Feature Story: Six significant subjects

A half-dozen of the most talked about topics from HRE conferences

By John B. Mugford

With the recent proliferation of healthcare real estate (HRE) conferences, professionals in the sector find themselves gathering quite a number of times in cities near and far to listen to panelists, often composed of some of the best-known executives in the sector, discuss the latest trends.

A good number of the subjects being discussed are direct and/or indirect consequences of the Patient Protection and Affordable Care Act (PPACA), which everyone knew would alter the landscape quite a bit, but perhaps not quite as much as it has.

Panel discussions at the HRE conferences usually touch on a variety of these topics and sub-topics, such as what’s happening in development, investments, facility pricing, rents, the architectural design necessities for today’s buildings, the economy and more.

Here at Healthcare Real Estate Insights™, we attend many HRE conferences year in and year out, soaking up information and writing stories along the way. Once again, 2014 saw us racking up plenty of frequent flyer miles, using up lots of ink taking notes, and draining our fair share of AAA batteries while recording these important discussions on our trusty digital audio recorders.

After our year of travels, here are some of the significant subjects that seemed to dominate the discussions at last year’s HRE conferences:

Where is MOB pricing going?

Certainly one of the most talked about topics at HRE conferences during the past year is the remarkably strong demand shown by investors for buying medical office buildings (MOBs). In today’s era, MOBs have evolved into highly sophisticated outpatient facilities that can be home to cancer centers, ambulatory surgery centers (ASCs), freestanding emergency departments (FEDs) and more.

Since 2012, demand and, as a result, pricing have been on a steady incline, with the 2014 national MOB sales volume breaking the all-time record and topping $8 billion in a year for the first time, according to statistics compiled by real estate research firm Real Capital Analytics (RCA) Inc. Also according to RCA, the average capitalization (cap) rate, or an estimated first-year return on an investment, for 2014 ended at or near the all-time record lows.

At the InterFace West Healthcare Conference in 2014, Vincent Cozzi, who at the time was the chief investment officer of Chicago-based Ventas Inc. (NYSE: VTR), said that “there is quite a lot of capital in this space and there’s even more capital forming on the sidelines, meaning I don’t really don’t see any upward pressure on cap rates.” Mr. Cozzi is now with Toronto-based NorthWest International Healthcare Properties (CA: MOB.UN).

Development: On the upswing?

For the most part, professionals in the HRE sector say that all of the changes taking place in healthcare, including the impacts of the PPACA, are driving a need for the development of new medical office buildings (MOBs) and other types of facilities in which they can deliver services along the continuum of care.

Also, all of the consolidation taking place in the sector – hospitals merging with other hospitals and health systems acquiring and hiring physicians and group practices – is resulting in these systems wanting, and needing, new medical facilities. They want the new facilities not only for consolidation purposes, but to help sell their brand and attract new patients.

Granted, new development isn’t going wild, but the country has been seeing a steady increase in new projects in recent years.

When it comes to MOBs, new deliveries in 2014 totaled 8.53 million square feet – that number only includes projects of more than 20,000 square feet of space, according to John Smelter, who gathers and compiles his numbers from Washington, D.C.-based CoStar Group and who shared them at a couple of conferences in 2014.

That 2014 figure was up 43 percent over the 5.97 million square feet of MOB space delivered in 2013.

And it looks as if the upward trend is continuing, as total deliveries in 2015 are projected to be 9.05 million square feet, which would be a year-over-year increase of 6 percent.

As for all healthcare projects, including hospitals, 2014 was expected to see construction starts of more than 70 million square feet, according to Philip J. “PJ” Camp, principal with New York-based Hammond Hanlon Camp (H2C). Mr. Camp reported the numbers during a panel discussion at the InterFace Healthcare Carolinas Conference in Charlotte, N.C. In 2015, according to Mr. Camp, the total should top 90 million square feet projected. By 2016 and 2017, annual starts are expected to top 100 million square feet, he noted.

“So we’re back to the races after four years of being a little bit down,” Mr. Camp said.

Throughout the year, HRE professionals sounded off on why they believe development is seeing an uptick. Those reasons include, but might not be limited to, the following:

■ Healthcare reform. “Obamacare will mean a lot of good things for healthcare real estate, as there’s no denying that there are going to be a lot more folks with insurance: 25 million more by 2016 after 14 million more in (2014),” noted Mr. Camp.

