Blueprint for third-party development

HREI^™ WEBINAR EXPLORES OFF-BALANCE SHEET OPTIONS FOR HEALTH SYSTEMS

 

By John Mugford

 

Up until just a couple of years ago, the idea of a health system hiring a company to develop, own and manage a medical office building (MOB) on its campus or in a satellite location was a relatively new concept.

But these days, almost everyone involved in the healthcare industry and healthcare real estate has heard about third-party development, also known as off-balance sheet financing.

While the concept of hiring someone to develop a third-party MOB might sound simple enough, there are certainly many complications and implications involved in the process.

As a way of informing health system administrators about this evolving strategy, Healthcare Real Estate Insights^™  and HREI^™  Executive Briefing^™  held an online seminar on Sept. 20, with each member of the audience using an Internet connection on his/her computer and the telephone to take part. Such seminars are also referred to as Webinars.

This particular Webinar was titled “Third-Party Development of Medical Office Buildings: What Every Healthcare Executive Needs to Know Now.” It was sponsored by three firms heavily involved in developing MOBs: Indianapolis-based Bremner Healthcare Real Estate, West Palm Beach Gardens, Fla.-based Rendina Cos. and West Palm Beach Gardens, Fla.-based DASCO.

The presenters were Jim Bremner, president and CEO of Bremner Healthcare Real Estate; A. David Carrillo, chief operating officer of Rendina Cos.; and Malcolm S. Sina, CEO of DASCO Cos. The moderator of the presentation and discussion was Murray Wolf, publisher of HREI^™ and its sister publication, Executive Briefing^™.

The Webinar addressed a variety of issues, such as the pros and cons of hiring a third-party developer, what to look for in a developer and owner of an MOB, how to make a new MOB an important part of a hospital’s overall strategy, selling the concept of third-party ownership to physician/tenants, how to assess market demand for a new building, third-party development trends, and others.

‘Hot’ developments

As Mr. Wolf introduced the topic, he noted that when HREI^™ was launched in January 2003, MOBs were not the “hot” investment and development opportunity they are today.

“But things have changed rather dramatically since then,” he said. “Medical office development has exploded nationwide.”

Prior to the last few years, real estate investors typically focused on the “four main food groups” of properties: office, industrial, retail and multi-family. Today, medical real estate is a $750 million market, and MOBs make up 34 percent of the total.

Mr. Bremner spoke about why MOBs and outpatient centers have become such an important part of a health system’s strategy. One reason is that consumers are demanding health services, such as outpatient surgery, closer to where they live. Also, many health systems face budget restraints and prefer to spend their capital on treating patients rather than owning real estate. Developing a new MOB or surgery center can also be a way to keep a hospital’s doctors happy, especially when they are offered ownership stakes in such outpatient facilities.

Mr. Bremner added that because of the “abundance of third-party capital that’s been flowing into the healthcare real estate market these days,” more and more firms are calling themselves medical real estate developers. As a result, hospital systems looking for a third-party developer should find a company that has experience doing medical real estate projects – which are often trickier and more complex than other types of development, he said. Third-party firms should also be flexible in their approach to choosing and working with architects and general contractors, he said.

“Some community hospitals are not-for-profits and they feel a need to work with local architects and general contractors, and it’s important for a third-party developer to be flexible enough to work with those firms,” Mr. Bremner said.

Physicians are key

Mr. Sina of DASCO noted that third-party developers need to be adept at working with a hospital and its physicians. Such firms should be able to explain to the physicians why a hospital is not taking the lead in developing a new MOB – mainly because, as noted earlier, hospitals would rather direct their cash into their core business. In addition, a third-party developer firms should realize that they will need to be patient in selling potential physician/tenants on a project.

“Meeting with physicians is very different that meeting with potential tenants of, perhaps, a commercial office building,” Mr. Sina explained. “And that’s why I think the larger, national developers who focus just on medical real estate are more educated about the process, because they have worked with physicians before.”

A third-party developer should also be able to perform the pre-development due diligence, such as gauging market demand. The firm should also know how to go about marketing a new MOB, and should be creative and flexible in its financing and leasing options for such a project.

“Physicians should also know that by hiring a third-party developer they can receive direct benefits, including a developer’s expertise – this all we do and we don’t pretend to be physicians or know how to run a hospital,” Mr. Sina said. “Physicians and hospitals also need to know that a third-party developer will take care of compliance issues, such as Stark (laws).”

Mr. Sina also went into detail about the physician ownership options available these days. He noted that he is not in favor of one such option: condo ownership for physicians.

“If a physician needs to increase or decrease their space down the road, it’s pretty difficult to do in a condo situation,” Mr. Sina said. “In many cases, after trying to solve their problems, physicians who own condos will throw their hands in the air and ask the hospital to buy them out. I’m sure many of you listening have had this happen to your hospital.”

Mr. Sina said he believes the best option is for physicians to invest in a portion of the facility, or real estate, itself. Such an option is usually offered in two forms: free equity, where a physician is given an ownership stake for committing to a long-term lease; and pari passu, in which physicians invest a certain amount and receive a stake in a project, independent of any leases they might sign. Mr. Sina said he considers the pari passu option the best choice for physicians because it provides them with an ownership stake that is not tied to a lease. It also seems to carry the least amount of risk for the physicians.

Financing favorites

Mr. Carrillo of Rendina Cos. also touched on the financial structuring options when third-party developers build MOBs.

He said Rendina prefers providing physicians, and sometimes hospitals, with equity deals in which tenants receive ownership stakes through signing long-term leases. Other investment options include what he called “traditional” deals, similar to what Mr. Sina referred to as pari passu, and hybrid deals, which combine the equity and traditional investment programs.

Mr. Carrillo said Rendina Cos.’ preferred structure has been the equity program because it does not put hospitals or tenants at risk, requires no cash investment by the physicians and/or hospital, and can reduce base rental rates and expenses because of the cash flow back to the investor-tenants.

“For signing a lease they get equity, and the tenants receive cash flow and equity appreciation,” Mr. Carrillo said. During the years, Rendina Cos. has distributed more than $175 million to its partners in MOB projects, he said.

Mr. Carrillo added that third-party developers with their own property management divisions can go along way toward keeping physician-tenants happy, which subsequently can keep hospitals happy as well.

“Having an in-house property management team of experienced professionals who know how to work with physician-tenants is a great way to guarantee the success of a project,” he said. “That’s because it takes some of the duties of running such a property out of a hospital’s hands. The property management team acts as a buffer between the physicians and the hospital.”

The third-party development seminar was the first of four such Webinars presented this fall by HREI^™ and Executive Briefing^™. The other topics covered include monetizations of medical real estate, the California healthcare real estate market and physician investment in medical real estate.

A full 90-minute recording of each Webinar, complete with copies of all the presentations and supporting materials, is available on CD-ROM. For details, please visit www.hreinsights.com. q