InFocus: Financing healthcare projects in Saudi Arabia – unlocking the hidden value

Mansoor Ahmed, executive director Middle East & Africa (MEA) Healthcare & Life Sciences, Education & Public Private Partnership (PPP) at diversified professional services and investment management company, Colliers, uncovers the financing methods to realise the hidden value in the Kingdom’s healthcare sector

The Kingdom of Saudi Arabia (KSA), with a population of 35 million is the most populous in the GCC. It is also home to the GCC’s biggest economy and is one of the largest in the region.

The Kingdom is undergoing fundamental structural changes as part of its Vision 2030, a framework aimed at reducing Saudi Arabia’s dependency on oil, diversifying its economy, and developing public service sectors such as education, infrastructure, recreation, and tourism. Healthcare also falls within this progressive strategy.

With the introduction of several legal and economic incentives, including 100% foreign ownership, the healthcare sector is one of the most attractive industry sectors in the Kingdom, offering numerous opportunities for private sector operators and investors.

Based on Colliers estimation, the KSA requires approximately 19,000‒20,000 additional beds by 2030. It will be a challenging exercise. Two of the biggest factors hindering the growth of KSA’s healthcare sector are the high cost of land and the availability of funds for capital expenditure — mainly for the construction of hospitals.

The opportunity, therefore, lies in unlocking existing value within the sector to support expansion programmes, or as alternative funding sources for new developments.

Unlocking the real estate assets through capital markets/REIT funds or through ‘sale and leaseback’ can potentially unlock a current US$59.0—US$63.4bn from property values alone, against a required investment of approximately US$33.8—US$35.6bn to establish an additional 19,000‒20,000 beds by 2030 within both public and private sectors. The unutilised US$25.2—US$27.8bn can be used to upgrade existing hospitals.

Capital financing one of the key factors hindering the growth of the healthcare sector

Establishing quality hospitals in KSA comes with a high funding requirement. Despite banks and other financial institutions actively seeking investments within KSA’s healthcare sector, they often limit their exposure by servicing known market participants with proven track records. International or regional operators contemplating entry into KSA’s market often struggle to secure project finance unless there is a recourse to alternative cash flows.

Further difficulties arise with the terms offered. Healthcare investments are typically long-term, something that conflicts with a bank’s risk appetite which typically extends to between 8—12 years.

First time entrants to KSA’s market without the financial resources ultimately end up searching for private investors to enter into a licensing and operating agreement from which they will extract a management fee. Alternative options include creating a Joint Venture (JV) with an investor whereby operators form and own the operating company (OpCo) while the investor owns the land and property (PropCo).

The various options available to operators based on availability of funds are:

  • Outright purchase of the land
  • Long-term lease of the land
  • Land as equity investment by the landlord
  • Long-term lease of the land and shell & core structure from landlord/investor
  • Creating a JV with the landlord/investor in an equity partnership;
  • Signing a management agreement with the landlord/developer/investor

Each of these options have financial, operational, and legal advantages and disadvantages and operators should seek professional advice before entering any such arrangement.

The Kingdom is moving towards encouraging more private sector participation in the healthcare sector, however the extent of investment required is significant.

Healthcare REIT A tool to fund development of healthcare projects and the capital market in the KSA

Although healthcare developments are traditionally considered as social infrastructure, healthcare assets are a legitimate class. Given the ongoing fractious and often volatile economic conditions traditional real estate and local bourses have offered limited scope to the private investor and regional funds.

Historically, healthcare projects supported by strong demographic demand attracted funds and private investors keen to seek out new avenues of investment. But as liquidity has fallen, so has the availability of finance for healthcare investment.

In the last few years, the healthcare sector has seen tremendous growth and continues to be one of the few sectors not to have been adversely affected by the economic fluctuations. This perceived immunity to economic cycles has made some view the sector as ‘recession-proof’.

In many institutional global markets, healthcare assets are normally considered as traditional ‘defensive (inflationary) plays’, offering low but firm yields. In the MENA region, these sectors retain their safe-haven status while providing returns that would usually fall in the ‘opportunistic’ category.

In last few years ‘sale and leaseback’ has gained popularity as an option for several existing operators who own their facilities but want to expand their operations by creating PropCo/OpCo structures, extracting value by selling and leasing back the real estate asset into a PropCo.

The PropCo, or asset, would then mainly be sold to institutional investors, with the property subject to a typical 25-year lease agreement.

The large ticket size of the investment, usually a minimum of US$50—US$70m for a 100-bed hospital, effectively excludes the retail investor from benefiting from the opportunities but, in Colliers’ opinion, one way of bridging the required investment is by creating more REIT funds.

Based on Colliers’ estimates, REITs in the Kingdom could unlock US$59.0—US$63.4bn in property value from the private sector, funds that could augment growth in healthcare.

In addition, the unitisation of physical assets also increases the size of the potential investor base. The expansion of REITs in the KSA is expected to benefit the Kingdom’s economy and capital markets by offering investors greater diversification, transparency, and accessibility to local real estate.

Moreover, it is expected to provide an opportunity for retail investors looking for the predictable income streams available from real estate assets.

Funding requirement by 2030 and conclusions

The healthcare sector in the KSA, especially in the private sector, offers several lucrative opportunities for developers, investors, and operators. However, it also possesses challenges: the high cost of capital; difficulties in attracting quality doctors and, especially, nurses; and funding constraints for new entrants.

The private sector and capital markets/REITs can play a significant role in fueling the growth of the healthcare market by providing much needed capital investment to fund the 2030 new hospital requirements.

Unlocking value from existing real estate assets through capital markets/REIT funds or through ‘sale and leaseback’ can potentially unlock US$59.0 to US$63.4bn from property values, which would deliver more than enough to cover the additional 19,000‒20,000 beds required by 2030 within both public and private sectors, and leave enough (US$25.2—US$27.8bn) that could be used to upgrade existing hospitals.

Colliers’ healthcare team is working with several market players to assist them in their plans either by expanding the presence of existing brands or attracting international brands to the region.

It is also assisting market participants with traditional funding options, such as debt and equity, or emerging funding options, such as OpCo/PropCo, or a JV with an investor, and REITs.