■ A need for new facilities in high-traffic, retail areas. At the same time that healthcare systems are providing more care in outpatient settings as a way to reduce costs, they are also seeking new markets in which to offer services and expand their brands and name recognition.

Deeni Taylor, executive VP for Duke Realty (NYSE: DRE), said during the InterFace Carolinas conference that the most common project he is seeing, and expects to see over the next couple of years, is the “50,000 to 60,000 square foot multi-specialty off-campus MOB with just one tenant or just a few. And I think we’re also going to see the larger health systems, the academic medical centers, building 150,000 to 200,000 square foot ambulatory facilities away from their main hospitals,” he added.

C. Thorn Baccich Jr., VP of development for Charlotte-based Brackett Flagship Properties, added that the country’s newly insured patients “don’t all live right around hospital campuses.” As a result, he said, it’s critical for health systems to find good locations for new off-campus projects, including, in some instances, sites in areas long dominated by competitors.

■ Health system consolidation and acquisitions of physician practices. When hospitals and health systems acquire physician practices, it raises questions of where to locate and perhaps how to consolidate all of their newly acquired doctors and groups. Putting more of those doctors “out in the marketplace, out where the patients are, has been a real driver of development,” Jason Hinkel, regional director of development for Dallas-based Caddis Partners, said at the InterFace Carolinas conference.

■ A drop in MOB vacancies nationwide. Data from CoStar, Mr. Camp pointed out, shows that the national vacancy rate had dropped to less than 10 percent as of early 2014. It is interesting to note, Mr. Camp said, that buildings built before 2007 have the lowest vacancies while newer MOBs have an average vacancy rate of 13.8 percent.

Who will own HRE facilities?

At many conferences, the question often arises as to whether the country’s health systems will give up the ownership of their real estate facilities, be it through selling (monetizing) assets, or allowing developers to build and own facilities in which they will be tenants and pay rent. The topic was discussed at several conferences.

And the conclusion is: It’s a mixed bag.

The topic of whether health systems might start giving up the ownership of their real estate assets, including acute care hospital buildings in sale-leaseback transactions, was discussed at the country’s largest HRE conference, BOMA International’s 2014 Medical Office Buildings + Healthcare Facilities Conference, held in May 2014 in Nashville. More than 1,000 people attended.

During a panel discussion, Peter Volas, senior director of real estate for the Cleveland Clinic, pointed out several reasons why systems might want to at least look into monetizing non-core assets such as MOBs. Those drivers, he said, include generating capital for future growth, increasing liquidity, improving a credit profile and getting out of the business of owning non-core facilities.

Tony Helton, administrator of the Division of Finance for the Cleveland Clinic, noted that the health system owns about 96 percent of the real estate it occupies.

“We basically haven’t monetized any of our assets,” Mr. Helton noted, for the most part because the Cleveland Clinic is a large and financially healthy system with strong credit ratings. As such, it can borrow money at rates lower than that available to development firms. The system, he adds, does not believe it can gain financially by leasing space instead of owning it.

As far as Mr. Helton is concerned, however, there are many other systems with lower credit ratings and plenty of capital needs that might start considering such moves.

The BOMA panelists noted that there are also other reasons, not just financial, why health systems might want to consider monetizing hospital buildings and/or other facilities in the future. Those include the notion that third-party real estate firms often keep the buildings looking better and more up to date, and run them more efficiently.
“Arthur Klein, who runs one of our biggest health system continuums in New York, Mt. Sinai Health, said that even though they are strong there is still such a big, ongoing need for capital that they need third-party capital to get involved,” said Jeffrey H. Cooper, chairman and executive managing director of Savills Studley in New York.

“He said the evolution of healthcare delivery has become a revolution, as health systems are going to be receiving less from the payer mix under the Affordable Care Act, which I really think should be called the ‘Insurance Act.’”

The loss of independent docs

As everyone involved in HRE knows, hospitals and health systems have been acquiring and employing formerly independent physicians and group practices at a rapid rate in recent years. According to some estimates, as many as two-thirds of the country’s physicians are now employed by health systems or, in California, foundations that employ physicians for health systems.

