The spread of the COVID-19 pandemic has forced many businesses to shut down completely. Many others are just managing, functioning with a skeleton staff. Most of these businesses cannot pay rent, which affects landlords facing a cash crunch. All these factors will have a negative impact on the commercial real estate business and medical REIT.
The deterioration in the current business conditions foretells a bleak future for commercial real estate markets. The demand for leased commercial space declined right at the beginning of the year (while the pandemic was still breaking out), and the conditions are likely to persist until the end of the year.
Resilience and Liquidity are the Watchwords
The need of the hour is corporate resilience as the pandemic has evolved as a significant detriment, forcing the need to create a safety net to prevent bankruptcy. The businesses that had healthy balance sheets with ample reserves are the ones that managed to pull through despite all odds like lost rental revenues, spiraling costs, and other such pandemic-induced issues.
A medical REIT must take appropriate steps to strengthen liquidity, and many firms are following this principle. They have adopted severe austerity measures to tide over the crisis and improve cash reserves. Property owners are likely to redraft lease agreements, and the fine print and force majeure clauses will be stringent. Lessees should do their homework as far as due diligence is concerned and explore pandemic insurance covers to take care of unforeseen twists and turns.
Uncertain Occupancy Rates
With social distancing being the norm, working from home and telemedicine will become more popular, leading to a steep fall in demand for medical real estate. Of course, where people have to work from an office environment, comparatively larger spaces will be required as social distancing has to be practiced. The new social distancing norm will probably add to the uncertainty and chaos, with the trend of caution witnessed almost throughout 2020 may extend up to the first quarter of 2021.
New Emerging Markets
The trend to move away from dense markets, seeking fresh pastures is likely to dominate the medical REIT scene. With different geographies adopting different laws to tackle the COVID menace, disparities and difficulties in some markets will be higher than in others. It will take some time for regulations to settle with consistency, although decisions will be made on a trial and error basis.
The experts believe that these variations will continue to linger due to various factors, including political compulsions and changing demographics. There is a likelihood of higher interest costs in smaller markets and sustained growth in off-campus facilities, with rural markets showing signs of faster recovery.
Portfolio Structure Changes
Public healthcare REIT filings are being keenly watched by investors wary about the flashing of red flags indicating something is amiss. However, most of the publicly traded scripts of healthcare REITs are very proactive. They disclose information to keep the investors informed to boost their confidence. The overall picture being depicted by these REITs is quite reassuring, especially for the retail and hospitality sectors. Some industry experts are stressing the continued dependability of the MOB subsector.
Skilled nursing facilities and senior housing are plagued by oversupply, labor-related problems, regulatory risks, reimbursement issues, which were present before the pandemic started. However, COVID19 has only worsened the situation, and these sub sectors are evolving as one of the hardest hit when compared to the other subsectors in REIT properties.
This subsector is suffering probably because of the population it services, prone to high risks from the virus. It is still not curtains for senior living facilities and nursing homes because of factors like the “Silver Tsunami” of the aging population of the 70s (the Baby Boomers), which can only trigger more demand for such facilities and overcome the oversupply that is plaguing the sector currently.
Changes in Property Mixes
The retail and hospitality sectors are more likely to witness changes in property mixes, which will largely be governed by investors and industry leaders’ investment goals and opinions.
Changes in the structure of portfolios may be based on how they react to the metrics like change in occupancy rates, rental revenues, and increase in property costs. Regulatory changes in specific markets or particular asset classes and general predictions of the healthcare and real estate sectors’ outcomes will also contribute to portfolio makeovers.
Based on these indications, several companies have already expressed their intention to make changes to the property mix by dispossessing current holdings to have increased liquidity by conveying their optimism in select asset classes and going public with their strategies harping on changes to portfolio composition.
Increase in Costs
Cost increases hit most medical REITs due to the effects of COVID19, which are likely to extend for a couple of years. Space planning and design have a forced makeover triggered by safety concerns and social distancing norms mandated by the authorities. The new design infrastructure features larger elevators, kitchens designed for minimal contact, and restrooms that call for fully automated fixtures to reduce transmission risk. All these translate to increased costs.
Some REITs anticipate an increase in cleaning costs and additional expenditure on PPEs, sanitation supplies, and extra pay to cover certain risks faced by building staff, all of which only add to the costs passed on to the tenants camouflaged as some component of the rent. Such increased costs may deter tenants from signing lease agreements and look for plausible alternatives like extended work from home cultures that do away with operating out of office premises.
Reliance on Equity Capital instead of Debt
When the pandemic hit the world, the REIT sector was somewhat prepared (though not for COVID-related issues) as it had strong balance sheets and enough liquid reserves. The sector had raised an impressive $440 billion in equity capital. According to CNBC, there’s still a ‘lot of opportunity’ in real estate as pandemic pinches the property market.
The funds they lapped up were deployed wisely to acquire additional properties, resulting in leverage ratios being the lowest in the past two decades. REITs were also smart enough to lengthen the maturities of their debts from the current 60 months to 83 months, thus buying more time. Such an intelligent move reduces the need to refinance debts in the coming months.
Summing it Up
The whole of 2020 has been a challenge for medical REITs and is likely to continue for several months, if not years. The future of medical real estate will largely depend on how COVID19 progresses or diminishes. Timely development of an effective vaccine may help control the pandemic, though how long that takes is anybody’s guess.