COVID-19 has introduced an altered reality for many around the world. With measures such as social distancing and forced quarantine, COVID-19 has induced an unprecedented global response to combat the rapid spread of the virus. The economic impact has been just as severe. As of April 23rd, American unemployment claims over the past five weeks have surpassed 26 million, a record-breaking surge over the short time period.i Stock market volatility, as measured by the CBOE Volatility Index (VIX), hit a record high on March 16th as investors panicked about the economic fallout due to COVID-19.ii
To help keep the economy afloat, the federal government passed a historic $2.2 trillion CARES Act stimulus bill on March 27th, providing direct checks to individuals, a boost to unemployment benefits, billions in loans to struggling agencies, and various tax credits.iii However, the initial Paycheck Protection Program, a business loan program to incentivize small-businesses to keep employees on their payroll, drained all of its $350 billion allocation within two weeks. Congress passed an additional $484 billion stimulus bill on April 21st, adding $320 billion more to the Paycheck Protection Program.iv
The market has responded well since its low in late March, rallying over 20%. Whether this rebound is founded in economic reality is yet to be seen, while millions of workers continue to lose their jobs and poor earnings reports reveal the effect of COVID-19 on the company’s bottom line. The next wave of uncertainty comes with the reopening of the economy. Every state is amid developing guidelines for the eventual reopening of their respective economies. States such as Georgia and Oklahoma look to reopen in the coming days, while others are offering a more conservative approach.v Health professionals are worried that reopening the economy, if premature, will lead to another spike in infection rates. There are points of optimism, as recent studies suggest fatality rates are lower than 0.2%.vi However, this finding relies on the accuracy of the antibody tests and other various assumptions of the population. Overall, there is still great uncertainty surrounding COVID-19, and the world is attempting to both understand and to blunt the impact from prolonged effects due to the virus.
How Has COVID-19 Affected the Healthcare Industry?
COVID-19 has had a bifurcated impact on America’s health system. Some hospitals in COVID-19 hotspots, like Queens, New York, are at or near capacity. Healthcare professionals at these hospitals are working long hours and exposing themselves to a highly contagious virus while experiencing an unfortunate shortage of personal protective equipment and other medical supplies, such as the ventilators necessary to treat critical COVID-19 cases. Other hospitals removed from COVID-19 hotspots are instead dealing with empty hospitals and employee furloughs, as they are not able to perform elective procedures.
The human suffering component of the COVID-19 crisis is deservedly given the most attention in the media and overall public conscience. However, the financial damage to the health systems will also have a lasting impact. Health systems contending with COVID-19 are having to allocate large amounts of capital towards the crisis and are unable to perform profitable elective procedures for less profitable treatment of COVID-19. Without raising reimbursement premiums, these hospitals are expected to lose an average of $2,800 per case, but, depending on the payer mix, losses could potentially amount to $8,000 to $10,000 per case.vii Health systems removed from COVID-19 hotspots, also unable to perform elective procedures, are contending with a lack of patients, empty hospitals and a precipitous drop in revenue that they are trying to offset with employee furloughs. According to the US News Hospital Rankings, an average of 25% of admissions to the top 10 hospitals in the U.S. were elective during the 2019 fiscal year.viii
Large health systems with hospital campuses are experiencing their fair share of financial pain, but perhaps even harder hit are the small private practices. With consumers told to stay home, private practices are struggling to cover overhead without a consistent revenue stream and “with some practices seeing no-show rates jump from 5% to 75%, smaller groups have had to resort to laying off employees to keep the doors open.”ix
The Effect of COVID-19 on the Future of Healthcare Real Estate
Expansion of Hub-and-Spoke Model
The effects of COVID-19 are likely to accelerate healthcare providers’ transitions to the hub-and-spoke model, increasing the demand for outpatient clinics ranging from 10-50k square feet. Aside from the lower costs associated with specialized clinics, COVID-19 has shown health systems the importance of keeping patients out of the hospitals to avoid overcrowding and resource shortages during a crisis such as the current pandemic. Also, COVID-19 has had and will continue to have a similar effect on consumer psychology, as patients will continue to prefer outpatient visits than to expose themselves to the infectious environment of a hospital, if possible.
Another trend that could emerge from the experiences of the COVID-19 pandemic is an increased portion of the workforce that works from home (“WFH”) full-time. Some estimates suggest that, pre-COVID-19 crisis, less than 4% of the workforce worked from home more than half the time. However, the same study suggests 56% of jobs could be conducted remotely with some regularity and 35% of employees would change jobs for the opportunity to work remotely full time.x The COVID-19 crisis has forced employers into a trial run on expanding working from home. Given the interest from employees in working from home, as suggested by the referenced study, and assuming this forced trial run makes employers more comfortable with employees working from home, it is likely that the amount of people working from home is likely to increase dramatically. Daytime populations in commercial clusters are likely to decrease and increase in residential neighborhoods. To respond to this shift in daytime population patterns, healthcare providers will be forced to provide more medical office space closer to the residential neighborhoods, which will further accelerate the demand for 10-50k square foot outpatient clinics.
