates set by the Federal Reserve impact the entire real estate market, including medical real estate. This means that as interest rates increase, the market can shift from the currently strong “seller’s market” to a “buyer’s market,” with less attractive pricing.
Rising interest rates result in money costing more to borrow. In recent years, mortgage rates and borrowing money has been at a historical low. The rise in interest rates is already causing valuation multiples to compress (seen in stocks and other investment assets, along with commercial properties) as borrowed money, which is typically used to acquire assets, demands a higher premium to acquire, and investors reassess valuations and risk profiles. This shift in market conditions has a direct impact on the bottom line for investors of all assets, including medical real estate.
While demand from investors for buildings supported by leases secured by strong operating medical tenants remains; rising interest rates, Fed balance sheet reduction, volatile stocks, and reduced access to “cheap” money, will continue to slow levels of property value appreciation, as compared to recent years. The combination of these factors contribute to a softening economy expected to experience a period of slower appreciation over the next few years. This provides an opportunity to realize value that has grown significantly in the medical real estate sector before continued softening occurs.
Currently, interest rates are still considered “low” on a 30-year timescale, even while they are expected to continue to rise from the near-zero levels we’ve seen over the last decade. Not only does this affect the prices that real estate investors and REITs can pay for medical real estate, but also the price that future incoming physicians can pay.
How does this impact long-term practice objectives?
If a medical real estate owner is planning or considering sale in the next few years, it could be advantageous to time a sales transaction while interest rates still allow for buyers to remain aggressive in their pricing. With further interest rate increases on the horizon; as stated by Fed Chairman Jerome Powell, it may be prudent to explore the long-term viability of an equitable liquidity event, aka how do you get money out of your investment before prices decrease.
Refinancing property has been advantageous over recent years due to low interest rates, but with increasing interest rates, refinancing is becoming less favorable when lenders are unable to refinance with a resulting reduction in monthly payments.
The trend of younger physicians buying into private medical practices has seen a decline over the last decade. This is expected to become more challenging as rising interest rates will create an additional financial hurdle that has already become more expensive than it already is. In combination with record high student loan debt, and a significant shift in new physician’s to employee roles vs private practice; primarily because of the high costs and liability they are burdened with coming out of medical school.
Is now the time to monetize Medical Real Estate?
It is generally expected that the Fed will keep rising interest rates and this trend will affect property values. The good news is that demand for medical real estate remains high. Especially in times of uncertainty and volatile market conditions, investors are drawn to investments which both show healthy returns and command a low risk profile. Buildings with leases secured by strong operating medical tenants fit that profile. Yet, no one has a crystal ball and volatile macro-economic conditions (Fed monetary tightening, rate hikes, inflation, supply chains, geopolitical conflicts etc.) will impact pricing of any asset, including medical buildings.
With interest rates still near 30-year lows, and forecasted increases, now may be the opportune time to consider a real estate sale and monetize the value of medically operated real estate.
In summary, higher interest rates in the market means money is more expensive to borrow. This results in lower valuations for real estate and creates a “buyer’s market.” Lower interest rates in the market means money is cheaper to borrow. This results in higher valuations for real estate and creates a “seller’s market”.
In my next article, I will be discussing the nuances of the Regulation D Reserve Requirement put in place by the Federal Reserve in 2020, and the impact it has had on inflation and leverage within the financial system.
Investment demand, sale transaction volume, and valuations for healthcare real estate have reached historic highs. Even if a real estate sale doesn’t meet your current objectives, addressing potential partnership challenges early will maximize the value and security of your investment.