Cover Story: The invincible MOB

No investment is recession-proof – or pandemic-proof. But medical office buildings come pretty close.

By John B. Mugford

As the Great Recession of 2007-09 dragged on, the hot topic of discussion in healthcare real estate (HRE) circles was, “Are medical office buildings (MOBs) recession-proof?” Developers, investors, brokers, lenders and others speculated about whether the HRE business – and particularly the MOB space – would be largely unaffected by cyclical economic downturns.

As it turned out, although virtually every commercial real estate investment suffered at least somewhat during the Great Recession, MOBs and other HRE generally far outperformed most other asset classes. The consensus was that if MOBs weren’t recession-proof, they had proven to be at least recession-resistant.

Today, we are faced with not only another recession, but an unimaginable worldwide pandemic. So with most HRE professional confident that MOBs are “recession-resistant,” the question has become, “Are MOBs pandemic-resistant?”
It will still be a long time before we know the full implications of the COVID-19 pandemic and its effects on the world economy. But have we seen enough to know if MOBs and other HRE are “pandemic-resistant?” So far, the signs are encouraging.

As the COVID-19 pandemic continued its rapid spread throughout the United States, HREI™ gathered its Editorial Advisory Board (EAB) April 24 for a virtual roundtable discussion on the Zoom app. We asked them to reflect on a very radically different sector, economy and world than had existed at the time of the most recent in-person board meeting in November.

Pressure on providers and rents

During the virtual roundtable, Ross Caulum, regional real estate director for the West and Mid-Atlantic regions for Livonia, Mich.-based Trinity Health, said that although many people in the sector consider hospitals to be “on the top of the food chain, we’re really not.”

Mr. Caulum explained that by being forced to temporarily shut down all elective surgeries, procedures and appointments, healthcare providers missed out on their most profitable lines of business, which subsidize urgent care and emergency services. That has forced them to request rent deferrals if they are tenants in third-party owned facilities.

For the most part, MOB-owning board members reported that although many rent deferral requests were made in April, more than 90 percent of the tenants had paid their rent as of the roundtable. In addition, those requests had moderated and all expected to eventually be made whole in the coming months as non-essential services reopen.

Thomas W. “Tommy” Tift III, an executive VP at Lincoln Harris CSG and president and CEO of Atlanta-based HealthAmerica Realty Group, said that his company has been dealing with the same issues concerning rent collections as most firms in the sector.

“Rent relief has been probably the number one thing we’ve been dealing with, and like others, we’re looking at each one on a case-by-case basis … as many these tenants are probably the higher end of the food chain and might be being a little bit opportunistic,” Mr. Tift said.

Shane Seitz, senior investment officers with Chicago-based Ventas Inc. (NYSE: VTR), agreed, saying that the firm is reviewing tenant financial information to separate the “needy” from the “greedy.” For companies like Ventas that also own senior living facilities, rent collections have generally been less than for MOBs. Mr. Seitz said although his company is still doing its best to do “creative” deals, COVID-19 has “obviously had an impact on our business.”

For attorney T. Andrew “Andy” Dow, chair of the real estate industry group with the law firm Winstead PC, the first month or so of the pandemic kept him very busy.

“We were dealing with lease renewals, lease modifications, rent deferrals, rent abatements, you name it,” said Mr. Dow, who is heavily involved in HRE. “We found ourselves negotiating with tenants and then corresponding, in some cases, on mortgage loan modifications.” But the initially flurry of activity has eased a bit at this point, he said.

Some board members whose firms own paid parking facilities associated with healthcare facilities say they have also taken a “big hit” revenue because some buildings are closed.

Most deals in the works have moved forward

For the most part, EAB members involved in MOB investing said that through the first couple months of the pandemic most of the deals that had been in the works earlier had moved forward, although a few were postponed since the onset for various reasons.

“All but one of our deals that we had under LOI (letter of intent) or under contract before April 1st is still moving ahead without disruption to price,” said Chris Bodnar, vice chairman of the U.S. Healthcare Capital Markets team with CBRE Group Inc. (NYSE: CBRE).

“Even in states like California, which had some of the most stringent shelter-in-place orders, we have been able to maneuver and facilitate property condition and environmental reports. Overall, things continue to progress, but there are some nuances like the debt markets that are fluid and changing day-to-day.”

Todd Kibler, a principal and leader of investment and financing activities for Milwaukee-based Hammes Partners, said that “given the ongoing uncertainty surrounding the progression of the pandemic, as an organization we have so far been very selective with respect to the types of investment opportunities we are currently pursuing.

“Investment activity remains robust on the acquisition side of our business as provider-owners of outpatient real estate seek to maintain liquidity for their practices and shore up their balance sheets. The liquidity generated from these real estate monetization initiatives are helping well-managed providers bridge the temporary disruption in their outpatient volumes.”

Transactions that are closing, Mr. Kibler noted, are taking about twice as long as normal as a result of more difficulties and complications in “underwriting, due diligence and financing time frames that are elongated” to allow more time for a thorough financial and operational evaluation of each tenant.

