Lender Pullback Hits Healthcare Real Estate As Office Woes Spread

Office has become a four-letter word for many real estate lenders, and that sentiment is now bleeding into the healthcare sector. 

The sector has seen demand remain relatively stable in the wake of the pandemic, but the presence of office space within many healthcare properties is creating concern among some lenders who want to reduce their exposure to the asset class, panelists said at Bisnow’s Mid-Atlantic Healthcare Real Estate Summit earlier this month.

They said the sector has seen lending dry up and tenants become anxious about the financial health of the buildings they occupy.

Healthcare lending was down 76% year-over-year during the third quarter, according to a Mortgage Bankers Association survey — the largest drop in lending of any asset class. Sales of medical office centers were down 62% year-over-year as of September, according to CBRE. 

“Getting a term sheet today is cause to go out to Le Diplomate and have a big dinner,” Trammell Crow Managing Director Eric Fischer said at the event, held at the Washington Marriott Georgetown in D.C. “That's how the market feels.” 

Receiving a term sheet from a lender, an initial indication that they are willing to lend on a deal, has become increasingly difficult for borrowers in the healthcare real estate space, said Thomas Park Investments CEO E.J. Rumpke, whose private equity firm focuses on the sector.

“I got a term sheet a couple of weeks ago for 8%, full-term [interest-only], three years, and I was ecstatic that I even got quoted, and that just sounds so gross, right?” Rumpke said to chuckles in the room. “Who wants to hear that? I’m sure guys in the room are getting some similar stuff.” 

Traditional lenders are so averse to the office market that any deal remotely tied to the struggling asset class could be blacklisted, panelists said. Many healthcare properties have medical office components, and even though medical office has outperformed the traditional office sector, they said it is still making lenders wary. 

“Some of the big national lenders in our space are saying if it's over 5% office, we're not going to lend on it,” JLL Capital Markets Managing Director Brannan Knott said.

Fischer said deals with an office component should look for alternatives. 

“Anything that is classified office, even if it's 5% or 10%, you're not going to work with a traditional lender, and it’s all debt funds at this point,” he said.

The deals that are getting done are acquisitions with all-cash proposals, panelists said. But for those that need debt, having an established relationship with a lender is crucial.

Rumpke said the deals that his firm and others in the market have been closing on have been “cookie-cutter, down-the-middle, no-risk, all-cash” transactions.

“Up and down the capital stack with debt and equity, there’s just the lack of people willing to take risks and put themselves out there because they just don't need to,” he said. 

Medical office doesn't appear to be much of a risk compared to other asset classes, according to a CBRE report released last week. The report called medical office “one of the most resilient property subsectors” and said it has less than 10% vacancy. Most traditional office segments are over 15%.

“Over the last couple years, I've seen firsthand the difference between traditional [office] and healthcare,” LaSalle Investment Management Managing Director Shaun Broome said. “For instance, the physical building occupancy for medical office recovered very quickly after Covid because we’re all still getting sick. You need your doctors.”

With all the distress in the office sector, turning traditional office into medical could be an option if the prices drop enough. 

“The office vacancy rate in D.C. is the highest it’s ever been,” Colliers Executive Vice President Adam Schindler said. 

“I think there'll be a lot of consideration, whether it's a health system or private developer that will come in and buy these buildings on a very low basis, and contemplate conversions either for direct users, for various medical modalities or for complete and total redevelopment,” he added.

But like residential conversions, medical conversions require a few fundamentals to work. Panelists pointed to hurdles like generators, air circulation and ceiling heights. Parking is an especially sticky problem in concentrated downtown areas. 

Fischer said that in D.C., the Height Act makes conversions all the more difficult. But even in the suburbs, where they are easier, he said conversions must have all the right things going for them: the right lender, the right capital partner, a compelling story and pre-leasing for between 50% and 75% of the building.

“I get nervous when office buildings start to think they can just be 100% medical,” said Stacy Bell, assistant vice president of business development and real estate at Inova Health System. “We might be able to solve for the air handling. We have great partners. … The parking is not something that’s as easily solvable.” 

Amid the difficult capital markets environment, more office tenants have pushed landlords to prove that they are in good financial standing, and panelists said medical tenants are also raising these concerns. 

“We're doing a very large occupier now that’s probably taking a third to two-thirds of our building, and we’re working through transactions to give them absolute assurance that you're not going to give the keys back to the lender,” Fischer said. “They’re going, ‘Hey, I don't know if this owner is going to be here a year from now. I don't want to occupy two floors in a vacant building.’ So that's an interesting twist.”

For tenants that are wary of committing, Thomas Park is signing extensions for much shorter terms than it would have in the past, Rumpke said, including extensions for two to seven years to just keep the tenant in place. 

“Keep the bird in the hand, keep the tenant in there and try to keep them happy,” Rumpke said, adding that the thinking behind the strategy is along the lines of, “Let's kick the can down the road and see where the world is in 24 to 36 months.” 

Fischer said the financing market could also take another year or two to normalize.

“It feels like we’re a bit in the eye of the hurricane right now, in that eventually we’re going to hit some very tough winds,” Fischer said. “But then we can steer the ship … deploy the sea anchor and we can sail ourselves to a safe haven. It feels as though this will be a '24 to '25 window.”