Monetization momentum continues
SECOND HREI™ WEBINAR DETAILS THE CONTINUING TREND OF DIVESTING ANCILLARY ASSETS
By Jessica Griffith
One of the most dramatic healthcare real estate trends in recent years has been the increasing number of sales involving medical office buildings (MOBs) and other healthcare facilities to investors outside of the traditional hospital system.
As recently as 2001, few healthcare executives considered divesting their real estate, according to experienced healthcare real estate veterans who have followed the industry closely for a number of years.
But the market has changed dramatically of late, and selling MOBs and other ancillary facilities has allowed hospitals to redeploy cash back into core missions and develop new business directions, said William Roberson, managing director of GE Healthcare Financial Services.
“There’s really been a change of attitude on the part of another group: investors,” added Murray Wolf, publisher of Healthcare Real Estate Insights™ and its sister publication, HREI™ Executive Briefing™.
Mr. Wolf noted that the investment community now recognizes the potential for superior returns from medical properties. “Demand has increased, price per square foot has increased and cap rates are falling,” he added
Healthcare Real Estate Insights recently hosted a Web-based seminar, also known as a Webinar, titled, “The Ongoing Trend Toward Monetizing Non-Core Assets: How Hospitals and Health Systems Can Maximize Value.”
Mr. Roberson was a presenter, as were Philip J. “PJ” Camp, principal with New York-based Shattuck Hammond Partners Inc., and Dan Colhoun, managing director of Denver-based NexCore Group LLC.
The presenters focused on the reasons for the increased number of monetizations, tips on how to structure a deal and recent statistics.
The number one reason healthcare companies sell MOBs and other non-core assets is to take capital out of real estate and redeploy it to other business purposes, Mr. Camp told the audience, who took part via the telephone and an Internet connection.
“Monetizing” means more than just selling a property, Mr. Camp explained. It means that a hospital extracts money from its real estate to improve its financial ratios, reduce debt, eliminate risk and achieve other financial goals.
Real estate can comprise 30 percent to 50 percent of a hospital system’s balance sheet, with minimal returns, Mr. Roberson added. The sale of some or all of a system’s assets can preserve debt capacity and reduce expenses.
Hospitals often choose to divest to meet strategic or operational goals, he said. Pulling capital out of real estate means it is available for the hospital’s central mission of patient care instead of tenant relationships and property management.
The deals also can enhance a hospital system’s relationship with its doctors. Physician-tenants often benefit from improvements and facility upgrades that often come with new management, Mr. Colhoun said.
In addition, new developers or owners frequently offer physicians an opportunity to invest in the buildings, which helps keep doctors loyal to the healthcare system by giving them a stake in its future.
Although it does not involve a sale, the development of healthcare real estate by third parties is related to the divestment trend, according to the presenters.
Anatomy of a trend
As the presented talked about trends and statistics, they noted that pricing and other transaction-related indicators for MOBs have increased significantly. In 2000, MOB deals totaled $622 million throughout the country. By 2003, that figure more than doubled to $1.5 billion and it reached 2.2 billion in 2005, according to figures from Shattuck Hammond Partners.
About $1.5 billion worth of MOBs changed hands in the first half of 2006. Although large portfolios make the headlines, Mr. Camp noted that the average MOB deal is between $6 million and $8 million.
The average price per square foot (PSF) nationwide for MOBs is $211, Mr. Roberson said.
Capitalization rates, the expected rates of return based on fundamentals at the time of closing, fell from around 10 percent in 2000 to 7 percent or lower this year, also according to Shattuck Hammond research.
“The continued cap rate compression indicates strong demand,” Mr. Roberson said.
New categories of buyers have entered the market, Mr. Camp noted. At one time, most of the interest in such properties came from real estate investment trusts (REITs), but medical facilities have benefited from industry trends, including a dramatic shift toward and older population in need of healthcare services. Tenant stability in MOBs is another reason for the increased demand from investors.