Despite those kinds of complications, “We are as aggressive as we ever have been for accretive deals,” said Dan Klein, senior VP of investments and deputy chief investment officer of Milwaukee-based Physicians Realty Trust (NYSE: DOC), which is solely focused on MOBs as opposed to a diverse healthcare portfolio.

“We’re not keen on doing diluted deals but accretive deals, and we’ll chase as hard as we can, “Mr. Klein said. “The state of the capital markets sometimes alters that approach a little bit, but my belief is cap rates will rise. I don’t think we have seen it yet, it’s very early, but I do believe over the immediate term we’ll see that happen and I hope I’m correct.”

Jim Kornick, a principal and broker in the Washington, D.C., office of Avison Young, said that, on occasion during this crisis, he has “pulled deals from the market that were not solid, core, core-plus deals. “Risk is bad right now… Frankly, from a personal point of view, I’ve been through this a few times, but nothing like this.”

“That’s why it’s still all about relationships with your clients and planning for what you see as the opportunities when we get to a more stable time. I’m actually very, very busy. Hopefully it’s not just action, it’s progress. We’ll see.”

John Smelter, who, until last year, was senior director with the Healthcare Real Estate Group (HREG) at Marcus & Millichap (NYSE: MMI) for nearly 30 years, and now works independently, said that he was ready to bring several assets to the market as the pandemic came to light.

“These are California assets for the most part … that are of the quality that would normally get national attention,” Mr. Smelter said. “I think that due to people not traveling, it is making it very difficult to sell assets like this.” Some assets are also experiencing temporarily reduced rent collection rates, he said.

As a result, he continued, “we’ve basically put a halt on bringing these properties to market until we can see what happens over the next month or two. I do think things are going to get better … and as things start opening up again and things get back to normal, people start traveling a little bit and start taking part in social gatherings and whatnot, I think hopefully everything will start loosening up, including the capital markets. But it is still … in the best interest of my clients to wait a little bit.”

James A. Schmid, chief investment officer of Media, Pa.-based Anchor Healthcare Properties, one of the most-active buyers and developers of MOBs in recent years, said the firm is trying to stay on “offense,” adding that “in terms of new investments, I think we’re moving forward on eight or nine transactions. We closed one … that had been progress for a while and that had debt.”

Mindy Berman, senior managing director and healthcare platform leader with Jones Lang LaSalle Inc. (NYSE: JLL), said that although the “level of (MOB) sales activity is definitely off, JLL is still doing a number of transactions and closing them.”

She added, “Financing is difficult these days, and we’re fortunate that we’ve found those sources of financing as we have a huge debt effort,” she noted. “But I also want to add kudos to the local banks and to add that in medical office there’s a good cadre of these groups that are still open for business. So what works is cleaner deals, as value-add is not so good anymore.”

Most of the “opportunistic” investors looking for acquisitions, she noted, seem to be “groups that have dry powder and either use lines of credit or are doing deals that can be financed.”

Darryl E. Freling, co-founder and managing principal of Dallas-based MedProperties Realty Advisors LLC, said the company brought to market at the beginning of March “two very nice stabilized assets in Southern California. We had very good response and we ultimately selected our best and final offer at the beginning of April and got very good pricing at or what we would’ve expected. We bought the project just a few years ago.”

He noted that MedProperties, like a number of other private equity firms and funds, are “still in the market and still looking to buy assets. Some debt is available, but as a number of people have said the project has to be right down the center of the fairway. So, we’re quite busy and we’re optimistic.”

Developments under construction have continued

For the most part, members of EAB involved in development of MOBs and other types of HRE facilities, said projects that had been started prior to the pandemic’s onset have continued – at least a good share of them.

Devereaux A. “Dev” Gregg, senior VP of development with Charlotte, N.C.-based Flagship Healthcare Properties, said that his firm was working on “four RFPs (requests for proposals) when this thing hit … and three of them have been put on hold while one of them is still plowing forward that we’re on the short list for.”

“But most of that work, as we see it, is kind of on the side right now,” he continued. “We’ve got two projects under construction and no blips at all on those. Contractors are right on schedule and there is no problems with supplies or labor. Lenders are funding everything, so that’s all in good shape.

“I’ll just add that I thought cap rates would move, but we haven’t really seen them move, which just shows we’re in a good sector as opposed to retail or hospitality.”

Richard Rendina, chairman and CEO of Jupiter, Fla.-based Rendina Healthcare Real Estate, said the company received PPP funding and that RFPs and acquisition opportunities were “proceeding.”

He said, “I have not seen the moves in cap rates or development yields that I had been hoping for.” However, he said the company is moving forward on certain projects.

“We’ve had one hospital project, kind of fee-for-service, inpatient use, that’s been put on hold,” he said. At the time of the call, Mr. Rendina said that many lenders had put their business on hold for at least 90 days.

