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How an epidemic revealed a supply gap in Chinese healthcare real estate

The rapid spread of coronavirus has thrown a spotlight on the country’s growing need for healthcare facilities, a sector of the local real estate market that remains undercapitalized.

The coronavirus epidemic has wreaked havoc on the retail and hotel sectors in China, with more than 75,000 cases in the country alone as at time of publication. However, the crisis has highlighted another challenge in the nation’s real estate market: the current undersupply of healthcare facilities.

As of February 2019, there had been a total of 33,000 hospitals in China, an increase of 1,866, or 6 percent, from the same period in 2018, according to one industry report. Although the increased demand for healthcare real estate in the wake of coronavirus has been difficult to quantify, news reports have depicted the supply/demand imbalance for facilities. A report from the New York Times described “long lines” as “a standard feature of hospital visits in China” as people prefer to visit the top hospitals – these hospitals are concentrated in the developed and wealthier cities in the country.

David Ellis, partner at international law firm Mayer Brown, said healthcare remains a small sector in Chinese real estate. “Healthcare real estate is not something that a private equity real estate fund would necessary go for because the asset is not as liquid as something like an office building,” Ellis explained. “Particularly when you are talking about hospitals, investors have big barriers in terms of investing in China because it is highly regulated as to whom could own the business.”

China has seen minimal foreign investment into the healthcare real estate sector to date. Since 2015, $2.3 billion has been invested in Chinese healthcare properties, with just $0.1 billion coming from outside mainland China, according to real estate transactions provider Real Capital Analytics. The transactions recorded by Real Capital Analytics were for development sites for hospitals and clinics, not existing assets.

Ellis told PERE that foreign investors face restrictions in owning and operating medical facilities, with the maximum equity they can own capped at around 70 percent. Most overseas investors will therefore need to work with a local partner when deploying capital in China’s healthcare sector.

In most cases, when land for a hospital is put up for tender, the government will require an operator to buy the land alongside the developer, according to Ellis, describing the typical investment process for hospitals in China. As a result, the developer and the operator will usually create a joint venture vehicle to acquire the land, so both the asset and its operation tend to be under the same entity, he said.

It is not easy to find a reputable operator in China, however, noted Collin Lau, founder of Bei Capital and founding shareholder of Hong Kong-based medical group Virtus. Most of the hospital operators are government owned and the number of foreign operators in the country is limited. Even if a developer could bring in a good operator, the firm would need to be well-versed on the licensing issues, he said.

Land supply for medical properties is another obstacle, according to Jeff Liu, managing partner at China-focused manager Starcrest Capital Partners. “There isn’t a lot of land that has prerequisite environmental approvals in place to build medical facilities, especially in infill locations of big cities like Shanghai that already benefits from the cluster effect of a well-established pharmaceutical industry.” A recent example would be the 2017 closure of Shanghai Redleaf International Women’s and Children’s Hospital, which was forced to shutter, reported the Hong Kong Free Press, by the local government because it was “illegally built on land owned by the armed forces,” according to an official announcement.

Barriers to entry aside, there are other reasons healthcare real estate investments in China do not make sense to most institutional real estate investors, according to Paul Guan, partner at international law firm Paul Hastings.

“Firstly, these investments require a long operational time to become profitable, while most private real estate funds can only hold the assets for up to five to six years,” Guan explained. Besides, most sizable healthcare properties can only be leased to general hospitals rather than specialized hospitals. Unlike specialized hospitals, general hospitals do not generate enough profits to afford rents that could meet the return requirements of most institutional investors, he added.

Although specialized hospitals are more profitable, they are relatively small and do not require significant capital, says Guan. The ticket size of these investments would therefore be too small for most institutional investors, he added.

Deals do happen, however. Laboratory facilities are a growing subsector in the healthcare real estate sector in China, according to Liu. Starcrest, for example, paid $110 million for Starcrest Life Sciences Parc, an asset being used for laboratory facilities, in 2018.

Some landlords are also endeavoring to form clusters of clinics within some of their office buildings, according to Ellis. He is seeing more investors looking to incorporate healthcare elements into new or existing real estate properties.

Medical clusters are not uncommon in Hong Kong, a city which is famous for its medical tourism industry among Chinese visitors, according to a CBRE report. For example, a commercial building in Central, the central business district of Hong Kong, was fully leased to Virtus in Hong Kong. The report points out that medical tenants typically are willing to sign a longer lease up to 15 to 20 years and pay a 10 to 20 percent rental premium compared to the traditional office occupiers in the city. However, Lau points out that licensing issues for both healthcare operators and landlords in China are more complicated than in Hong Kong.

Despite the regulatory hurdles in the sector, healthcare spending in China has climbed from less than 500 billion yuan ($71.6 billion; €65.8 billion) in 2000 to more than 5 trillion yuan in 2017, according to a JLL report. The upshot in demand will bring a “renewed focus” on the sector, the report stated. That focus stands to only sharpen as coronavirus continues to ravage the country and its economy.