Speculation about the ancillary (and perhaps unintended) effects of President Barack Obama’s healthcare reform plan abounds, and now real estate investors are wondering whether how it will impact the medical office space market. The consensus is that stability and persistent need in the market will vouchsafe successful growth, particularly in property on medical campuses and outpatient facilities. Demographics are a huge driver in this area as the country prepares for a 36% increase in people aged 65 and older in the next decade. For more on this continue reading the following article from National Real Estate Investor.
The medical office sector has historically performed well—even during the recession—and this year should be no exception, according to analysts who say indicators point to a year of increasing activity.
Such predictions come even as providers of healthcare face some daunting headwinds, including uncertainty about the impact of President Barack Obama’s proposed healthcare package and the status of Medicare and Medicaid in a time when cuts to government spending are likely. But these concerns are not likely to discourage investors who recognize the many upsides of medical office space.
“We’re just seeing more and more investors being attracted to the space because of the stability of the product type,” says Chris Bodnar, head of the Denver-based healthcare capital markets group for CB Richard Ellis. “Physicians usually invest a lot of money into their spaces, and patients are location-sensitive,” he says. Plus, sites with multiple tenants often benefit from a synergy of foot traffic and referrals within the building, as doctors feed each other business.
Investors have focused much of their attention to date on properties on hospital campuses. But demand is growing for outpatient services provided at off-campus sites, a trend that may expand the playing field for the REITs, institutions and privately held firms that traffic in medical office space. In some cases, retail landlords are also entering the picture, as hospitals looking to expand their patient base move into retail spaces in neighborhoods where the demographics and income levels are promising.
The undeniable demographic shifts afoot across the country are fueling much of the attention paid to medical office in recent years. Over the next decade, the segment of the U.S. population age 65 and older will grow by 36 percent. and account for 54 million people “It’s an industry that can’t be ignored,” says Ray Braun, managing principal of EnTrust Healthcare Properties.
According to Ventas Inc., soon to be the largest REIT in the field focused on medical office, the healthcare and senior demographic will account for 20 percent of the gross domestic product by 2020.
What’s more, the “Patient Protection and Affordable Care Act” spearheaded by President Obama promises to swell the ranks of Americans with health insurance by as much as 30 million to 35 million people. The impact of the healthcare legislation is already being felt in some parts of the country, even as states move to challenge parts of the law and the presidential election raises questions about how the legislation could be transformed if a Republican takes the office.
Such vagaries mean caution for some owners and investors. “Reform impacts us a lot more than a recession,” says Eric Johnson, Houston-based managing director of the healthcare advisory service group for Transwestern. “The most important thing we need is direction. … Once we figure out which way we’re headed, we’ll see a lot of pent-up demand.”
Meanwhile, interest in the medical office sector is likely to remain steady. “There is probably as much or more capital chasing medical office transactions than there ever has been,” says Shawn Janus, head of the national healthcare practice for Chicago-based Jones Lang LaSalle. “The issue has been a lack of product.”
Driving high value
Lack of product wasn’t always a problem. From 2006 to 2008, the market was hit with an oversupply of space, says Al Pontius, national director of Marcus & Millichap’s office and industrial properties group in San Francisco.
Marcus & Millichap anticipates 6.3 million sq. ft. of medical office space to be delivered in 2012—up from last year, but 60 percent below the annual average seen from 2006 to 2008, when the glut occurred. During that time developers built an excess of off-campus medical offices in growing communities, expecting to cash in on growth in local populations. But when the recession hit, their potential patients began to delay medical services that weren’t pressing.
“Medical office and medical services are not recession-proof,” says Pontius. “Basically, being a patient is somewhat synonymous with being a consumer. For anything elective, even if insurance covers it, I’m still going to have a copay and deductibles.”
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During the recession, vacancy among medical office grew to 12.1 percent in 2009—high for the medical office sector, but still low compared to the office sector as a whole. Since then, it has fallen to 10.9 percent, according to Marcus & Millichap.
The medical sector now finds itself with a lack of product, which has contributed to an uptick in value. According to a March 2012 study by CB Richard Ellis, the value for class-A, on-campus medical office space has reached a historical high. Half of the 90 respondents to the survey of medical office investors, developers and real estate investment trusts reported that cap rates were below 7 percent. Two years ago, only 2 percent of respondents anticipated that cap rates would go below 7.5 percent.
The CBRE study also foresaw growing demand for medical office space this year, with 81 percent of respondents classifying themselves as “net buyers.” Sixty-one percent said more investors would be looking to buy this year than last, and most anticipated the supply of space would remain flat.
Some analysts believe more space may come to the market, however, as hospitals look to monetize their real estate assets. Doing so reaps proceeds to put toward acquiring physicians’ practices, a growing trend, and provides insurance against a possible decline in reimbursements if federal entitlement programs are targeted for cuts. But hospitals enjoy only limited access to the bond markets for financing, making their real estate a source of needed capital.
“Our expectation is that there will be more and more product to acquire, and we’re starting to see evidence of that,” says Braun.
Braun’s new position underscores his optimistic outlook. EnTrust Realty Advisors, an affiliate of the Skokie, Ill.-based Alter Group, announced in February that it has established EnTrust Healthcare Properties to acquire up to $100 million a year in medical office and healthcare-related buildings. It will focus on smaller assets usually overlooked by REITs and institutional buyers.