Finally, the hub-and-spoke model should continue to expand as more practices are absorbed into the larger health systems. As stated above, one of the main crises currently affecting the healthcare sector is the struggle of private practices to stay afloat during the pandemic, which could lead to more consolidation of the health care industry into the larger systems. In turn, the expansion of larger systems will increase the need for Class A medical office space to support the absorbed smaller practices.
Shift in Capital Allocation
Faced with dramatically reduced revenues, health systems have had to fund losses and reevaluate long-term capital allocation. While the pandemic is still prevalent, normal capital expenditure budgeted for investing in and upgrading real estate will be put on hold. Looking forward, health systems have already indicated that long-term capital plans will need to be reevaluated. For example, Kaiser Permanente recently announced they were cancelling their planned $900 million, 1.6 million-square-foot headquarters in Oakland, CA. Kaiser’s decision could indicate that the COVID-19 pandemic has shown healthcare providers the importance of keeping cash on hand to remain nimble when the industry is faced with the next healthcare crisis. This dynamic could lead health systems to shift their real estate strategy towards leasing as opposed to owning.
Implementation of Telehealth
COVID-19 could be the catalyst that pushes telehealth to the forefront of primary care. On March 17th, the federal government announced that telemedicine services would be fully covered by Medicare through the length of the outbreak.xi This announcement aims to limit unnecessary exposure for people who need noncritical care, however, it could also be setting up an easier transition to telemedicine post COVID-19. Prior to the announcement, telehealth care had largely been limited to people living in rural areas, forcing many patients to meet face-to-face in compromised medical facilities. The quick adoption of telemedicine by both healthcare providers and patients during the pandemic indicates that this technology will likely be embraced by many in the future. A 2019 study stated that “66% of consumers are willing to use telehealth, and 8% have tried it”.xii Besides patients, it will be important to monitor how private insurance reacts to this change and how telehealth reimbursement rates will be structured going forward. The healthcare system has the technology to implement telemedicine, and COVID-19 is pushing this change along at a rapid pace.
This implementation of technology will likely result in a shift, but not a complete overhaul, of the healthcare real estate strategies. Dr. Barbara Spivak, Mount Auburn Cambridge President and Chairman predicts that one potential shift will encompass the in-person patient mix. She believes that primary care physicians will deal primarily with patients with chronic care conditions, as those without underlying conditions will be treated virtually.xiii Additionally, there might be increased specialization among medical offices, and healthcare real estate will need to adapt. These technological changes, however, will not diminish the need for procedural outpatient clinics and other medical offices that require face-to-face appointments and surgeries. Investors and developers within the healthcare real estate space should be prepared to adapt to new challenges caused by telemedicine, but healthcare is still an industry that largely requires in-person visits.
Healthcare is still viewed as a defensive sector investment, and many investors will likely continue to allocate capital towards healthcare real estate at their current pace as a prolonged recession looms in the coming months. According to a survey completed by ERE Healthcare Real Estate Advisors, 73% of healthcare real estate investors plan to continue acquiring properties within the sector.xiv The long-term investment plans have not fundamentally changed due to COVID-19. Additionally, investors may allocate more towards healthcare real estate because of the uncertainty surrounding the retail and office sectors. Office investors are uncertain how work-from-home practices will affect the sector post COVID-19, and brick-and-mortar retail properties were already facing pressures due to the rise of online-retail. The COVID-19 lockdowns are forcing tenants out even earlier than expected. Healthcare real estate, by comparison, is a haven for investors. A recent report released by Green Street Advisors, LLC evaluated 18 segments of the commercial real estate market and found that MOBs should provide the lowest level of risk in the event of a coronavirus-sparked recession. This continued interest and investment in healthcare real estate should help keep the overall cost of capital low, which drives lower rent rates for tenants on existing and new-build projects.
The world is currently on hold, waiting to see what the new normal will be post COVID-19. The social and economic impact of the virus will influence the future of healthcare real estate, forcing those involved to adapt. Going forward, healthcare providers will likely expand on their hub-and-spoke model. Providers will look to expand their reach rather than clustering outpatient centers around hospitals. This will force a shift in capital allocation, as providers may seek to lease rather than own in order to avoid committing capital to long-term projects. Providers may also increase their reliance on third-party developers instead of undergoing their own build-to-suit projects. Additionally, telemedicine has illustrated that it has a future in healthcare. This technology could alter the in-person patient mix in the future and is something to be monitored. Ultimately, healthcare real estate should be considered a safe investment to place capital during these uncertain times. COVID-19 has shifted the future of healthcare real estate, yet it has also increased the sense of urgency around the need to strengthen our healthcare industry for the future.
Authors: Ben Ivory and Kyle Ulman