Now is a tumultuous time in healthcare – Providers are under pressure from many different directions and a there are many questions about how these pressures and changes will impact health care real estate.  With over 35 veteran healthcare agents across the country, Healthcare Properties Group is in a unique position to understand how these dots are connecting.  What follows is a list of high-level trends the team is already observing, as well as trends that are anticipated.

Healthcare REIT’s are a Force to reckon with

As the economy (and markets) continue to struggle, investors are putting millions of dollars per day into Healthcare-centric Real Estate Investment Trusts (REIT’s).  One recent estimate is that such REIT’s have averaged over $40M per day in fundraising over the past 18 months.  It’s not a bad move for investors – Medical Office Buildings are high-quality and well-maintained, the leases are long, and everyone agrees that there will be continued demand for the services the tenants provide.  Furthermore, vacancy rates for MOB’s have averaged roughly 12% nationally since 2009… over 5% less than that of the general office vacancy rate.   To provide a return for investors – and thus continue growing and performing – REIT’s must deploy funds into working assets.  Therefore, REIT’s are increasing demand and subsequent transaction velocity.

As evidence of this trend, Garth Hogan, National Director – West for Grubb & Ellis’s Healthcare Properties Group, was recently quoted in a publication as saying, “The local investors have been more of a force in the medical office market in California, but we’re seeing that change.  The REIT’s are coming back to California and are getting more aggressive with their pricing.”

MOB Cap Rates are Low

As buyer competition has risen, cap rate have been driven down.  A panel at a recent healthcare-centered BOMA (Building Owners and Managers Association) conference stated that recent cap rates ranged from 6 percent to 8 percent for acquisitions.  For new developments, the rates are about 1% higher.  These rates are significantly lower than current cap rates for other offering types.  According to Clint Parker, the Capital Markets Specialist for the Healthcare Properties Group, “Two years ago, REIT’s were averaging cap rates in the low 8% range on acquisitions, and these numbers rarely went below 7.75%.  Today, the low 7% range is fairly common for premiere On-Campus Medical Office Buildings.”

Consolidation

Accountable Care Organizations (ACO’s) and Electronic Medical Record (EMR) requirements are two among two initiatives forcing costs on practitioners.  Meanwhile, reimbursement cuts and payer mix shifts threaten the very revenues needed to cover these costs.  When combined, these factors place an extra-heavy burden on small practices.  For many such practices, the simple answer is to join with a larger practice group or a hospital – a trend that has been going on for several years already.  A recent Medical Group Management Association (MGMA) report asserted that nearly 50 percent of medical practices were owned by hospitals and health systems as of 2008, and the industry consensus is that this number has since steadily risen and will continue to rise.

Real estate wise, this consolidation will manifest in two primary ways – at the business level and the space level.  Business-wise, it will require more creative and strategic thinking.  As Todd Perman, National Director – East for the Healthcare Properties Group puts it, “Consolidation between medical practices, hospitals and health systems will be a given in the coming years.  That consolidation will definitely drive more real estate issues with reuse, monetizations, and a variety of alternative real estate strategies being increasingly common.  Organizations that understand the trends will be much better positioned to survive these trying times.”

At the space level, this consolidation trend manifests itself via larger spaces.  As practice groups add doctors, their space requirements grow.  Similarly, as hospitals and systems buy up practices, they wind up controlling larger percentages of buildings and tend to merge these various small groups into a single, larger or multi-specialty space.  On this topic, Hogan recently stated, “As the cycle progresses, we’ll see more demand for large floor plates of 15,000 to 40,000 square feet from medical office tenants.”

Healthcare Facilities will be More Varied

Historically, MOB’s within walking distance of a hospital (“on-campus MOB’s”) were the sole trophy assets of the medical world and off-campus buildings were a varied lot.  As the world has grown “flatter,” however, so has medical real estate.

Today, in markets across the country, offices and retail centers are being converted to medical centers.  One such example occurred several years ago in Newport Beach California, where a 200,000 SF office park was converted from regular office use to medical.  The property had to be re-zoned, base systems like HVAC and plumbing had to be enhanced, and a parking complex had to be added.  And it was a success – the facility is now fully leased.

Many new developments are also going off-campus and implementing new design models.  As consumers demand more and more convenience, town center models are developing in which retail, office and high-end medical properties (and sometimes residential) are all merged into the same development.  These developments are frequently located in – or abutting – busy population centers.  Future re-use plays an important role in this off-campus strategy, as the facilities can be be re-purposed according to future demand shifts.  An example of this design is Atlanta’s Perimeter Town Center, which adds retail, personal professional services, and even education to a very strong (and very convenient) medical development located within 2 miles of a significant hospital campus.

