COVER STORY, JUNE 2012

EVOLVING TRENDS IN HEALTHCARE
A look at 2012 — a tumultous year in the medical office market.
Beth Young and Henry Hagendorf

When we look back at 2012 so far, one word comes to mind regarding healthcare real estate: turbulent. There are so many trends that are having a big impact on hospitals, doctors and patients that it is difficult to narrow it down to just a few. As usual, money, market share and politics are the driving forces.

CAPITAL

Access to capital for hospitals and doctors has been greatly restrained compared to the “good ole days” just a few years ago. There are state budget cutbacks, reduced reimbursements by Medicare, Medicaid and insurance companies, and healthcare reform is putting the spotlight on return-on-investment (ROI), scrutinizing costs and increasing care for patients.

Doctors tend to see a fork in the road. On the left is the decision to close their private practices and go to work for a large healthcare system. On the right is an opportunity to consolidate with other physicians and expand their private practices. The benefit for doctors joining a larger practice or even a hospital, as many are currently doing, is that they can keep pace more easily with capital and technology needs.

When an independent doctor or small private practice joins a healthcare system, it often means office space is vacated in a medical office building (MOB) and sometimes even

abandoned if it was owned by the doctor or practice. Smaller cities report buildings being vacated as doctors return to work with healthcare systems; and in those locations, few other doctors are looking to buy or lease an empty medical building.

Investors of MOBs are divided in their opinion of whether MOB’s have stabilized, are losing value due to doctors trending back to hospitals or are gaining value due to the increasing medical care that is needed as Baby Boomers age. A larger percentage believes it is a good time to buy, but a significant percentage will hold their investments, or even sell some buildings.

Another issue with capital is the trend toward healthcare systems selling some of their real estate to put the capital back into their core business for equipment and modernization, needed capital improvements or to develop new facilities. Often the hospital continues to occupy the buildings under a sale-leaseback scenario, with lease terms of at least 10 years and often as long as 15 to 20 years. Investors prefer longer term leases that are guaranteed, annual rent increases and on-campus properties because of the higher-occupancy levels.

The heightened focus on ROI and patient-centered care is causing many hospitals and healthcare systems to develop “outpatient controlled cost” clinics, “accountable care organizations” or “federally qualified” clinics that save patients and healthcare systems money. Off-campus clinics mean patients don’t need to pay higher priced hospital bills, while healthcare systems may treat patients quickly and conveniently without all the overhead costs associated with a hospital or a medical center.

Other factors with capital that are causing concern for healthcare systems and property investors include:

• Continued unavailability of financing for speculative medical office construction

• The increased cost of capital

• The difference between rental rates for existing properties versus newly constructed projects

• Capital constraints on hospitals will increase, not decrease, with health care reform.

MARKET SHARE

The healthcare business is like every business — market share is important to success, and particularly important to the larger players. One trend that is affecting as many as 90 percent of healthcare systems is mergers and acquisitions. Most systems are currently planning on acquiring or merging with another healthcare system.

Most surveys of hospital executives, owners and investors predict that when healthcare systems acquire or merge with another healthcare system, some will use the existing square footage of the acquired system, and more will also develop additional facilities. Two other surveys state opposing opinions. One says that a large percentage of acquiring systems will close down the existing hospitals and relocate the patient volume to the existing campuses of the acquiring healthcare system. The other survey says only a minority of the acquiring systems will shut down the facilities of the systems they purchased. We’ll have to keep an eye on that to determine the real trend.

Market share is also very important to REITs. Many believe the acquisition activity by healthcare REITs is having a huge impact on the healthcare investment property market. Private investors have been all but shut out of the bid process for core medical buildings and on-campus properties. This statement by Danny Prosky, president and chief operating officer of Griffin-American Healthcare REIT II, Inc., that was released at the end of the first quarter of this year paints an eye-opening picture of the healthcare REIT scenario: “Our portfolio of healthcare-related real estate more than doubled compared to 2010 and, as a result, important financial metrics, such as modified funds from operations and net operating income, experienced exponential growth of approximately 500 percent and 400 percent, respectively, as compared to 2010,” Prosky says.

POLITICS

During the next decade a demographic market shift will happen as the 65-plus age segment will expand around 36 percent as Baby Boomers transition toward retirement. It’s no secret that this age group, as they further mature, will incur more medical expenditures driving healthcare demand and a need for development of expanded facilities and medical office buildings, especially in the areas of cardiology, orthopedics and oncology.

Boomers’ parents, concerned about health reform’s vast impacts (and other political subjects), are using technology and the internet to influence the vote in November. If you have anyone in your life that is older than 70 and active on a computer, you probably receive numerous emails each week, (strongly) hinting at the importance of voting and even the party for which you should vote. The elephant in the room — healthcare reform — is having a considerable impact on medical real estate as it is still under Supreme Court review. With an adjusted 9 million new patients expected to be added to America’s healthcare system via healthcare reform legislation, it’s a given that more medical space will be needed. There are several factors that encourage uncertainty and competing claims on scarce capital, and all of these factors are causing delay in the timing of new real estate projects. But new construction in the skilled nursing, independent and assisted-living facilities has been strong and will increase (not so much due to health care reform as the demographic shift).

A related issue will require the use of electronic health records (EHRs). Although health care reform’s emphasis on reporting and record keeping is placing a higher priority on health information technology and electronic medical records than on new construction, the use of EHRs will free up physical storage space allowing it to be used for more critical purposes. Another trend that will have the opposite effect — reducing office and hospital admissions — is tele-health: treating patients, especially those who need constant monitoring, via telecommunications. Both trends will require improved data storage; so many hospitals will plan on developing data centers in the next 3 years. Data centers serve a viable need for health systems looking to upgrade its data infrastructure with wired cable systems for building automation services as well as wireless services for patient safety features and patient charting.

These are just a few of the multitude of issues that are affecting healthcare real estate. As we said, it’s difficult to limit this subject. Hospitals, investors, practitioners and patients will be better positioned to survive if they understand the trends taking place as the dynamics of healthcare continue to evolve.

— Beth Young, CCIM, LEED AP and Henry Hagendorf, CCIM, LEED AP

©2012 France Publications, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 553-9037.