Insights from a Hot Healthcare Real Estate Market
According to a recent analysis of the U.S. healthcare real estate market by Colliers International, all signs point to full steam ahead. Michael Roessle, director of office research for the USA and author of the report, noted, "In 2016 and beyond, there will continue to be strong demand for medical office space as healthcare spending rises and demand from an aging population grows." He went on to say, "Investor appetite is driven by higher yields compared to other asset classes, low interest rates and a stable tenant base with strong credit."
The report also noted medical office building inventory continues to be low with vacancy rates under 10 percent nationally. While working with an expert in healthcare realty has benefits for providers at any time, tapping into that insight is particularly helpful in periods of high demand to ensure expectations for location, space, build-out and price are met.
Healthcare Realty Trust, a Nashville-based, publicly traded Real Estate Investment Trust (REIT), focuses on owning, acquiring, developing, leasing and managing outpatient facilities across the country with a major emphasis on medical office buildings (MOBs). Founded in 1993 with 21 healthcare facilities in the portfolio, the company now has $3.4 billion invested in nearly 200 properties, owns 14.3 million square feet in 30 states, and manages 9.9 million of that square footage internally.
Doug Whitman, executive vice president of corporate finance, said having properties on campus or adjacent to major health systems is a key focus. While many of these properties are linked to not-for-profit systems, he noted Healthcare Realty also works with HCA, CHS, Tenet and other major for-profit providers.
However, he noted, "If we're purchasing an asset or developing it, we generally don't do it in partnership with hospitals or physicians." He added that while some physicians do still want to own their building, it isn't as common in larger projects in the post-2008 financial crisis world. "I think the financial crisis sobered up a lot of people about being overleveraged in owning illiquid assets like real estate."
For Healthcare Realty, with an eye toward long-term investment and the ability to finance at the corporate level, it's a different matter. "The vast majority - 60-80 percent - of MOBs are owned by hospitals, but there are enough systems out there to say 'My money is better tied up elsewhere,'" he explained. "For them, it's capital avoidance."
Therefore, Whitman noted, their partnership with a health system is most often a working relationship, rather than financial partnership, to develop properties that answer specific needs and then lease the health system space in the new facility.
Whitman said it's typical in those situations to have long-term leases, such as a 75-year lease with 10-year renewal options. With many of Healthcare Realty's developments being on or adjacent to the system campus, Whitman said, "About 55 percent of our properties have a ground lease where the hospital owns the land ... 45 percent, we own the land."
In addition to the financial aspect of working with a healthcare real estate developer and operator, Whitman said the expertise of organizations like his is also crucial. "We've seen what works in terms of layout and amenities," he pointed out.
For example, Whitman continued, it's important to include a private entrance so a surgeon or physician can quickly and efficiently get to their office instead of walking through a crowded waiting room where the provider might easily be stopped multiple times. Similarly, making sure the layout is conducive to patient flow, creating easily accessible parking, and wayfinding - which Whitman called critical - are all skills born of experience. "We have been developing probably 20 of the 23 years we've been in existence," Whitman added.
With a continuing trend toward the delivery more care in the outpatient setting, he expects to see an ongoing need for new or updated facilities. Whether it's his company or someone else's, Whitman said it really is crucial to find someone who has both the capital and industry expertise to develop, lease and maintain highly functional, highly specialized healthcare spaces.
Carr Healthcare Realty, a national firm headquartered in Denver, sits on the other side of the healthcare real estate spectrum but with the same industry expertise.
"To break it down to its simplest terms, we are space finders," said Matt Poppert, an affiliate broker in Carr's Nashville office. "We only work with healthcare clients, and we only work for healthcare providers. We don't represent any landlords, and we don't represent any sellers."
That clear delineation, he said, avoids any type of conflict of interest that might come from trying to represent two parties with competing interests and allows the broker to negotiate aggressively on behalf of the provider. "The analogy I like to use is it's kind of like going to court and having a prosecutor represent you. You're going to get a deal done, but it's not going to be in your favor," he said with a laugh.
It's equally important, Poppert continued, to be represented by a firm that understands the specialized needs of not only healthcare ... but the subspecialties under that umbrella.
For example, he said an ophthalmologist who specializes in cataract surgery, which lends itself to older patients, ideally should be located where a traffic light allows for easy access to the parking lot. Similarly, he said dental practices cost two to three times as much as a typical build out because of the complex plumbing issues.
"Every practice has a slightly different build-out cost," he said. "As we're negotiating with a landlord, if you don't understand those variances, it will cost the provider/tenant more," he said.
Some of the key areas he said are easy to overlook include:
- Location: The biggest issue for healthcare real estate is one that holds true for most commercial ventures. It's critical to be convenient and visible.
- Access: Providers need to consider how easy it is not only to get in the parking lot but also to get in and around the building.
- Space: Carr said carefully considered dimensions of hallways and rooms are important so that providers wind up with an office that functions as intended without paying for dead space.
- Due Diligence: Understanding the terms of the lease and undertaking a rigorous due diligence process before signing can avoid headaches down the road.
- Leverage: Carr said many clients don't really understand the leverage they have as healthcare providers who are typically financially stable and looking for a long lease. "In a lease situation, healthcare providers are the best tenants a landlord can get, but if they don't understand how to properly posture that value back to the landlord ... again, they'll end up losing in concessions," Poppert said.
"We tell clients all the time what a landlord thinks 'fair market value' means is what you are willing to pay. You have to have data to actually know what the value is," he noted.
Poppert pointed out real estate is typically the second highest expense in a practice behind payroll. "Why," he questioned, "would you risk that kind of expense in a long-term lease or purchase situation without representation?"