Transactions (April 2006)

Busting through 6 percent



By John Mugford


There may be no way to confirm it, but the early-March sale of a portfolio of five medical office buildings (MOBs) in Orange County, Calif., might represent one of the lowest – if not the lowest – overall MOB cap rates ever recorded: 5.8 percent.

Even if the cap rate does not break a record, it certainly breaks a barrier – 6 percent – long thought to be, well, unbreakable.

“What will be interesting is to find out is if this is the lowest cap rate ever recorded – in Southern California or in the country,” says the broker on the transaction, John Smelter, senior director of the Healthcare Real Estate Group at Marcus & Millichap. “It is no doubt a very low cap rate.”

The seller of the portfolio of what Mr. Smelter called “solid Class B buildings” was Nashville, Tenn.-based Vanguard Health System, the fifth largest for-profit hospital company in the country with 19 hospitals in five states.

Los Angeles-based Jamison Properties acquired the five buildings, which included a 400-space parking structure, for $30.3 million. That represents an average price per square foot (PSF) of $153. The MOBs are located on the campuses of West Anaheim Medical Center, Huntington Beach Hospital and La Palma Intercommunity Hospital. (Please see sidebar “The Portfolio” for more details.)

Jamison was founded in 1995 by Korean immigrant David Lee, a physician who set up the company as a tax-deferred investment opportunity for eight other Korean immigrant doctors. Today, the company has more than 100 investors, with 90 percent of them being Korean, according to news reports.

In the past 12 years, the company has become the largest owner of commercial property in Southern California, with more than 20 million square feet of offices and shopping centers. It is also a major player in the medical office market, as it now owns about 1 million square feet – including the Vanguard portfolio, says Dr. Lee.

Sold at list price


Several things about the portfolio sale indicate how much demand has revved up for MOBs in recent years.

Marcus & Millichap, on behalf of Vanguard, received 18 offers during a 10-day call-for-offers period back in mid-December. Eight of the offers came in above the $30.3 million asking price. Mr. Smelter says part of the reason for the number of offers was that Marcus & Millichap targeted potential buyers it believed would be interested in this particular portfolio of MOBs.

When it came time to choose a buyer, Vanguard selected Jamison and its list-price offer of $30.3 million. You read that correctly – at a time when MOBs are such a hot investment, the portfolio was sold for its asking price. These days, MOBs are often sold for more than list, according to a variety of healthcare real estate experts.

However, Mr. Smelter notes that Vanguard had several reasons to choose Jamison Properties.

“Ultimately, Vanguard chose a buyer that basically had no contingencies and offered to give them $1 million cash – non-refundable, pass-through to the seller’s account,” Mr. Smelter says.

In addition, most of the other bidders were prepared to embark upon the “typical two or three weeks of doing their due diligence and reviews.”

Such reviews commonly include environmental, structural engineering, electrical and property condition reports, as well as others.

“Because we are in a strong seller’s market, buyers are scrambling for medical office product – there is certainly a shortage of the property type,” Mr. Smelter says. “As a result, the buyers who really want to participate will either come in well above the list price or make an offer such as this one.”

“In this case Jamison said it would take a look at the title report and the purchase agreement, and they said they’d like to get a purchase agreement signed by all parties within 48 hours and close on the acquisition within 30 days,” Mr. Smelter says. “Having a buyer that could move that quickly is important. In sales like this, it’s always a function of price and timing.”

Unlike many recent MOB sales in which the seller, typically a hospital, retains ownership of the land underneath MOBs, Vanguard sold the land along with the buildings.

“We recommended that Vanguard sell the properties on a fee simple basis,” Mr. Smelter says. “There are enough CCRs [conditions, covenants and restrictions] in place that run with the property that we didn’t see the need for a ground lease. I think that typically enables us to get an additional 50 basis points on a cap rate.”

Room on the cap


While the 5.8 percent overall cap rate might seem like a daunting challenge a the buyer, Mr. Smelter says Jamison is likely to find ways to improve its rate of return on the investment.

“Obviously, at a 5.8 percent cap rate the debt service is not going to allow for much of a cash flow,” Mr. Smelter says. “So they really have to look to the future. And in this case, one of the most important elements is that the overall price per square foot of $153 is significantly below replacement value. I would say it’s about 50 percent below replacement value.”

Mr. Smelter also sees room to raise rents in the portfolio. He says as the owner of the portfolio, Vanguard had focused on keeping its doctors happy while being careful not to violate the Stark laws.

“But the buildings definitely include some old leases,” Mr. Smelter says. “And as those leases roll over, the new owner will have a chance to move up to market-rate rents.”

He adds: “Of course in any portfolio sale the new owner can’t just come in and flip a switch and get market-rate rents tomorrow. But in this case, my feeling is that the overall rents in the portfolio, on average, are about 20 percent below market. There’s definitely room to move these rents to market in the future.”

Mr. Smelter says ARGUS projections for the future performance of the buildings, potential lease rollovers and the typical assumptions on lease renewals, as well as other factors, all indicate that Jamison’s future returns for the portfolio “look good, very appealing.”

“Selling at such a low cap rate is definitely a reflection of the market we’re in,” he says. “I think if we would have had rents at market rates, my guess is that we would have sold the portfolio in a 6.25 percent cap rate range.”

“Sure, we broke the 6 percent cap rate, but I think it’s because there was room on the rents,” he adds.

Mr. Lee of Jamison Properties says he does not comment on the fundamentals of such deals, but adds: “We like medical offices, on-campus medical offices, because of their long-term cash flow and stability. And we like these buildings because they are on the campuses of strong hospitals.”

More 6 caps?

It seems likely that not very many, if any, future MOB sales will break the sub-6 percent barrier. That’s because nationwide MOB sales statistics compiled by Marcus & Millichap indicate that average cap rates have stabilized in recent quarters – at right around 8 percent. (For more information on nationwide MOB sales statistics, please see “Average price jumps to $200 PSF” on Page 3 of this month’s edition of Healthcare Real Estate Insights.)

In addition, Mr. Smelter and Yitzie Sommer, senior research manager for Marcus & Millichap, say that as yields on 10-year treasury bonds continue to rise, as they are expected to do, cap rates should start to creep upward from that 8 percent mark as well.

Even so, the market could be in for at least one more sub-6 cap-rate sale. Marcus & Millichap’s Washington office was reportedly in negotiations for the sale of a portfolio of Maryland buildings at a possible cap rate of below 6 percent. That sale, which is expected to close in coming weeks or months, could be the last of its kind for quite a long time.q



The Portfolio

Here’s what Jamison Properties acquired:

  • § West Anaheim Medical Buildings, Anaheim. Two MOBs built in 1975 and 1982 with a total of 82,439 square feet on the campus of 219-bed West Anaheim Medical Center. The offering also included a 400-space parking structure. Vanguard acquired West Anaheim Medical Center and the ancillary properties from Plano, Texas-based Triad Hospitals Inc. in 1999. The MOBs and parking structure are located on 2.59 acres and had a list price of $14.5 million.
  • § La Palma Medical Buildings, La Palma. Two MOBs with a total of 58,812 square feet on the campus of La Palma Intercommunity Hospital in the city of La Palma. The buildings, which were built in 1972 and 1975, had a list price of $8.3 million. Vanguard acquired the hospital and MOBs from Long Beach, Calif.-based Memorial Health System in 2000.
  • § Huntington Beach Medical Tower, Huntington Beach. A 56,846 square foot tower located on 2.6 acres at 130-bed Huntington Beach Hospital. The list price was $7.5 million. Vanguard acquired the hospital and MOB from Triad in 1999.

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