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The Aussie healthcare opportunity hiding in plain sight

Originally appeared in Live Wire Markets.

Australian investors are savvy when it comes to opportunities in healthcare – but this one has flown under the radar (until now).

With an ageing and affluent population, and a healthcare sector that has been recognised as one of the best in the world, most Aussie investors are familiar with healthcare opportunities. 

We have some great companies and healthcare providers that drive innovation and meet the demand both nationally and internationally. 

But what about the facilities within which healthcare services are administered? I would imagine fewer investors have considered that opportunity set. You couldn’t accuse Real Asset Management (RAM) of that, however. 

The RAM Essential Services Property Fund (ASX: REP) listed on the ASX in 2021, focusing on high quality Australian medical and essential retail real estate assets, leased to essential services tenants. But that’s not what we’re here to talk about today. Things have evolved since then, and RAM is launching a new, more focused, RAM Australia Healthcare Opportunity Fund

As Executive Director and Head of Real Estate Matthew Strotton explains:

“Over the last couple of years we’ve been become more focused on delivering bottom-up solutions in healthcare rather than pursuing pre-existing opportunities.

“We felt it was the right time to invest internally and form a team that were actively looking to pursue development and value-add opportunities – rather than buying pre-existing.”

Strotton adds that the RAM team has built a program that can now build opportunities and invest for the longer term. The team includes construction experts, who have long-standing relationships building and operating private hospitals. RAM has also worked to embed itself as a solutions provider that can work with and alongside operators.  

“The expansionary needs of our healthcare operators are symbolised by that because operators work so closely with their development partners, their landlords, to not only deliver upon the identified solutions but also find new ways to grow,” says Strotton. 

In the following episode of The Pitch, Strotton further explains the opportunity in Healthcare real estate, how and why RAM forms strong relationships with its partners, and why now is the right time to invest. 

Edited Transcript

What makes Australian healthcare such a rich opportunity set at the moment?

Matthew Strotton: It’s an interesting time for the market, not only because we’ve been experiencing such volatility in capital markets and what everyone’s well aware of – this inflationary period that we’ve gone through – but it’s given healthcare a little bit of a chance to reset itself in terms of what it means to be an investment sector for commercial real estate. 

Healthcare is still a maturing asset class, and in this environment, it’s given investors an opportunity to perhaps consider a wider range of opportunities from the listed sector to the unlisted sector and across the risk spectrum. 

There is a greater range of opportunities now for investors to pursue the asset class, and I think in this environment, where there’s heightened interest around the financial health of some of our operators and the ability to then pursue related real estate in and around the sector, I think is giving rise to more and more interest in the sector.

We seem to be at an evolutionary point in healthcare. How are you standing by your partners as they reassess the landscape?

Yeah, it’s a great question. It’s quite a prominent body of work for us at the moment. We’re sitting down, engaging with our operators, listening to what they’re experiencing. 

Like many sectors, not just healthcare, but like many sectors, this financial volatility, this financial market volatility, as well as a sustained level of volatility in inflation and certain other elements that have affected healthcare like labour shortages and labour costs, input cost rising, is causing operators to take a closer look at their models, both their financial models, their operating models. How they’re investing capital to grow their existing models, maybe they’re revisiting their operating models, and all of those potential changes they look to address give additional changes. Invariably, it’s a rise in the needs for their commercial real estate.

That’s where the partners like RAM come into the equation. The greater that we can understand those needs as they evolve, particularly in times like this, is going to give rise, I believe, to a greater range of commercial real estate solutions. 

The word you mentioned there is “evolution”, and the evolution of those needs is indeed changing. The typical form of healthcare real estate solutions is evolving over time. It’s becoming more localised, becoming a model that is more and more hybridised with the public hospital provision, the public health system provision combined with the private healthcare provision, and, as I said, as a landlord to a degree, but more what I see as a working partner alongside our operators to find and nurture those real estate solutions. 

I think it’s a very interesting time, and as you say, it’s a somewhat evolutionary, least of which because of the volatility we’ve experienced and how that’s drawing operators to revisit their models.

As your partners reassess their real estate needs, are they looking to extract more from existing assets, or are they looking to new assets – or a combination of both?

Matthew Strotton: I think it’s almost consistently a combination of both.

