Dialysis Net-Lease Properties and the Tenant Success Entanglement

As a result of the COVID-19 pandemic, the net lease medical office market has seen all-time highs in investor demand, transaction volume, and cap rate compression. In 2021, medical office transaction volumes topped $16 billion—the sector’s all-time highest. Previously, the medical office sector saw its best year in 2017 with $15.5 billion in transaction volume. With many retail tenants struggling to pay rent as a result of the pandemic, investors found a safe haven in medical office assets. The medical office sector established itself as an area in which investors could shield themselves from the three main concerns within the retail sector:  the pandemic, a recession, and the Amazon Effect. 


Within the medical office sector, dialysis clinic properties have always been a focus for net lease investors. DaVita Dialysis and Fresenius Kidney Care are two of the blue-chip names who have seen cap rate compression over the past two years as a result of the pandemic. However, as COVID continues to wind down, it is important to take a step back and evaluate how the pandemic affected these clinics, as well as the short-term and long-term outlooks for the asset class. While it is true that investor sentiment has deemed dialysis clinic properties to be pandemic-proof, recession-proof, and Amazon Effect-proof, there are a number of other factors which could impact your real estate investment. 


One of the main reasons net lease investors like dialysis clinic properties is because of the growing rate of chronic kidney disease among our aging population. There is a constant and growing supply of patients who will need the services offered at brick-and-mortar dialysis clinics. While I do agree in general, it is important to note that COVID-19 had a disproportionate effect on dialysis patients. Chronic kidney disease was one of the top comorbidities for COVID-19, with a crude mortality rate of 44.6% among COVID patients with CKD (according to the NIH). This means that clinics which may have been strong performers before COVID may not be anymore depending on how many patients were lost to COVID. 


More specifically, patient insurance is a main factor in the strength of the clinic, including how it pertains to the real estate. It is true that private insurance patients are more profitable for the clinics, as private insurance companies pay higher rates of reimbursement to the clinic. On the other hand, patients on public or government insurance are less profitable for the clinics, as the clinic receives lower reimbursement rates. If a clinic loses a patient who was on private insurance and replaces them with a patient on public insurance, the clinic becomes slightly less profitable. This is always something to consider when investing in a net lease asset with high patient turnover such as a dialysis clinic, but especially so in this post-COVID healthcare landscape. 


On top of that, shifting incentives for healthcare providers will affect dialysis clinics and other medical office investments. In general, we are seeing the introduction of Pay-for-Performance initiatives and incentives.  Pay-for-Performance is designed to improve healthcare by rewarding strong performing clinics with higher reimbursement rates. Conversely, clinics that are not performing well can be penalized financially for poor performance. As a net lease investor, it is important to consider how the compounding success or compounding failure of clinics due to pay-for-performance incentives may affect your investment. 


Additionally, there continue to be incentives for kidney transplants and at-home dialysis availability, which can drive patients away from brick-and-mortar dialysis clinics. For example, DaVita Dialysis recently announced the formation of their new company focused on the development of at-home dialysis treatment solutions in collaboration with Medtronic. This announcement demonstrates the need for dialysis providers such as DaVita to keep up with the shifting healthcare landscape and invest in alternative solutions, which will ultimately pull patients away from their brick-and-mortar locations. 


Whether you are interested in buying, selling, or holding a dialysis clinic property, it is important to consider how the above will impact the net lease dialysis space. First, we are already seeing more consolidation among dialysis tenants in markets where they had multiple clinics. In order to shield yourself from this risk as a net lease investor, focus on dialysis clinics in states with Certificate-of-Need requirements. CON laws make it difficult for new clinics to enter the market, as well as for clinics to shut down, as they require approval by the state to do either. 


Evaluate the possible strengths and weaknesses associated with your dialysis clinic property and how those relate to the aforementioned factors. More specifically, here are some things to consider:

  • Does this market have enough patients who need dialysis?
  • Consider the demographics. Specifically median household income:
    • Lower income communities have higher rates of CKD.
    • Higher income communities likely have more patients on private insurance. 
  • What services does the clinic offer? 
    • Does the clinic offer at-home dialysis training services?

Income (or median household income) can be a solid indicator of performance associated with a dialysis clinic. Unfortunately, lower income markets are more prone to chronic kidney disease and therefore typically have higher demand for dialysis clinics. However, clinics are not guaranteed to perform well in low-income markets, so investors run the risk of having to redevelop and re-tenant those clinics, which may be more difficult in those tertiary markets. On the other hand, dialysis clinics in higher income markets are easier to redevelop and re-tenant if the dialysis tenant vacates.  Additionally, dialysis clinics in high-income, or primary and secondary markets, are likely to have a higher rate of patients on private insurance. As you can see, there are many contradicting factors related to dialysis clinic real estate, which can make it difficult for many net lease investors who are typically looking for minimal risk and responsibility. Alternatively, consider investing in a medical office asset with less patient turnover than dialysis clinics, such as urgent cares, dental clinics, or ambulatory surgical centers.  


Aside from dialysis and medical office assets, industrial properties also saw increased investor demand and cap rate compression since the start of COVID-19 and may be a strong alternative for investors. Given the current state of the economy and recessionary environment we find ourselves in, I believe there are specific areas of industrial real estate that are well positioned to perform strongly over the next few years. I am cautious of retail distribution warehouses, such as Amazon distribution facilities, as inflation has been driving down consumer spending on retail products. I believe the strength lies with industrial tenants who focus on building supplies/materials and their distribution, as we still face various supply chain shortages. 


While net lease investors have seen a push towards medical office assets over the past two years, there are certainly weak spots associated with the asset class, which demonstrate that the medical office sector may not be the safe haven investors thought it would be. Despite thriving throughout the pandemic, dialysis clinics may now be at an inflection point. There are many questions to be answered for dialysis clinics and medical office assets in the current, post-COVID, political and economic landscape.


Connect with Chris Conley: