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Medical building sector offers ‘great opportunity’

A nurse/educator leads a diabetes education class at a medical office. Experts agree that Canada’s medical buildings are a solid investment. But, to date, the country’s real estate investors haven’t realized this subsector’s full potential.

Fred Lum/The Globe and Mail

In early 2017, a medical office building on Toronto's popular Bloor Street West sold for $11.5-million. The four-storey structure has the zoning and redevelopment potential to be torn down and rebuilt as a 14-storey condo building.

But to do so would drop its value to $8-million, $3.5-million less than its value as a medical building – despite the fact that it is 10 storeys shorter.

At first glance the math doesn't seem right, but Huy Lam, a vice-president with Colliers who specializes in health-care real estate, says it is. The building is worth more as a medical building, with its 26 stable, likely recession-proof tenants – even in Toronto's red-hot condo market.

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"It doesn't matter if the economy goes up and down, health care will always be constant," says Mr. Lam. "We have universal health care so all of the doctors' [salaries] are guaranteed by the government and that makes the doctors as tenants very stable and safe."

The need for these commercial spaces is also expected to surge as Canada's population grows older, increasing demand for medical services and the buildings in which they are provided.

The experts agree that Canada's medical buildings are a solid investment. But, to date, the country's real estate investors haven't realized this subsector's full potential.

"In 2016 and beyond, there will continue to be strong demand for medical office space as health-care spending rises and demand from an aging population grows," according to Colliers' most recent Health Care Marketplace report.

Indeed, Statistics Canada reports that nearly 25 per cent of Canadians will be older than 65 by 2031.

Peter Riggin is president of NorthWest Healthcare Properties REIT, Canada's publicly traded medical building REIT (real estate investment trust), and he says he's surprised by the lack of activity given the enormous opportunity in the space.

"We see medical office buildings as good long-term investments and very appropriate for REIT investors in Canada," says Mr. Riggin. "They're looking for stable distributions and increasing distributions over time. Not huge home runs, but more singles and doubles, and we think health-care real estate and, in particular, medical office buildings provide that."

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Canada is lagging behind this global trend, especially compared with its southern neighbours. In the United States, more than 20 publicly traded health-care REITs own everything from retirement homes and medical office buildings to hospitals (an opportunity not available in Canada).

In fact, NorthWest has gone beyond its borders to countries such as Australia and Brazil to expand its portfolio to include private hospitals.

But Canada's market still offers great opportunities, according to Mr. Riggin.

"It's a very stable sector and it is because we have demographics as a tailwind to us, where we have an aging population and lots of continued growing needs for medical services," he explains. He adds that medical services are in demand in the country's urban, suburban and rural settings.

"In commercial real estate you can never ignore or discount location," says Mr. Riggin, whose Canadian portfolio is comprised of 58 buildings with more than 1,000 tenants coast to coast. "But in the world of medical office buildings, we feel it plays second part to the tenancy of the building. Really, to us, that's the key component to making a medical building appealing to us."

In fact, medical buildings often fall under the Field of Dreams philosophy – if you build it, they will come – as long as there is parking.

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"We're just at the front end of this [trend]," says Frank Magliocco, partner, national real estate leader for PricewaterhouseCoopers LLP. "There are some that are seeing this as a great opportunity and are ahead of the curve and are completely focused on this market."

Considered a niche market by PwC Canada, medical buildings are predicted to grow in popularity with developers and investors, according to its 2017 Emerging Trends in Real Estate report.

But many investors are at risk of missing out, says Mr. Magliocco, because they may underestimate "the profound effect" of Canada's aging population on real estate.

"I think that those [people] that anticipate it and those that have the leading edge, like those that are potentially investing now in some of these areas – like senior housing, retirement and medical – could benefit in the future."

Medical buildings may also have the added bonus of fending off the effects of rising interest rates – something experts expect to happen in the near future. Canada has not experienced an interest-rate hike for seven years and there are concerns that an increase from the Bank of Canada could put some commercial real estate operators at risk.

"It is a very interest-sensitive environment, without a doubt, so I'm not going to discount that," says Mr. Magliocco, but he cautions this situation gets "overblown."

He explains that because medical-building tenants tend to have long leases, this works to the owner's advantage in the event of a rise in interest rates.

"If you're a good operator you would have set your mortgage maturities and your lease profile maturities to sync up, so if interest rates do go up you can capture some of that increase through rental increases in the future."

He adds, "My opinion is that over time we are definitely going to see this particular segment grow."

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