European Healthcare Real Estate is increasingly seen as an asset class, not least because of its performance during the pandemic. Ed White, Client Consultant within the MSCI Coverage Team, looks at healthcare in context of the overall real estate market and analyses the reasons behind its recent strength and ongoing popularity
European Healthcare Real Estate built on solid foundations
MSCI Private Real Assets Indexes measure the investment performance of real estate across the world. MSCI produce a suite of healthcare indexes across Europe and in other regions incorporating investment performance of healthcare buildings owned by most of the major investors in the healthcare real estate market. The analysis presented below focuses on the previous year’s performance and places it in the context of the wider real estate market.
Capital growth, income return
MSCI’s Property indexes measure the unlevered total returns of directly held property investments from one valuation to the next. The use of Total Return as the principal measure of performance allows the analysis to be broken down between capital growth and income return. The structure of ownership, whether that be through a REIT, pension scheme or private equity fund for example, has no bearing on the underlying property investment returns.
Performance of real estate measured using Total Return varied across European countries quite markedly in 2020. Much of this differential was due to strategies and policies put in place by individual governments in response to the Covid-19 pandemic. The impact of these strategies and policies may have far reaching effects on the real estate market, both negatively and positively.
Certain policies, such as restricting the movement of people is likely to have benefited the logistics sector which carried on many years of strong performance throughout 2020. However, sectors that were more reliant on the movement of people such as shops, leisure and hotels did not perform nearly as well. Figure One looks at aggregated performance across the Eurozone for the individual sectors and it can be clearly seen Industrials, of which logistics is a major component, produced total returns in excess of 10% for the 12 months to the end of 2020. Leisure, one of the sectors which really suffered, produced total returns in excess of -10%. Healthcare across the Eurozone was one of the strongest performing sectors producing an annual total return of 7.4%.
The headline index total returns hide, therefore, wide volatility between sectors that cannot be ignored. Figure Two looks at the total return generated across sectors within each European country; the spread between top, which in all cases is industrial (apart from Switzerland) and bottom, which is almost exclusively hotels, are amongst the widest on record with some countries such as the UK, Belgium and Norway experiencing spreads in excess of 20% between top and bottom.
Beyond these headline sectors we can begin to break out different types of real estate. MSCI is reliant on contributors within each country to provide data from which we can produce robust and consistent indexes. Consequently, for the purposes of this analysis we will now focus on the indexes which have the greatest level of information for healthcare assets and begin to analyse the drivers of performance.
On a pure country level basis MSCI found that Sweden had the strongest performance in the year and the UK had the weakest performance overall when analysing the All property Total Return (Figure Three).
This pattern is replicated when looking at Healthcare assets in isolation too, however the most noticeable feature is that healthcare outperforms all property in all countries except the Netherlands where practical parity with the wider market is reached.
The valuation and occupier data as well as all associated property costs MSCI collect from contributors, allows us to perform a detailed deconstruction to help uncover the drivers of performance within these total returns. The first stage of this is to deconstruct the total return metric into its income component, principally rent, and the capital growth element principally valuation plus or minus costs. Figure Four shows the Capital Growth and Income Return for healthcare and the wider market in each country.
Excluding Sweden, what is most noticeable is the minimal level of capital growth across markets. This means recording of positive total returns in these countries are reliant on income return. The income return is the long-term defining feature which underpins European Healthcare performance year on year; 2020 was no different with higher income returns across all countries compared to the wider market.
Importance of income
Disruption to income has been one of the key determinants of performance in 2020. In the wider property market, some occupiers have negotiated differing terms to fulfil their rental payments and some occupiers have been unable to or decided not to pay rent at all. This cashflow volatility, something which is often not associated with real estate as an asset class, has been felt across the European Real Estate markets and, in particular, within certain sectors.
Never-the-less many markets have been able to grow income over the year contributing to the general long-term trend of income growth in real estate. Focusing on the largest markets in Figure Five, France and Germany have both grown income, if only marginally, although the UK has suffered at both the All property level and within the healthcare sector.
There are several reasons for the UK displaying this negative growth but perhaps most of all is the hastening of structural change occurring within the retail sector due to the pandemic.
We do see this across Europe, but currently, on a more limited basis.
The flip side to retention of companies renting property and growing income is measurement of vacancies within assets. Whilst we have seen marginal growth in income, we have also seen greater growth in vacancy rates throughout 2020. The largest markets saw an increase in vacancy across all sectors, although Germany recorded the greatest increase at the All property level, moving from 2% through to over 5% in the year.
Healthcare has not been completely isolated from this increase in vacancy but has not seen anywhere near the increase in other sectors. In fact, it was only the Netherlands that registered a significant uptick in vacancy, with the remaining markets maintaining the status quo.
Combining both the growth in income and the stabilised vacancy rate from healthcare real estate allows for a consistent level of income return generation and comfort that these cashflows minimise volatility. Chart Seven displays the income return and capital growth over the last three years and it can be clearly seen that the main driver of total return is the income component in most markets.
As the sector becomes increasingly complex and investment targets different types of healthcare real estate, the ability to disaggregate beyond the headline healthcare numbers becomes increasingly important.
Chart Eight looks at some of the differing types of healthcare real estate MSCI is currently recording at an aggregated European level. The performance differential between these sectors is surprisingly tight, particularly if we were to place them in comparison to different types of retail, for example. Medical Centres and Physical and Learning Disability Homes have tended to perform most strongly in the year although historically these have been marginally weaker in their performance.
Stability and growth
In summary, European Healthcare has performed extremely strongly in 2020 and is one of the top performing real estate sectors across most European Countries. The core element of this performance is the strong and stable income which is generated, underpinning movements in capital growth. The sector, from an investment viewpoint, simply hasn’t seen the volatility or extreme values other sectors have experienced over the course of the last 18 months.
This perhaps is one reason why we continue to see increasing allocations to healthcare real estate from institutions alongside increased volumes into newer types of real estate, in particular the wider universe of social real estate. Many organisations and vehicles aligning to United Nations Sustainable Development Goals (UN SDG’s) see healthcare as a core component of this strategy and consequently we hope to see the growth of indexes in this space in the future.