The percentage of employed physicians is expected to grow in coming years, even in markets such as New York, long considered the last bastion of the solo-physician practice. The reasons behind the loss of independent doctors are numerous, including the fact that all providers, including independent doctors, are facing serious cuts in reimbursements in coming years. Large health systems are better equipped to survive such cuts.

Also, more and more new doctors today, those coming out of medical school, would rather work for a large health system, where they can care for patients without having to be entrepreneurial, without having to pay for new equipment, without having to deal with so much red tape, and without having to work such long hours.

The topic was discussed at a conference in New York hosted by Jersey City, N.J.-based CapRate Events LLC and titled the “Healthcare Industry Perspective.” During the discussion, several New York-based physicians noted that some steps are being taken to assist doctors who want to remain independent.

Dr. Scot Glasberg, president elect of the American Society of Plastic Surgeons, noted that even a growing number of plastic surgeons are joining health systems. The American Society of Plastic Surgeons, however, feels “obligated to figure out how we can help our members in private practice stay in private practice.”

Dr. Paul Orloff, an independent physician and president of a group that represents local doctors, the New York County Medical Society, told the crowd: “I think (independent doctors) can survive for a long, long time by making some adaptations and addressing some concerns.”

The M&A effect on real estate

What kind of an effect is the loss of independent doctors as well as all of the hospital mergers taking place having on HRE developers and building owners, who used to depend on small practices to fill much of that space in their MOBs?

For one thing, a larger percentage of MOBs are now occupied by health systems, a number of which have solid credit ratings. And, if a developer can land a hospital system as a pre-leased tenant, that system will often occupy 50 percent or more of a building, meaning the developer can get the project in the ground sooner and find good financing at better rates.

Mr. Taylor of Duke Realty said that all of the physician group acquisitions taking place “has brought hospitals to the point where they are wanting to aggregate those practices together in larger buildings in ambulatory settings. As a result, you’re getting hospital leases as a result of the physicians they’re acquiring. By the time a developer is trying to do a new project, the hospital might be 50, 60 percent of the total occupancy. So from that standpoint, consolidation has helped.”

On the flip side, however, signing the remaining independent doctors or small groups to leases is getting more difficult, in large part because such practices are not sure how long they will be independent. And, because vacancy rates were high for several years, doctors got used to being able to land space for lower rental rates.

“All they want is short-term (leases),” Mr. Taylor added about independent physician/tenants. “They’re focused on rental rates and escalations, so it does make it harder to sign independent groups in some of the larger buildings. The other thing is, especially in the Carolinas, you still have some small groups that have remained independent. And so you don’t have a big practice to really be the engine or the anchor tenant if you don’t have the hospital-employed docs or the hospital uses in your building. It’s hard to make a big development work by trying to fill up the space with just the independent groups.”

Focus on healthcare, not reform

Many discussions concerning the PPACA that took place in 2014 focused on how the 2010 law has forced hospitals and health systems to start delivering better care in less-expensive ways – the notion being that health systems need to “do more with less.”

However, at an HRE conference in Minneapolis, the topic was looked at in a different way. At this conference, sponsored by the Minnesota Real Estate Journal, healthcare executives rejected the notion that healthcare reform is driving all of the changes. Instead, they said that a changing society, a changing healthcare consumer, and a need to cut waste out of the nation’s healthcare sector is driving most of the changes.

Raymond Piirainen, director of real estate for Minneapolis-based Fairview Health Services, said: “What happens in Washington, to me, is just irrelevant.” While everyone commonly hears that healthcare reform means that “providers need to do more with less,” Mr. Piirainen said, “Wait a minute. If I do more with less and keep doing more with less, pretty soon I’m doing everything for nothing.” Instead, “What we really need to focus on is doing less with less.”

That means streamlining, standardizing and leveraging best practices, Mr. Piirainen explained.

“Whether it’s the Affordable Care Act or other things, we are seeing what I call horizontal alliances or mergers, economies of scale, that we’re involved in.” The Fairview system, he said, was considering a number of collaborations and partnerships – even with competitors.

“A couple of years ago, we would never consider having a joint laboratory or a joint IT facility,” Mr. Piirainen said. As a result, the real estate opportunities include more than just clinical space, he said. 