News & Analysis: Cogdell Spencer (March 2006)

REIT is interested in Indy



By Murray W. Wolf


Cogdell Spencer Inc.’s acquisition last month of Methodist Professional Center One, an Indianapolis medical office building (MOB), was notable for several reasons:

▪ It was the first acquisition by Cogdell Spencer (NYSE: CSA) since the Charlotte, N.C.-based real estate investment trust (REIT) went public Oct. 26.

▪ It was the firm’s first foray beyond the Southeast region.

▪ It was the first step in a planned expansion in the Indianapolis metro area.

▪ At a time when MOBs are frequently sold to the highest bidder, it was an off-market, negotiated transaction.

▪ It was a sizable deal: $39.9 million for the eight-story, 171,500 square foot (gross) MOB and an adjacent 951-space parking deck.

▪ The seller was an affiliate of Lillibridge, the Chicago-based healthcare real estate firm better known for buying than for selling.

“Our target area continues to be the Southeastern United States, as it has been during our 33-year history,” Matt Nurkin, Cogdell Spencer’s vice president of acquisitions, told Healthcare Real Estate Insights. “However, we’re looking for – aggressively looking for – opportunities that allow us to form a long-term relationship with strong healthcare providers and strong physicians in the local market.”

Cogdell Spencer executives say this deal provided such an opportunity. The MOB is on the campus of Methodist Hospital, which is considered the flagship of fast-growing Clarian Health Partners, Indiana’s largest health system. The Clarian system also includes Indiana University Hospital and Riley Hospital for Children.

“We’re excited about an opportunity to enter the growing Indianapolis market and are very positive about the healthcare real estate market in general, and growth over the next 18 to 24 months,” Mr. Nurkin says.

Indy opportunity

Cogdell Spencer concentrates on the Southeastern states – especially North Carolina, South Carolina and Georgia – because those states have some of the nation’s most stringent Certificate of Need (CON) laws, Frank C. Spencer, president and CEO, said Feb. 28 during the REIT’s fourth quarter 2005 earnings conference call.

Stronger CON laws give Cogdell Spencer’s hospital partners “a significant degree of protection against competition,” he said, which also helps to insulate the REIT’s MOBs from competition.

Even so, Mr. Spencer called the Methodist deal “a beachhead acquisition,” adding that Cogdell Spencer plans to further expand its presence in the Indianapolis area.

“We are currently negotiating a joint venture with a local real estate firm that manages our new Methodist Professional Center One – a joint venture in which we will be the majority owner.”

The local partner is REI Real Estate Services Inc., a Carmel, Ind.-based firm that currently manages the Methodist MOB.

Mr. Spencer explained that REI has a strong market position in Indianapolis but limited experience with medical properties, whereas Cogdell Spencer has more than three decades of healthcare real estate expertise but is new to the Indy market. The firms’ complimentary attributes presented a “great opportunity” for a joint venture, he said.

“It appears that we can do more together in terms of growing the Indianapolis market than either of us could do by ourselves,” Mr. Spencer said. Teaming with REI was a strategic decision, he added, not a condition of the sale.

But REI is not likely to be Cogdell Spencer’s only partner when it comes to specific projects. Physicians are also likely to be part of the ownership mix.

“I think that’s a trend that continues to grow, both in the Southeast and nationally,” Mr. Nurkin says. “Our business, over the years, has structured many joint ventures with physicians and the local healthcare systems they’re affiliated with, and will continue to do so in the future.”

7.5 percent cap rate

The $39.9 million Methodist MOB acquisition closed Feb. 15 and was announced six days later. At the time of the announcement, the 136,389 square feet (rentable) of space was 94.7 percent occupied by Methodist Hospital and a variety of third-party medical practice groups.

The cap rate on the Methodist MOB acquisition was slightly more than 7.5 percent, Mr. Spencer said during the earnings conference call.