Buyers of MOBs now include private owners and developers with an interest in real estate. Even so, the Webinar presenters issued words of caution, noting that not all of the players in this category are interested in long-term ownership. Regional buyers also purchase MOBs, as do physician tenant groups, foreign funds, pension funds and insurance companies.
As an example, when Shattuck Hammond facilitated the sale of five MOBs for Novant Health in Charlotte, N.C., the firm reached out to 75 investors before choosing a development company to purchase the $122 million portfolio.
Not all healthcare real estate sales involved MOBs, the presenters noted. In fact, healthcare systems are selling ambulatory surgery centers and other outpatient facilities, and ancillary structures such as parking garages also end up on the block, Mr. Roberson said.
Specialty ownership groups may take an interest in parking ramps, labs or other niches within the healthcare market, Mr. Camp added.
He also said healthcare systems need to review their portfolios and determine which properties are suitable for monetization.
Structuring the deal
Healthcare systems can take multiple routes to monetization. A direct sale is the most straightforward method even though it does not provide the hospital an ongoing relationship with the buyer, Mr. Camp said. As a result, he said such a transaction is not appropriate for on-campus facilities.
More common is the sale-leaseback, or partial lease-back, in which the hospital leases space in the MOB. Ground leases, in which the hospital retains ownership of the land itself and leases the building on a long-term basis, also give the hospital some measure of involvement, which Mr. Roberson said is important to many healthcare systems.
“Control usually is obtained through a ground lease,” he said. Hospitals retain ownership of the land in 99 percent of the deals he observes, and these ground leases typically have lengthy terms of 75 to 99 years.
Mr. Roberson said he always stresses the importance of a hospital maintaining a level of control of an ancillary facility after divestment. Through the use of a ground lease, a hospital can influence the tenant profile, prohibit competitive services on the property, prevent the sale of the property to a competitor, and request first refusal of space and first offer if the property is resold.
Some health systems sell assets to their captive insurance companies, Mr. Roberson noted.
Hospitals should have a say in the choice of property manager of an MOB, particularly if a hospital’s staff or its physicians occupy space in the building, he added.
As Mr. Camp noted about ground leases, “the list of controls is so extensive now that it virtually is like having an ownership-like control over the property.”
As previously mentioned, a joint venture with physicians presents another option for healthcare systems. These deals typically include the doctors and a third-party investor, with or without participation from the hospital.
For the physicians, these deals provide an investment opportunity at a relatively low unit cost, Mr. Colhoun said. The doctors don’t have to worry about construction loans or long-term debt financing, and they have some liquidity.
“For a fairly small amount of money, they can invest in a large building,” he said. “The development deals are perceived as more attractive to physicians,” but a stable, existing asset also attracts physician investment.
More and more healthcare systems are becoming attracted to the idea of monetizing real estate and the trend should continue into 2007, Mr. Camp said.
He noted, however, that that the monetization market could be reaching a plateau. That’s because by this time, most hospitals have at least considered divestment, although many continue to own most or all of their real estate.
As with any mature market, MOBs will enter a second generation of transactions as REITs and private owners decide to turn their investments into cash.
The market is beginning to consolidate, Mr. Colhoun said, and investors are broadening their interests in respect to the kinds of healthcare properties they are willing to acquire.
“It used to be the attractive trophy assets on campus were the buildings of choice,” Mr. Colhoun said. “Now investors are looking at off-campus buildings, especially if they play a strategic role within the health system.”
The seminar was the first of four such Webinars presented in recent weeks by HREI™ and HREI™ Executive Briefing™ . Other topics were third-party development trends, physician investment in medical real estate, and the California healthcare real estate market.
Each of the Webinar presentations, complete with all of the audio and visual materials, are available on CD-ROM. For more information, please visit www.hreinsights.com.qq
Jessica Griffith is a business writer specializing in commercial real estate.
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