New construction will continue and even increase

With an adjusted 9 million new patients expected to be added to America’s health care system via the Healthcare reform legislation, it’s a given that more medical space will be needed.  A recent statistic from the CBRE Econometric Advisors / Dodge Pipeline states that there were over 1,200 MOB projects under way and over 4,300 planned as of the end of 2011.  These two factors alone lead to the inevitable conclusion that new Medical Office development will continue.

In conclusion

In this changing healthcare climate, the key to success for practitioners, hospitals, and investors is a strong and current awareness of the macro- and micro-economic drivers affecting all involved parties.  Those who understand the extraordinary pressures from legislation, compliance, capital requirements, reimbursement cuts, consolidation, competition, and a huge influx of patients – and grasp how they impact all aspects of an organization (real estate or otherwise) – will have the clarity needed to react quickly, with foresight and knowledge.  In the end, these organizations will emerge stronger and better poised to prosper in the years ahead.

Specific to healthcare real estate, it’s similarly true that not all commercial real estate teams are created equal, and it’s important to work with a team that truly specializes in healthcare. There are many excellent teams across the country with a deep understanding of commercial real estate.  However, there are very few real estate teams that have a deep understanding of healthcare’s intricacies and cause-and-effect relationships  AND a possess full grasp of all aspects of the commercial real estate world.  And there are fewer still with a national reach and true inter-agent collaboration for the sharing of knowledge, trends and best practices.  Just as one visits a medical specialist for an important medical issue, it is well worth the time to seek out a specialized healthcare real estate team before making that next big real estate decision.

About the Author

John Cobb is a Senior Advisor with the Healthcare Properties Group at commercial real estate firm Grubb & Ellis.  John specializes in healthcare and healthcare technology representation, primarily in the southeast. You can find his bio and contact information at http://www.healthcarepg.com/john_cobb_bio.php.

Garth Hogan

HPG’s own Garth Hogan (National Director – West) was recently quoted extensively as a source in the national publication Real Estate Finance Intelligence.  The text that follows offers summary highlights from that article.

Trend #1: Cap Rates are dropping as buyer distributions shift

Cap rates are dropping for medical office buildings in California as more national players are looking at acquisitions in the state.  “The local investors have been more of a force in the medical office market in California, but we’re seeing that change,” said Garth Hogan, co-head of the healthcare group at Grubb & Ellis.  “The real estate investment trusts are coming back to California and are getting more aggressive with their pricing.  We’re starting to see sub-7% cap rates and more and more competition for buildings for sale.

Trend #2: Physicians employed by hospitals

There is a national trend of physicians giving up independent practices to be employed by a hospital or medical group.  This phenomenon is clearly evident in some California markets, such as San Diego.  “In markets like Los Angeles and Orange County, physicians are less prone to want to be employed by a hospital or medical group. But in San Diego, this model has been employed for years and the city is growing into this without effort.  The same is true of Phoenix,” Hogan said.

Although some markets in the Western U.S. and nationally haven’t been able to adapt to this shift, it will become more important as health care reform legislation is implemented.  “One of the requirements of the legislation is that physicians have to store all records electronically, which is very expensive and technical,” Hogan said, noting that this is easier for a doctor to achieve as part of a larger organization.

Trend #3: Larger floor plates

This shift to physicians as employees means that there will be growing demand for large floor plates of 15,000 to 40,000 square feet from medical office tenants, he added.

Trend #4: Adaptive Re-use

Similar to the rest of the country, there is substantial adaptive re-use going on in California, with offices and retail centers being converted to medical office centers.  Hogan pointed to a medical office park in Newport Beach that had been acquired and converted from a regular office park several years ago.  The owners had to get the property re-zoned for medical use, enhance certain systems such as increasing the water and HVAC systems and adding a parking complex.  The 200,000 square-foot complex is now fully leased, he added.

Trend #5: Limited New Development

There is little or no speculative medical office development but Hogan noted that a new development can get financing with significant pre-leasing of 50-75%.  Cities such as San Francisco are seeing more new development or adaptive re-use of downtown properties.  “If there is demand from major hospitals, an investor will align for a project, “Hogan said.  Other factors governing development are population density and income levels, he added.

You can find Garth’s bio and contact informaion at http://healthcarepg.com/garth_bio.php.