Harrison Street CEO: Cutthroat Portfolio Pricing to Continue in 2017

Nowadays, buyers are paying premiums for medical office portfolios—and that ultra-competitive pricing is likely to continue into 2017.

That’s according to Christopher Merrill, the president, CEO and co-founder of Harrison Street Real Estate Capital. Currently, the Chicago-based real estate investment management firm and its affiliates manage about $11.5 billion in medical office, senior housing, student housing and self-storage real estate assets across the country.

Medical Office News sat down last week with Merrill, who shared his predictions for the top medical office trends in 2017, why Harrison Street shies away from certain medical office tenants, and more.

Below are the highlights from the interview.

On medical office trends he expects to see in 2017:

“I think there’s a big incentive to continue consolidation in the health systems. In a lot of cases, it enhances the credit of your building. If you have multiple physician groups in a building, now they’re being acquired by the hospital system. That consolidation is driving stronger credit, so I think it will enhance the industry.

There’s also going to be a real need for more space. I think the industry’s going to continue to grow. The question is, will there be more development in medical office? Time will tell, but I think the industry’s going to continue to grow as things move away from the hospital setting. The growing industry is good, and should create more opportunities.”

On the trend toward off-campus medical office buildings:

“It’s all about the customer base. It’s sort of a hub and spoke mentality: get into the community, so [patients] don’t have to necessarily come to the hospital. Capture that customer. It’s a way to go into the community, grab your customers, without having to necessarily bring them to the hospital.

Really, it’s about who’s the credit behind the asset. We typically don’t want to just own an off-campus medical office that doesn’t have some sort of hospital affiliation. There are people out there who do invest in properties that are not affiliated with a hospital, that are off-campus or in the middle of different towns and [are occupied by] all third-party physician groups. For us, that’s not as resilient as if you had a hospital tenant in the market.

When we’re going off-campus, per se, it’s really got to have some level of backing by a hospital system that wants to be in that location. Because that makes it more resilient.”

On current medical office M&A pricing trends:

“I think it depends on the asset, but I think [pricing is] really competitive.

I think that in medical office, if there is a large opportunity for someone to move a lot of money, you’re seeing premiums—premiums for size, premiums for portfolio. There’s still opportunities to do onesie-, twosie-type investing. But if there are portfolios, pricing is getting pretty high.

People’s desire to say that they have medical office exposure is outweighing the actual underlying assets of the portfolio. So, that’s something that we’re not really chasing that prevalently, because we see the portfolio as we underwrite each deal, and we say, ‘Boy, they’re just not worth what that price is.’ But others see it as a way to really make a big splash, to have a medical office, to check that box.

We are seeing pricing for portfolios not really matching the risk/return profile of the underlying portfolio of real estate… but I don’t think I see the portfolio premium going away.”

On how the potential economic climate under President-Elect Donald Trump might impact Harrison Street and the medical office industry:

“When we set up our business, we tried to choose asset classes that were not tied to economic cycles. The investment that we do at Harrison Street is around education, health care, storage—these are asset classes that do well in good and bad times.

The economic cycle is not what’s driving the need for medical office. From our standpoint, we’re not trying to pick and choose when we enter the marketplace. To me, what does economic growth do? It can have some benefits, but it also has some negatives. Do you have asset classes that you can reprice your leases? 80% of the leases in our strategies are shorter-term in nature, not necessarily in medical office, but in senior housing, self-storage and student housing… in an inflationary environment, you can re-price your rents, so that’s a positive thing.”

On want- vs. need-based procedures, and what Harrison Street looks for in medical office properties:

“[Harrison Street looks for] a number of things [in a medical office asset]. We look for the backing, the hospital sponsorship, what’s the credit of that hospital, how well is that hospital doing. We look at the market—what are the demographics of the market that we’re in? What are the procedures that the building’s offering; are they need-based procedures or want-based procedures? Want-based procedures might not do well in tough economic times—are they dermatology or plastic surgery or things that are just not needed? We want to be in need-based procedures.

[We also make sure it’s a] quality facility, quality building, [that there are] the right amenities in the building [and] the right parking ratios.”

On the potential threat telehealth poses to the medical office industry:

“You can lump [telehealth] in with the same thing as online education. I don’t necessarily view it as a threat—it’s such a small percentage of the industry. I think it can be a complementary service if you offer it at your buildings or at your universities. I think kids are still going to go to universities, and people obviously still have to go to the medical office building for their procedures. I think it’s a complement—I think you’ll see some physician practices offering it as a way to complement their services. For me, it becomes an added service to the facility.”

Written by Mary Kate Nelson