PM Realty is no latecomer to the market

HOUSTON-BASED FIRM HAS BEEN INVOLVED IN MED REAL ESTATE FOR SINCE 1964

By John Mugford

Houston-based PM Realty Group LP has been around for 50 years and its 1,300 employees provide development, construction management, engineering, property management, investment sales and leasing services in a wide spectrum of commercial real estate. Some of those sectors include retail, commercial office, multi-family and industrial properties.

But, from the outside looking in, PM Realty (PMRG) might seem to be one of those “johnny-come-lately” firms entering the medical real estate industry. Not so.

Even though its healthcare efforts have not been as well publicized as other aspects of the business, PM Realty got its first medical office management assignment back in 1964, eight years after the firm was founded.

A johnny-come-lately it certainly is not.

Over the years, PM Realty Group and its healthcare concentration, Health Realty Partners, which got its name in 1998, have developed, managed or leased more than 15 million square feet of medical office space. The firm has worked with more than 125 hospital systems and negotiated more than 3,000 leases with physicians or physician groups.

Currently, Health Realty Partners provides management services for about 1.5 million square feet of medical office space throughout the country, with a heavy concentration in the Southeast and Texas. The firm currently owns, or is a partner in, seven MOBs with a total of about 500,000 square feet.

That ownership total, however, is expected to take off, as PM Realty and Health Realty Partners recently formed an MOB acquisition and development fund with JP Morgan Chase. The fund is open-ended, as the institutional investor continues to raise capital above and beyond the initial $100 million.

Leading the healthcare effort for PM Realty is J. Ernest Johnson, who is president of Health Realty Partners and who has been with the company for 12 years. Prior to joining PMRG, Mr. Johnson was with Chicago-based JMB Properties Co. He has more than 25 years of experience in commercial real estate.

Healthcare Real Estate Insights^™ had the opportunity to interview Mr. Johnson in recent weeks, asking him about his firm’s involvement in healthcare real estate as well as the state of the industry. As Mr. Johnson answered questions, his office window provided him a perfect view of the Texas Medical Center, the massive collection of healthcare facilities and hospitals located in an area just south and west of downtown Houston.

HREI^™ : How has your company evolved into healthcare real estate?

Johnson: PM Realty Group has been in the field of managing and leasing medical office properties for about as long as the company has been around – and the firm was started in 1954. In the past, medical properties were simply part of a portfolio that an investor acquired. Or it might have been that a few investors bought a building because of a location and those buildings were managed, incidentally, as part of the services we would provide to a client. But then in 1998 we were aware that we’d accumulated a nice assemblage of non-acute care medical buildings and decided to start pursuing the medical industry for a number of reasons. We’ve been emphasizing these efforts more in the last several years.

HREI^™: What has that entailed?

Johnson: Well, we grouped the buildings together and starting providing some special training that we thought our managers should undergo to work with facilities of this type and to learn to work better with hospitals and physician/tenants. So at that point… medical office buildings became a specialty of the company. Since then we have managed portfolios for hospitals and hospital companies, including HCA, Tenet Health, and others, and we’ve taken the expertise that we’ve accumulated in order to pick up plenty of other projects, not only to manage and lease but to help healthcare systems capitalize their real estate assets if they want to sell or refinance them. We also have the capabilities to do development and we have the funds to do acquisitions as well. So we’re now in the medical office building sector soup to nuts.

HREI^™: We know you’re involved in the ownership of MOBs and we saw a report recently that you were involved in a deal with an institutional investor, New York-based AIG Global Real Estate Investment Corp. Is that something you do fairly often?

Johnson: Yes, it is. I would say that we are results driven and if the best results can be accomplished by bringing in partners, whether it’s a hospital, healthcare system or an outside partner such as an AIG, which has been a tremendous partner, then that’s what we’ll do.

HREI^™: How much of a percentage of your real estate portfolio, or business, is healthcare for PM Realty?

Johnson: Not that big on a percentage basis. We manage 160 million square feet of properties overall, nationwide, and Health Realty Partners manages about 1.5 million square feet of healthcare properties, which is a relatively small percentage for the overall company but a rather significant total for the industry.

HREI^™: Does having the larger PM Realty firm behind the healthcare effort help you out?

Johnson: Certainly. What we’re able to bring to the table is this expertise the overall company has gained from managing 160 million square feet. You know, buying power is buying power, whether it’s buying goods and services or whether it’s having enough product in a given market. We’ve gained enough clout that, for example, in the case of a disaster we could get our contractors and subcontractors into a certain market to get properties up and running, which is extremely important in the medical business.

HREI^™: So while your firm’s healthcare portfolio might be a small percentage of your overall portfolio, there are other services, consulting type services, that you provide to your clients that don’t show up in total square footage. Is that right?

Johnson: That is right. We’ve worked with MedStar Health, the largest system in the Baltimore-D.C. area, advising them on the sale of some of their properties. We’ve advised them in other areas as well, and we’ve done the same for quite a number of other systems. That’s part of what building a relationship with these types of clients does for a firm in the long run. When you start with a firm in a rather small way and do a good job on a number of projects or assignments, eventually the client comes to depend on you as part of a solution to any number of challenges they might face.

HREI^™: What are some of the problems that you see healthcare systems facing with their non-core medical real estate these days?

Johnson: There are a couple of major areas. One problem is that a lot of the properties healthcare systems own are aging. Add to that the fact that systems are facing unique financial challenges these days, including the squeeze with reimbursements, and that makes it hard for them to find the capital they need to put back into these aging properties.

HREI^™: What can a firm such as yours provide in these instances?

Johnson: What we’re seeing is that the systems are having to make decisions about whether they should leave these properties on their balance sheets, which are very limited in terms of income production, or take capital out of the properties and put it back into the system. The thing is, a healthcare system could just put an ad in the paper and sell an MOB very easily under the current conditions. But they are starting to realize that they need an MOB owner who is going to be a partner with them – almost as if this new owner is part of their healthcare family and can understand their struggles and their needs and their challenges.

HREI^™: And who exactly should that buyer be if the system is going to benefit?

Johnson: It shouldn’t just be an owner that comes in and raises rental rates while lowering the amount of services in order to create a bigger spread and create more value for the property – those buyers are a dime a dozen. A hospital needs a partner that is sensitive to the challenges the doctors are facing, that is sensitive to the patients who come in and out of the building, and a partner that’s sensitive to the ongoing change and the nature of the healthcare industry. That’s the challenge they find. It’s not just making the jump to sell their assets, but being able to feel comfortable in making that leap.

HREI^™: Do you think the large institutional investors can be good, overall, for the industry and for a hospital system? Or, if they are going to enter the market, should they partner with a firm that’s been involved in developing, owning and managing medical properties and working closely with hospitals?

Johnson: You’ve hit the nail on the head. The institutions are very eager to get into the healthcare business. But many of them are smart enough to know that this is industry presents a different set of circumstances than your typical real estate investment. Typically, large institutional investors look for large properties, 250,000 square feet and up, in large metropolitan areas. But as we’ve learned, sometimes the best healthcare system is in an area that is not necessarily an NFL city. People get sick in Shreveport, La., just like people get sick in Dallas. You have to look beyond these primary markets to find hidden gems. Many institutional investors are not equipped to do so without the help of a firm that knows the industry.

HREI^™: Do you have any examples of this, of finding, as you call it, hidden gems in secondary markets?

Johnson: We’re currently working on one in a suburban market outside of Dallas – I can’t say what it is. But we’ve recently completed programs in Rockwall, Texas, and in Rowlett, Texas, where we came in with private money and teamed with a healthcare system to sponsor a new medical office building to provide services that were needed in that community. The project has been embraced by the doctors – we had the building almost 90 percent leased by the time it opened, and we actually expanded the building by 30,000 square feet between the planning and the time we opened. So the success and demand is there.

HREI^™: When you work closely with doctors on projects like that, what are the major needs of the doctors? What are the most valuable services a firm such as yours can bring to the table?

Johnson: The art and science of building construction today has advanced so rapidly. In the old days, you could lift up the hood of your car and probably find out what was wrong. These days… you could mess things up if you don’t know what you’re doing.  That’s how building technology is today. If you proceed down the road with someone who understands healthcare real estate and has a good team in place, that can provide guarantees on maximum costs on contracts, the design, development and construction of a project can go very smoothly and at an extremely accelerated pace.

HREI^™: What’s the potential downside to not knowing what’s under the hood, if you will?

Johnson: If you’re a group of doctors looking to develop a building and you don’t team up with someone who knows the business – things can happen along the way. There might be deviations from the plan, which can kill you in change order costs. That can take your returns and profits south in a hurry. A physician who has never developed a building, or who built one with 5,000 square feet eight years ago for he and his partner, really needs to partner with a development firm that knows the business, can keep costs down and deliver the project on time.

HREI^™: Do you have an example you can point to?

Johnson: About five years ago, we were working with a group of physicians that wanted to build an endoscopy center in a suburb of Dallas. We helped with site selection and some initial building concepts and designs. They wanted to finance other projects and were going to build an initial building of about 12,000 to 15,000 square feet. They came to us and asked what their building would be worth after they had it up and running. I told them it would probably be worth about 20 percent less than they would invest into it. They didn’t think that made sense, but I told them they were building a specialty use building that would be attractive only to buyers that were doing the exact same thing these doctors were doing. Any potential buyer’s objective would be to determine the costs of building new versus retrofitting the existing building. In this case, the 12,000 square foot building would have cost about $10 million, but for a potential buyer it would have cost at least $2 million to renovate for some other use.

HREI^™:  What was your solution?

Johnson: We advised them to acquire a couple more acres of land and urged them to develop a bigger building, a 60,000 square foot medical building. We said that when they open with these rents their building will be worth about 30 percent more than they invested in it. So we led them through that project – designed it, built it, handled the development and construction and when the building opened we were at 96 percent occupied. Today, it’s 100 percent occupied and is worth much more than what they have in it. Had they gone with the smaller version, it would have been a $12 million mistake.

HREI^™: On the PM Realty Web site, your firm talks about strategic management and strategic planning for medical real estate. Is this case an example of that?

Johnson: Exactly. There were other reasons to develop the larger building. For example, they actually had less personal liability on the larger building than they would have had on the smaller building, which frees up money for the balance sheet. They had the ability to enhance their practice with the larger building, too, because they could bring in complementary practices into the building, which enhances their referral basis and allows them to cross-refer back to physicians. As a result, the value of their practice went up, which meant their stress level of being doctors went down.

HREI^™: We’ve all heard reasons why medical office buildings have become such a trendy investment, such as they provide steady returns, the rest of the real estate market got weaker, and the tenants are credit-worthy, long-term tenants. Are there other reasons why you like the space?

Johnson: What I tend to like about medical office, and what drives these stable returns, is that once you build out an MOB your re-tenanting costs are relatively low. A doctor who needs three exam rooms needs three exam rooms – they’re not really that concerned about the flow within their space, as long as it works. The fact is, you can put a doctor in second-generation space, or third-generation space, at the cost of paint and carpet and a minor fix-up. And that’s very intriguing to investors because it avoids that big dip in capital. The other great thing about medical office space investments is that you’ve got a great built-in referral base, i.e., other physicians. When you lose, for example, a family practice group from your building, the odds are that one of your tenants is going to give you the name of another group they’d like to see in the building. You’ve also got the hospital on your side, too, because they are always recruiting new physicians who need space.

HREI^™: How about some downsides to being involved in medical office?

Johnson: Well, here’s what I think is the dirty little secret to being involved in medical office buildings: they tend to be small. That is one of the challenges that a lot of groups face and is, quite frankly, one of the reasons a lot of investors come into this business and then leave. It’s a challenge to manage 50,000, 60,000, or even 70,000 square feet when there might be 35 tenants, each one of whom is a small business person who needs plenty of attention. And you also have hundreds, if not thousands, of people coming and going from those medical office buildings each day. That’s difficult. But it’s also why we think firms such as ours are so well-positioned to be in this business. With our scope, it’s not very difficult to add a 60,000 square foot building. If you’re a self-managed fund and don’t have the resources to go out and manage these buildings, it can be taxing and stressful.

 

HREI^™: What’s your strategy on holding properties – is it long-term?

Johnson: There are cases where we might be looking at a five- to seven-year hold on buildings and then they might be sold. But in many cases we might finish a fund one year and start another fund the next year and roll some of the properties into the new fund, which maintains our ownership and management of them. Or, we might often look at other exit opportunities, such as continuing to maintain control by continuing the management or leasing of buildings, or flipping them back to the hospital through a purchase option. We’ll always be in the healthcare industry, whether or not we’ll have buildings for 50 years – I would doubt that.

 

HREI^™: Houston did not get hit very hard by Hurricane Katrina, but the storm certainly had an effect on the healthcare industry in the Gulf Coast region. Are there still lingering effects from that?

 

Johnson: It’s interesting that you mention that because I think there are tremendous opportunities for real estate firms that can assist some of the systems down in the Gulf area. Some of those systems are still trying to figure out ways to bounce back. We’re interested in getting down there to see if we can help a system. For a system trying to get its hospital going again, having a knowledgeable firm take care of your MOBs can certainly make life easier. q