With Record Numbers of New Patients Expected To Need Outpatient Care, Experts Say Boom in Medical Office Deals Will Happen -- But Investors May Have to Wait a Bit Longer
February 17, 2010
By: Randyl Drummer, costar.com
In early November, health-care real estate operator HCP, Inc. chief executive Jay Flaherty told investors that the reopening of capital markets, combined with "the expected near-term passage" by Congress of healthcare reform legislation, could set forces into motion bringing a burst of fresh medical office and other health-care property deals in the first half of 2010. In fact, Flaherty boldly predicted that deal volumes for the first six months would likely exceed the sum total of all transactions in the space since the beginning of 2007. What a difference three months can make. With the passage of major healthcare legislation far less certain now than it was before the upset victory last month of Massachusetts Republican Scott Brown in the contest for the late Ted Kennedy's seat in the Senate, prospective buyers and sellers of MOBs and other health care properties have largely opted to stay put on the sidelines and re-evaluate the ever-changing political and economic landscape. Though lawmakers are hoping to eventually overhaul the bill and get it through Congress, "obviously the health care reform catalyst is certainly, if not removed, delayed," Flaherty acknowledged in HCP's fourth-quarter 2009 earnings call last week. "With the markets turning somewhat choppy for a variety of reasons, we're in a position, I think, that we're sensing a lot of people are reevaluating how they want to do and when they want to do the transactions that they have got lined up and in the queue," he said. Health-care developers are closing following the legislation's progress with good reason. Universal health care could bring an estimated 30 million new insured patients into the system, and if an common formula for measuring medical office space needs is correct -- 1.9 square feet for each patient -- the nation would need to add another 60 million square feet of new development to keep up with demand. At the same time, the debate over healthcare reform, and even the renewed fretting over capital markets, are just a blip on the screen of the larger health-care screen in some respects, a momentary pause for a sector driven by immutable demographic and supply/demand forces. Foremost among those metrics is the growing numbers of aging baby boomers who will need medical care as they head into retirement. "Hospitals are under economic stress and have lost money on their investments because a lot more people are coming into the health care system as the population grows older," said Jeffrey H. Cooper, executive managing director with Savills US. "The third-party reimbursers like Medicare, Medicaid and the private insurers are all getting stricter in what they reimburse, and cutting back on paying for in-patient procedures. All at the same time, there's been this push by those three entities to cut reimbursements, even as investors are still having trouble accessing capital markets." The push now to move patients out of hospital rooms and into ambulatory care and outpatient facilities such as surgical care centers and medical office buildings is accelerating rapidly, added Cooper, who moderates a panel discussion sponsored by the New York City chapter of the Urban Land Institute (ULI) Thursday on investment strategies for healthcare real estate in the fledgling economic recovery. Other participants include John T. Thomas, executive vice president, medical facilities, with Health Care REIT Inc. (NYSE: HCN); Vicki Match Suna A.I.A., senior vice president and vice dean for real estate development and facilities, New York University Langone Medical Center; Jonathan L. Winer, executive vice president, Seavest, Inc., and Eric Fischer, principal for healthcare facilities, Trammell Crow Company. With insurers declining to pay for hospital stays and so much existing hospital space becoming functionally obsolescent, "There's just a tremendous demand for MOBs," Cooper said. "That's where the real growth in the business is. With more people headed toward these outpatient facilities, a lot more of them will have to be built." Hospitals and their doctors groups hope to monetize their holdings by developing more MOBs, either on campus or as near the hospital as possible, then selling to investors and leasing back the buildings to for 15 or 20 years. Publicly traded REITs such as HCP, Nationwide Health Properties, Inc. (NYSE: NHP), Ventas, Inc. -- and Duke Realty Corp (NYSE: DRE), which has a sizable health-care development operation -- have joined non-publicly traded REITs like Health Care REIT Inc. in accumulating sizable arsenals of cash for an eventual boom on the investment and development market. NHP acquired a Pacific Medical Building property this month in Poway, CA and a majority interest in a joint venture that owns a property in Gilbert, AZ, for a total of $90 million. The REIT, which has one of the strongest balance sheets in the sector with more than $1 billion in available capital at the end of the fourth quarter, expects to close on another five California properties by the end of the quarter as part of its phased purchase of PMB's portfolio. "For 2010, our strong financial position combined with improvements in the capital markets and the economy has shifted our attention to growth," said Douglas M. Pasquale, NHP chairman and CEO. Private equity investors and capital providers are also interested in jumping in. But third-party investors want to see strong preleasing of between 50% - 70% by hospital physician practices, and investor prefer they be located right on the hospital campus. "That really reduces the volatility of tenancy, particularly on the campus of a healthy, creditworthy hospital," Cooper said. The bulk of the Duke Realty Corp.'s projected $100 million to $200 million in new development starts this year will be for MOB starts, said Denny Oklak, chairman and CEO of Duke (NYSE: DRE) In one of the largest construction starts of last year, Baylor Health Care Systems, Inc. chose Duke to build its 460,000-square-foot, $154 million outpatient cancer treatment center on the Baylor University Medical Center campus in Dallas, scheduled for delivery in 2011, with financing arranged by Savills. "Frankly, MOB is the only asset class where developers are finding any positive demand drivers," Cooper said. Leasing activity in Duke's MOB portfolio is "reasonably good" with smaller spec space taking a bit slower to fill, Oklak said. Although the healthcare reform debate was "kind of hanging over the industry like a little bit of a cloud," people are starting to loosen up as chances recede of the previous bill passing and activity is beguinning to pick up, he said Physician groups, the major occupiers of hospital campus MOB space, are facing economic pressures of their own in the uncertain environment. Although health care reform will bring more patients into the system and greater cash flow, shrinking reimbursements from insurers and the government will continue to squeeze margins for doctors. Primary care physicians are being hit the hardest, with reimbursements sometimes not meeting the cost of services rendered. All these factors will put doctors who own their buildings and aren't affiliated with a hospital or healthcare system at a severe disadvantage, Cooper said. Many of those practitioners will find themselves stuck with the equivalent of non-institutional Class B or lower property. At the same time, on the investment front, there haven't been a lot of large new institutional-grade deals where the hospital sells its existing non-acute care facilities to investors and leases them back. Hospitals are still too busy shoring up their capital positions in the weak market for tax-exempt bonds, Cooper said. But that will change soon enough. "The outlook is great for this sector because people are living longer and more people will likely have to be treated at ambulatory space as a lower cost as reimbursements tighten," he said.
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