“We’re going to work on that and hope we can improve that a little bit,” he said. “We’re taking a hands-on position in the management of the process, and are doing that in a joint venture in this case.”

Why Lillibridge sold

The seller was LHRET Indianapolis LLC, a limited partnership affiliated with Lillibridge, one of the nation’s largest private healthcare real estate firms.

Methodist Professional Center One was built in 1985. Joe Kurzydym, Lillibridge’s chief financial officer, says that it was acquired by Lillibridge Health Trust, the firm’s first private REIT, in June 1999 – the third property acquired as part of that portfolio. The MOB was later shifted to Lillibridge Healthcare Real Estate Trust (LHRET), the company’s second REIT.

Lillibridge hasn’t discussed it publicly, but the firm recapitalized LHRET in December 2004 through the California State Teachers’ Retirement System (CalSTRS). CalSTRS paid $95 million to acquire a 95 percent equity interest in LHRET, including 24 MOBs totaling about 1.7 million square feet, according to information recently obtained by HREI.

Lease rates at Methodist Professional Center One were essentially flat with no rent increases from the time Lillibridge acquired the property until this past June, when virtually all of the leases rolled on the same day, Mr. Kurzydym says. Lillibridge was then able to bring the lease rates to market levels. Even with the rent increases, most of the tenants renewed and Methodist Hospital took most of the remaining space, keeping occupancy near 100 percent.

Lillibridge officials decided to sell the MOB because they felt they had created significant value by bringing the lease rates up to market levels during their six years of ownership Mr. Kurzydym says.

“We had a good relationship with the hospital, so it wasn’t that,” he says. “It was just the time for an asset to go.”

Despite the sale, Lillibridge remains a major player in the Indianapolis MOB market. In June 2003, the firm announced that it had acquired a portfolio of 11 MOBs in the Indianapolis-area totaling 722,000 square feet from St. Vincent Health, a unit of St. Louis-based Ascension Health. (For more on that transaction, please see “Lillibridge closes on MOB portfolio” in the July 2003 edition of HREI.)

Even though St. Vincent and Clarian are competitors, Mr. Kurzydym says any potential conflicts of interest were addressed even before the St. Vincent acquisition, adding that it was not a driver for the sale of the Methodist MOB.

Off-market opportunity

At a time when it seems like most MOBs are sold through a competitive bidding process, the Methodist MOB was sold through an off-market negotiated deal. Lillibridge understood the value of the property and didn’t feel the need to go through a broker, Mr. Kurzydym explains. He says the Lillibridge team was already acquainted with Cogdell Spencer.

“I also talked to others in the space,” he says, adding that he offered the opportunity to about 10 firms and received about five responses before negotiating a final deal with Cogdell Spencer.

Cogdell Spencer’s Mr. Nurkin says: “For better, for worse, as much interest as there is in medical real estate these days from the institutional world, it’s getting awfully competitive and awfully pricey, and so if you can find an off-market deal, it’s a good thing.”

During last month’s earnings conference call, Mr. Spencer said that Cogdell Spencer is projecting about $100 million worth of acquisitions for 2006. The Indianapolis deal brings the firm to about 40 percent of that goal.

“We also continue to be active in the bid process and off-market negotiations,” he said. The REIT is currently evaluating about $180 million in potential acquisitions, about 40 percent of which would be off-market deals, he said.

As for development, Cogdell Spencer has two projects in the pipeline that it hoped to break ground on during the first quarter. But, focusing on states with strong CON laws can be a double-edged sword. Due to delays related to CON approvals, Mr. Spencer said those groundbreakings would probably be pushed back to late in the second quarter

However, Mr. Spencer noted that such delays are not uncommon in the business. In addition, he said the firm recently entered into letters of intent (LOIs) for two more projects expected to break ground this year, with completions scheduled for 2007. Those projects should keep the firm on track to meet its development goals, he said.

Other than saying the LOIs were with “another new client,” Mr. Spencer did not disclose further details. ‘

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