Special Focus: Physician Investment (May 2006)

A growing piece of the MOB pie

MORE AND MORE PHYSICIANS FIND EQUITY DEALS ATTRACTIVE

 

By Jessica Griffith

 

Medical office developers began offering doctors a share of real estate profits more than two decades ago. For most of those 20 years, the practice of having physicians involved in the ownership of medical office buildings (MOBs) remained somewhat under the radar.

However, as reimbursement rates have tightened in recent years, physicians have looked for ways to diversify their incomes. As a result, more and more doctors have been asking for, and receiving, financial stakes in the buildings that house their practices.

“Physicians are making less money each year than the previous year,” says Jason Dodd, principal with The Cirrus Group, a development firm based in Dallas. “We’re seeing more investment opportunities because that is what physicians want.”

Exact figures on how many developer-doctor partnerships exist are hard to obtain, but the companies that offer investment shares say many physicians participate. The doctors receive an opportunity to expand their earnings beyond the practice of medicine, and developers receive extra assurance that their buildings will remain leased with stable tenants.

“We like the idea of having some synchronicity with rentpayers,” says Tim Oliver, senior vice president of healthcare development with Denver-based NexCore Group. “We like that alignment.”

Two ways to equity

Physician investment falls into two basic models. In one, the doctors purchase a limited partnership in the building; in the other, they receive equity in exchange for lease terms, usually long-term leases.

DASCO Cos. in Palm Beach Gardens, Fla., began offering physician equity in MOBs about two decades ago. According to the company’s CEO, Malcolm Sina, the practice was popular from the beginning. Mr. Sina says the physician participation rate remains the same today — about 50 percent choose to invest — as it was back then. Individual physicians typically invest $10,000 to $25,000.

The company does not tie a physician’s investment to signing a lease.

“We try to offer the lowest possible rent without the partnership interest,” Mr. Sina said. Physicians then make a separate decision whether to invest in the MOB.

The Cirrus Group presents a similar model to its tenants.

“We do not have free equity programs,” Mr. Dodd says. “We keep the tenancy and investment opportunities mutually exclusive because we don’t want to get into a system of haves and have-nots in the building.”

Mr. Dodd says 90 percent of the company’s projects have physician investors, with an average individual investment of $75,000.

Not all developers offer equity on every project. Nashville, Tenn.-based Healthcare Realty Trust (NYSE: HR) usually will oblige doctors who ask for equity ownership in MOBs, even though the company does not make it a standard practice to make such offers.

 “It is the exception rather than the rule and we typically wait for the physicians to ask,” says Doug Whitman, HR’s senior vice president for investments. “We do it more as a strategic move, if it is important to the physicians whom we want in the building.”

Most doctors invest as individuals because members of a multi-physician practice likely are in different stages of their careers and have different financial goals and assets. In some cases, physicians create a separate business entity outside of the practice and then invest as a group.

For Rendina Cos., its Equity Participating Program has worked for nearly two decades and the company has no plans to change it, says President Daniel Messina. The Palm Beach Gardens, Fla., company has developed more than 100 medical office and professional office buildings and more than 95 percent of them offer an equity program.

“It is rare for tenants not to take advantage of it,” Mr. Messina says. He adds that during the 18-year existence of the Equity Participation Program, tenants of Rendina’s projects have received more than $175 million in cash distributions.

As in the purchase-equity model, physicians have become limited partners in the building. They sign a 10-year lease and, in exchange, receive a share of equity based on the square footage of the lease. The leases also are personally guaranteed by the physicians and contain built-in escalators that raise the rent by a predetermined percentage each year.

“We require long-term leases,” Mr. Messina adds. “It makes the project more secure for all the partners and brings value to the leases.”

Occasionally, doctors will purchase an existing building without assistance from a developer. Family Medical Center at Garland, a 20-physician family practice, formed a partnership to purchase one of the buildings it leases in suburban Dallas.

Family Medical Center operates from three locations, says Dr. Cliff Fullerton, a physician in the group. Two of the buildings are on medical campuses and the doctors are not concerned about sudden rent increases, but the North Garland building is on a busy intersection near new retail and commercial development and real estate values in that area are rising.