Some of the larger hospital provisions at the moment, it’s an interesting story where you do see the hospital expansion of services that combined with the pre-existing hospital services, and then you’ll see a cath (cardiac cathertisation) lab introduced, or there’ll be additional services, almost like they grow organically over time.

At one end of the spectrum, we still see that some of our partners are continuing to do those expansionary works. Notwithstanding, I think they’re taking a little, perhaps, of a pause in how they expand, but the provision of new services, a lot of our deal flow pipeline is working within the private operator space and expanding the day hospital provision, which, as I noted before, is really becoming a bit more localised. 

So they’re looking to expand not just in major urban areas but looking a little bit further towards outer suburban as well as regional locations because these day hospital provisions are becoming more effective. 

The treatment is becoming, I’d say, more effective again because treatment’s being able to deliver in a shorter timeframe, recovery times are reducing, so our operators are responding to that and introducing, again, it’s a simplistic way of almost more localised solutions.

Honing in on interest rate volatility, what impact is that having, and why is now the right time to be considering the opportunity?

It’s the forward-looking nature of real estate where interest rates have really taken their toll, that this initial volatility and now really where investors, where operators, and fund managers alike are expecting that interest rate volatility not only to cease, but where are interest rates going to land? 

And will that be at a sustainable level, and how that contrasts with cash yields and total return expectations, and beneath that, the potential for future leasing tension in effect to be able to offset those rises in cap rates through rental growth.

A lot of equations in there, but what it has done, like we’ve all witnessed, that interest rate volatility has caused a repricing in cap rates across all sectors. That’s impossible to deny. I do believe healthcare has probably fared the storm quite a deal better than retail and office. I think there’s a little bit more to come.

I think the consensus is that interest rates, there is still an element of unknown left in where interest rates are going to land. The statement that we will have interest rates at a higher level for longer. Look, I don’t think it’s such a bad thing for real estate. I think that the thing that concerns me with real estate is the ongoing uncertainty with what volatility remains. 

If we were to look ahead, and we’re at least somewhat more convicted in the notion that interest rates might be at or around this level for a longer period, that’s at least a more firm set of footprints to work from than the volatility that we’ve experienced.

So you will see cap rates reach a new level of equilibrium in all of our sectors. A lot of that will come down to that investor demand, which you and I spoke about earlier. That starts to re-emerge, looking for relative value in Australia. That will be, I think, the next most poignant indicator of where cap rates are going to safely land. 

The re-emergence of capital, particularly from offshore investors taking a look back into the Australian market, I think that capital has been a little bit more subdued over these last 12 or 18 months. I think, quite rightly, to witness this repricing. Once we get closer to that, where investors are confident to start putting capital back to work, that’ll be a very strong early indicator of where I think pricing is going to stabilise.

Can you tell us a little bit more about Real Asset Management and the healthcare opportunity that you offer?

Matthew Strotton: RAM has been investing in healthcare for close to 10 years now. Most will be aware of our listed vehicle that came into the ASX in late 2021, which is investing in both healthcare and essential services retail assets. 

At or around that time and over the last couple of years, we’ve been looking at, which is really a natural extension of our skill set in healthcare to become a little bit more focused on delivering bottom-up solutions in healthcare rather than pursuing pre-existing opportunities, which we still actively look at, we felt it was the right time to invest internally and form a team that were actively looking to pursue development and value add opportunities. This was, in effect, rather than buying pre-existing, “Let’s go and build a program that can then build those opportunities and invest for the longer term.” But doing that meant really bringing on board a team that was a little bit non-traditional.

We’ve got construction experts who have long-standing relationships building and operating private hospitals as opposed to a traditional investment or development manager where there might be a landlord-operator relationship. We’ve worked more to embed ourselves as a solutions provider that can work with and alongside our operators. 

The expansionary needs of our operators in healthcare really are somewhat symbolised by that because operators work so closely with their development partners, their landlords, to not only deliver upon the identified solutions but to work together to find new ways to grow. 

Having a strong partnering approach there has been very important to us, and I believe it’s paying strong dividends with our operators, who get to appreciate that landlord-partner relationship. 

This is really a partnering approach to work on both those identified and to-be-identified real estate solutions.