COVER STORY, AUGUST 2009

MOB: SECTOR OF STABILITY
With the need for healthcare increasing, development and leasing  in the medical office sector is stable.
By Alan Blinder

Panelists on the InterFace “Big Picture” session at the InterFace Medical Office Chicago conference on April 28th. From left to right: Murray Wolf, Publisher and Founding Editor of Healthcare Real Estate Insights; Vincent Cozzi, Managing Director of Ventas Healthcare Properties; Todd Varney, Executive Vice President of Rendina Companies; Gina Weldy, Director of Finance & Real Estate for Northwestern Memorial Hospital; and Chris Bodnar, Vice President, Investment Properties, Private Client Group, with CB Richard Ellis.

While many sectors of real estate are seeing low occupancy and suppressed investment sales rates, medical office buildings have remained a relatively safe bet in the commercial real estate market, say speakers and panelists at the recent InterFace Medical Office Buildings conference, held in Chicago. “If there is going to be a darling [of real estate sectors,] healthcare will be the darling,” says Todd Varney, executive vice president with Palm Beach Gardens, Florida-based Rendina Companies.

“It’s still a great business to be in,” says Gina Weldy, who directs finance and real estate at Chicago’s Northwestern Memorial Hospital. “We’re not a speculative business, so you haven’t seen us overbuilding. Therefore, our growth is going to continue.”

As with all commercial real estate sectors, fewer entities have been lending for medical office properties, though these properties have had an advantage. Lenders have been scouring the nation for quality projects in major markets, where many MOBs are located. “If [lenders] have got to change a plane in order to get there, they just won’t even look at the books,” says Vincent Cozzi, a managing director at Ventas Healthcare Properties.

But, he continues, developers in smaller markets should still try to find support. “People get sick and need care in those markets, too. The challenge is finding the debt capital to go into those markets. Good financing sources will follow good people to good deals. It’s just harder to get them done today.”

Developers have been more selective about their projects recently, but, according to Varney, they are finding ways to get deals done for existing clients, which include medical use buildings like hospitals, surgery centers, and medical practices. In the rare instance that developers take on new clients, the three criteria that are the most important are long-term growth plans, financial standing, and reputation of the owning entity.

Experts say that projects with financial support from hospitals have had the best chance of winning financing and moving ahead. The U.S. government has helped to trigger additional hospital involvement by expanding a program of the Department of Housing and Urban Development (HUD). The Federal Housing Administration, one of the department’s agencies, administers the Section 242 program, which provides financing for capital projects at the nation’s hospitals.

Until recently, the application for a Section 242 loan was daunting, in many cases taking more than a year to process. However, in spite of the lengthy timeline, hospitals often chose to move ahead, and HUD has provided $30 billion in mortgages to more than 400 hospitals.

Recognizing the broader economic benefits of expanding healthcare by expanding hospitals and building more medical facilities, the federal government has streamlined the application process. CB Richard Ellis’ Chris Bodnar says that the application process “has sped up quite a bit; it takes about 60 days to go through the application process today.”

Even with federal financing, hospitals and other medical development entities are still carefully managing their risks. Bodnar notes that buildings will often be 70 to 80 percent pre-leased before they are financed. “The success of the project is determined before it is constructed,” Bodnar says.

Careful risk management has paid off and it is now rare for healthcare properties to be distressed. If a property is distressed, Bodnar says, “I think you have to question whether that property should be in the healthcare sector going forward.” In Bodnar’s experience, he has seen some physician groups leave an older, less functional building, often because of a merger with a larger practice, triggering later distress. If a building is too dated to effectively serve healthcare needs, Bodnar argues that the landlord should consider converting the building into an office property.

Conversely, it is not easy to convert an office property for medical use.  “It’s viable, but I don’t think you can kid yourself: It’s painful.” says Weldy, who is currently overseeing one property conversion. She notes that the infrastructure demands for medical offices are much different than traditional office properties. “It’s not something that you can just do overnight. You really have to think about the use of the entire building before making these changes,” Weldy says. Varney notes that converting an office property to medical office may be the only option in congested downtown areas.

While medical office properties have endured the recession better than other property types, healthcare real estate investment trusts, like all REITs, have been down as of late. “Everything has been down and down really badly,” says Cozzi of Ventas Healthcare Properties. Cozzi says that the share price of his firm’s REIT has been down over 65 percent. During a 12-month period, one healthcare REIT’s share price fell from $52 to $17. That price fluctuation may be more reflective of investors’ current view of real estate versus real property performance, though.

But the healthcare office market may be changing as large corporations explore ways to maximize employee productivity. Bodnar says that some large companies, looking to more carefully manage care and reduce the number of hours employees miss while going to medical appointments, are building medical centers into their office complexes. He cited the recent work of technology giant Cisco Systems, which built a 24,000-square-foot on-site medical center at its headquarters in San Jose, California. Cisco is not the only company to provide primary care on-site; Intel and Pitney Bowes are among the other corporations that have opened facilities on site.

Hospitals are primarily constructing outpatient centers and diagnostic facilities with capabilities such as magnetic resonance imaging (MRI). They are also dealing with the challenges of balancing growth goals with responsibilities as healthcare providers.

“If the economy worsens, we will inevitably see an increase in the uninsured and underinsured. That is something that we can try to manage and plan for, but it is not something we can control. When patients come into your facility, you treat them,” says Weldy. Such obligations put pressure on our hospital developers’ plans, she adds. “A hospital has to balance its financial goals with its operational goals.”

Even as costs and pressures rise, hospitals continue to plan for the future. “Our big plans haven’t changed,” Weldy says. Because of the economic slowdown, though, Weldy says that hospitals are having to be more creative in finding ways to make those plans come to life. “We are looking at alternative ways to partner to get some of that work done.”

To keep growth plans on target, “the smart hospitals are looking past the headlines,” Varney says. “The savvy hospitals are putting the plans in place, using their finances on their core business, and bringing in third-party developers.”

View of the audience.

He also argues that hospitals beginning projects now can be a positive economic force in the short-term and a strong competitor in the future. “Healthcare is doing nothing but growing, so let’s not put our head in the sand right now and further depress the construction and labor markets. Let’s go out there and expand our services so as the economy turns, our buildings will be coming on line and we’ll be ahead of the competition.”

The experts at the InterFace Medical Office Buildings Conference urged investors and others to keep faith in the sector. One noted that, even with the recession, the healthcare industry has not shrunk, accounting for 17 percent of the gross domestic product. “It’s a great business. Like anything else, there are challenges, but we just need to dig in and forge ahead because all of the statistics are out there for success in the future. We just need to get through those short-term blues,” Varney concludes.

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