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Hospital Nameplate Adds to Medical Office Value

By Patricia Wassick and Deborah Carolson for Commercial Investment Real Estate

Original Headline: Hospital affiliation is a strong indicator of MOB asset value

The U.S. demand for medical services (with skyrocketing numbers of baby boomers hitting age 65,)…32M additional Americans (with) health insurance…(and increased) job creation among healthcare practitioners…will increase the demand for medical office buildings (MOB) by 19 percent by 2019, according to ULI. The need for an estimated 64M SF of additional MOB space in the coming decade dwarfs the 6.3M SF that will deliver this year. Therein lies the conundrum of the MOB market: As vacancy rates dip below 11 percent and occupancy tightens, development is moribund. Why does a cautious attitude afflict the office market’s strongest subsector?

Physicians vs. Hospitals

In addition to broader economic factors affecting all commercial property types, healthcare real estate is impacted by increasing levels of regulatory compliance. The (health care bill upheld by the Supreme Court) has fostered significant marketplace uncertainty, profoundly influencing how tenants (physicians) and MOB owners (hospitals and equity investors) are approaching their real estate decisions.

Physician practices are hedging their options by “waiting it out” and taking more–measured, conservative approaches to their MOB space requirements. Specifically, healthcare tenants are frequently remaining in place, minimizing relocations and facility expansions, and opting for shorter–term lease renewals of 12 months to 24 months.

Conversely, hospitals and affiliated health systems are operating as if healthcare reform will proceed either partially or wholly intact. These entities frequently have large geographic footprints, own significant real estate portfolios, and cannot afford a wait–and–see approach, given the need for longer lead times and bureaucratic realities of large organizations. Generally, hosp

itals are taking a more aggressive posture, pushing forward with distributed networks of healthcare facilities. Well–located MOBs, strategically positioned throughout patient communities, are highly desirable as they can achieve operational efficiencies and lower operating costs.

MOB Asset Value

As more physician practices move to hospital ownership, a MOB’s hospital affiliation, or lack thereof, is an increasingly important indicator of asset value. From the perspective of MOB investors, hospital affiliation may provide greater overall tenant stability and credit ratings as the hospitals themselves become the lessees. This trend is enhanced by healthcare systems’ push for strategically located MOBs to form the backbone of their increasingly dispersed facility networks. In addition, real estate investment trusts and institutional investors, which accounted for 45 percent of 2011 MOB sales volume, specifically target health system–affiliated properties. Therefore, the investment community, physician tenants, and capital market participants increasingly favor hospital–affiliated MOBs.

Hospitals, in recent years, have gravitated toward the prospect of MOB ownership; however, their perspective in many cases may be shortsighted. In essence, they own the practices/occupants, so why not own the real estate? Some argue that hospitals have purchased and sold physician practices in the past and the pendulum will again swing away from owned physician practices, making long–term real estate decisions based upon short–term trends a costly mistake.

The recurring uncertainties of healthcare reform have curtailed physician–owned development projects over the past few years. Physicians continue to look for more flexible and fluid occupancy alternatives, with shorter–term lease options providing the desired flexibility. The same uncertainties have also affected the investment market for physician–owned, non–affiliated properties. Due to institutional investors’ requirements for creditworthy tenancy, private investors with greater risk tolerance encounter infrequent competition from institutional investors for non–affiliated MOBs.

Additional Opportunities

In addition to MOBs, other non–medical real estate properties are becoming important components of hospitals’ comprehensive approach to building networks of healthcare facilities. In particular, spaces and pad sites within well–located retail centers are forming health systems’ increasingly brand–specific, front–line facilities.

There are significant advantages to specializing in healthcare real estate in a mature secondary market. Midsize markets are large enough to support specialization and encompass significant MOB inventories that attract local and regional investors as well as institutional capital, including large REITs. This broad investor cross–section provides opportunities to work with and represent a variety of owners with varying investment objectives. These relationships, in turn, enhance healthcare tenant advisory services.

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