U.S. Healthcare REITs Can Withstand Medicare Reimbursement Cuts

By Jan Svec,
Senior Director, U.S. REIT group, Fitch Ratings

Recently announced cuts to Medicare’s Prospective Payment System sent shock waves through the healthcare industry. Despite this news, healthcare REITs are well-prepared to deal with reimbursement cuts. There will be uncertainty in the market until owners and operators implement strategies and action plans to deal with the reimbursement cuts. A likely outcome will be increased mergers and acquisitions.

Healthcare REITs, nonetheless, are in a strong position due to three major reasons.

Portfolio granularity: Healthcare REIT portfolios are generally quite granular and are expected to grow in size over time. This trend is a plus, because granularity can diversify a REIT’s exposure to the many risks inherent in the industry including, but not limited to, exposure to volatility in reimbursement rates and regulatory risks. Many of these risks vary significantly across property types and geographic regions.

Location, Location, Location: Location is important to tenants in all sectors of commercial real estate, but nowhere is it more important than in healthcare real estate. Generally, tenants have multiple choices for leasing space and are typically less dependent on specific assets for their business profitability. However, owners of healthcare real estate are generally in a better relative position in lease negotiations with operators because, without the facilities, the operators would not be in business.

Strong Asset Management: Healthcare REITs have demonstrated a solid track record of optimally managing their portfolios. Strong management has traditionally included portfolio recycling as well as lease structures that provide downside protection and opportunities to renegotiate key terms or change operators if the operator defaults. REITs are prohibited from operating the facilities that they own; therefore they must be skilled at finding good operators and adapting to changing market conditions.

It should be noted that Fitch has long-viewed and still views declining reimbursements as a credit concern. Nonetheless, healthcare REITs are in a strong position to deal with pending reimbursement cuts for the foreseeable future.