“We were not sure we could afford to stay here much longer,” he says.

Sixteen of the doctors plan to purchase the 20,000 square foot building from Healthcare Realty Trust for $2.3 million. The deal was expected to close in April.

“The number-one reason for us was to control where we practice,” Dr. Fullerton says. “And, if we want to move later, we will have some equity to do that.”

Doctors as partners

The value of the equity physicians purchase varies widely, from less than 20 percent to 49 percent of the total development, although the doctors as a whole typically wield a minority interest.

Physicians from all sectors of the profession take an interest in equity, but specialists are more likely to participate, Mr. Sina says. The reason?  Sheer economics.

“Specialists overall have higher reimbursements and higher salaries,” he says, adding that doctors in urban markets also tend to have more interest in equity deals.

For the developers who choose to offer equity to physicians, the benefits of these partnerships outweigh any concerns. Most say the biggest challenge is that numerous physician partnerships make the deals more complex.

It is easier to have a relationship with a single capital partner because the amount of investor relations’ work increases with the number of partners, Mr. Oliver says.

“It takes more work and more education and sometimes more legal expense to create incentives for physicians to invest,” he says.

“Administratively, the deals are more complex, but we don’t think of that as a negative,” Mr. Dodd adds.

When tenants also are owners, they tend to take more interest in the care and upkeep of the building, adds Peter Kloepfer, senior managing director at NexCore. They have a longer-term commitment to the building and will help find new tenants when vacancies arise.

For NexCore, doctor involvement is so essential that when the company launched a search for a new capital partner, it rejected investment firms that did not share an interest in physician equity deals.

“A lot of them didn’t want to embrace physician investment because it can be a hassle and can reduce the dollars they can put to work,” Mr. Oliver says. NexCore eventually selected RREEF as its capital partner.

Not every developer is suited to this type of equity deal, Mr. Kloepfer adds.

“I think there is a lot more talk about physicians investing than there are physicians investing,” he says. “A lot of developers think they should do this, but they aren’t used to dealing with physicians as partners and not tenants. It is a different relationship than the traditional landlord-tenant relationship, with a higher level of touch required.”

Physicians, hospitals benefit

As interest rates fell in recent years, the real estate market looked attractive to many doctors, Mr. Sina says. But he says equity in a developer-built project is a better alternative for these physicians.

“Even if they invest, they don’t have to sign on the mortgage debt; we do that and we also take responsibility for any cost overruns on the project,” he says. “Also, it takes a major time commitment and financial commitment to develop a project, time that physicians do not have.”

Most doctors buy equity because expect to be long-term tenants. However, DASCO allows physicians to retain the equity even if they retire or move to another location.

Some investment flexibility is available, Mr. Dodd adds. For example, physicians can increase their investment in certain projects and also can sell equity if they retire or their situation changes.

Developers say physicians earn a return on the investment at the same rate as the general partnership. Hospital and healthcare clients appreciate physician equity because the deals satisfy the doctors’ interest in real estate ownership with no risk to the hospital.

Also, many hospitals would prefer their physicians not leave the campus and build their own, competitive, MOBs, Mr. Sina says.

“A lot of times, physicians will prefer to build off-campus and avoid ground-lease restrictions, but hospitals prefer to have them on campus,” he says. “They can satisfy the needs of the physicians to have ownership in real estate without the headache of doing it themselves.”

Physician investment is not the only way to build an MOB. In fact, developers such as DASCO stress that no project is dependent on physician equity and that their companies can and do build MOBs with internal capital resources if doctors do not show any interest.

The physician investment model will have a place in some markets but will not be the norm for every project, Mr. Dodd says.

“I think it would be hard to do in an MOB that was part of a ten-building hospital campus,” he says. “It is a good model but not the only way to build a building.”

“I think we will stay on this path as long as doctors view real estate as a sound investment,” Mr. Whitman adds. “And for some, there is an emotional component. They want to own the space they occupy.” q

Jessica Griffith is a business writer specializing in commercial real estate.