As healthcare systems look to unload assets, some are also seeking to outsource their handling of real estate, creating another avenue of opportunity.
“Much as PNG and Microsoft did in the corporate world, hospitals are realizing that they are not real estate people,” says Janus. “That brings an efficiency to managing their real estate.” Janus estimates that health systems can save up to $10 million by outsourcing, which can, in turn, improve their bond rating and access to capital from the bond markets.
REITs are still expected to ink most medical office transactions this year, according to Marcus & Millichap, and are likely to focus on assets on hospital campuses and on top-quality off-campus sites, which historically have been more stable investments that trade at lower cap rates. Their cautious approach will give private investors an advantage in pursuing off-campus medical buildings unaffiliated with local hospitals.
Though on-campus assets may draw the judicious investor’s attention, the growth of off-campus space is expected to heat up in coming years and account for a significant portion of medical-office activity.
Ventas forecasts a growth of 30 percent from 2010 to 2020 in ambulatory care facilities. This growth will also drive job creation, accounting for an expected addition of 127,000 physicians—nearly three-quarters of all new physician jobs industry-wide, according to Marcus & Millichap.
“We’re seeing more RFPs now than we’ve ever seen for new facilities in the outpatient environment,” says Janus of Jones Lang LaSalle.
The drivers toward a growth in outpatient care are likely to remain steady, Janus says, regardless of whatever changes may stem from revisions to national healthcare legislation. Some outpatient facilities that have been growing in number include imaging, oncology and ob-gyn centers. The lower cost of establishing off-campus locations allows hospitals to add patients while spending relatively less on space.
With medical care and technology improving, fewer overnight stays at hospitals are required, says Pontius. Innovation in telehealth—checking up on patients remotely—might also affect how spaces are used.
Further complicating matters is the possibility that Walmart might expand its offerings for primary care within its stores. It signaled its intentions last fall when it issued a request for partners who would help it develop a “low-cost primary care healthcare platform.” Such a move would disrupt traditional patterns of where people go for healthcare.
“If Walmart starts providing primary care for two million patients, that’s two million patients who, at least for primary care, aren’t visiting a doctor at a traditional medical office building,” says Pontius. “The significance to the medical office sector is, what does that do to the demand for space?”
Meanwhile, hospitals are striving to increase their market share and attract new patients. “You don’t do that by requiring that they come to your location wherever you are,” he says. “You establish a presence where you’re closer to where people live, making it more convenient for them.”
This retail-like mindset is sometimes called the “hub and spoke” model, with hospitals serving as the hub and satellite offices increasing their footprints.
Investors looking to pick up off-campus medical office sites are more likely to pursue locations related to hospitals, rather than being unaffiliated with a health system. Investors see such offices as a more stable target for their core funds, often backed by pension fund dollars.
“The pricing that we’ve seen for this product type has exceeded what it was back in 2007,” says Bodnar of CBRE. Buyers will also seek locations in areas with favorable demographics and a base of patients with health insurance.
Class-A on-campus office space remains the “golden child” of the sector, he says, “but off-campus has received a lot of attention as well” when sites are connected to hospitals. Kaiser Permanente has expanded its off-campus offerings in recent years, developing what the provider likes to call “medical buildings on steroids.”
Developers see upside
As healthcare providers move to expand into desirable communities, they’re finding willing partners in retail landlords, some of whom are seeking untraditional tenants to shore up their revenues after weathering the recession. For providers, the shopping centers provide convenient and affordable locations, as well as desirable foot traffic.
Healthcare systems and specialty hospitals are now setting up primary and urgent-care clinics in big-box spaces such as former grocery stores, or popping up alongside dentists and chiropractors. For example, Phoenix Children’s Hospital recently leased 6,000 sq. ft. in a shopping center in an affluent suburb of the city.
The benefits are also evident at office parks, where medical tenants are just one class of occupant. Healthcare providers and biotech companies are the backbone of the Miramar Park of Commerce in Miramar, Fla. The Broward County site was initially designed for high-tech companies, but developer Sunbeam Properties found that the local market for those businesses wasn’t deep enough. A deal with a pharmaceutical company in 1990 started Miramar Park on the path to becoming a destination for medical offices.
The companies at Miramar have attracted each other over time, says Andrew Ansin, vice president of Sunbeam, drawn by the secure location, ample parking and the ability to share knowledge and equipment with each other. Miramar Park’s infrastructure can accommodate their needs for special plumbing, ventilation, generators and other trappings of the healthcare sector. As an added bonus, capital improvements supporting such technologies in buildings make the sites more attractive to future tenants if the space is vacated.
Sixty percent of the new tenants at Miramar Park last year were healthcare related, including OPKO Health, which opened a 17,000-sq.-ft. office and lab. The federal healthcare legislation has already started to affect Miramar Park: WeCare Health Plans, a startup Medicaid HMO that’s part of the state’s response to the new health plan, also joined Miramar last year. WeCare expects to expand throughout the state in coming years.
Some tenants have also increased their existing space, helping Miramar Park stay strong through the recession. “Just being established as a place for medical business goes a long way,” Ansin says.
This article was republished with permission from National Real Estate Investor.