“But we’ve had REIT financing for three of our assets as well as construction financing for another project that was approved just prior to the coronavirus shutdown, so those dollars are accounted for… I think healthcare real estate again is showing its strength during a time of uncertainty and volatility – so we’re still happy to be in that arena.”

For Anchor Health Properties, most projects were proceeding, Mr. Schmid said.

“Our development projects, by and large, have continued,” he said. “That’s probably the biggest surprise for me. We’re staying active on a number of projects all over the U.S., and we’ve also seen some new RFPs come out that have been awarded, which again was surprising to me. But, there seem to be a fair number of health systems that are in good financial position that are looking forward to the future and have had some planning going on now for several years. So those have continued.”

Eric Fischer, managing director in the Washington, D.C., office of Trammell Crow Company, said the firm “learned a lot of lessons in the Great Recession that we were able to bring into quick action this time” and it is “faring well.” He said the firm is working closely with established capital partners like Seavest Healthcare Properties and the firm plans to “continue moving forward opportunistically over the next couple of months.”

“We’re fortunate that most of our … projects are in the development and entitlement stage,” Mr. Fischer added. “But still, it’s very lumpy and rocky out there, and you start and then your project is stopped. It’s difficult to manage, but we’re more fortunate here in the D.C. area than other markets…”

Out in Arizona, Sharon Harper, CEO of Peoria, Ariz.-based Plaza Companies, said that “construction hasn’t missed a beat. We have about 45 construction projects going on, four of those being ground up and the rest being tenant improvements (TIs). So far, so good on that. About a thousand beds in senior living. We shut everything down and went to top-level protocol well before our governor did, and that’s paid off.”

Jud Jacobs, who is an executive VP and partner with Dallas-based Caddis, noted that his firm has been closing deals without postponements, although it did have one health system that delayed the signing of a new lease because it put all deals on hold.

“We’re still making proposals both on acquisitions and development,” Mr. Jacobs said. “I mean we have some RFPs we’re participating in that were in the works before this all started. I haven’t heard about any new RFPs coming across my desk since this started, but we’ve closed on some acquisitions, which, by and large, are a challenge. I think the next few months are anyone’s guess, but I’ve just been really impressed with our team and how they’ve kept things going throughout this tough time.”

Malcolm Sina is the executive chairman of Palm Beach Gardens, Fla.-based Sina Companies, a development firm with heavy emphasis on healthcare facilities.

“All of our projects on the construction side are still fully manned and still on schedule and on budget,” Mr Sina said. “Leasing has clearly slowed, even though deals that were in the works are likely to get done. But, any new efforts have pretty well slowed right now, as doctors and hospitals have put a lot of that on hold. Most new developments that are in the pipeline right now are also on hold … which means our debt and equity raising for projects is on hold right now as well.”

Mark Toothacre, president of San Diego-based PMB, a long time healthcare facility development firm, said that all of the company’s development/construction projects were “proceeding, except for one in Washington (state) that was shut down, and we’re seeing a little bit of problems with productivity in a social distancing sense on the job.

“Our development pipeline though, thankfully, is proceeding very well,” he noted. “So I was surprised by that. We’ve got six or seven deals in the pipeline, which all but one are actually moving relatively quickly.”

He said PMB has run into some issues with tenants signing off on tenant improvements, “but we’ve been really good at keeping our entitlement permitting processes going through virtual meetings with our municipalities.”

HRE lending ‘is beginning to loosen up’

When the pandemic tore the economy apart in its early days, many HRE sector professionals said the debt market, or many of the lenders in the market, took a bit of a pause to assess the situation. But after a period of time, some lenders had emerged as active players, according to EAB members.

“The healthcare real estate lending market is beginning to loosen up,” said Mr. Kibler of Hammes. “Many previously active healthcare lenders, including banks and life insurance companies, took a pause for four to six weeks until their underlying cost of capital stabilized and management of the pandemic began to take shape.” But he added that those institutions that have recently reentered the marketplace are being very selective.

Mr. Schmid of Anchor Health Properties agreed, saying, “For the most part, the deals have be pretty much right down the fairway. We’re still taking … shots at new transactions both big and small. But for anything that’s not right down the fairway, we’re looking at setting it aside for 100 days or so.”

Jeffrey H. “Jeff” Cooper, managing director with West Palm Beach, Fla.-based HRE Capital, said that on the “construction side I think those construction lenders that are still in the market are requiring greater equity and greater mezzanine (debt), or equity involved – in other words they’re lending on, in some cases, even below 50 percent of loan-to-cost. So that puts a big burden on trying to get the rest of your capital stack.”

Still a good business to be in

Since the onset of the pandemic, numerous professionals involved in the MOB sector have expressed their gratitude for being involved in an industry that, for the most part, has held up rather well during the crisis. As several EAB members noted, the proof of the sector’s strength and appeal is evidenced by continued demand for the product type from a wide range of investors. This demand, they note, has kept pricing strong and cap rates low.

Compared to the Great Recession, Mr. Seitz of Ventas said, “Healthcare should fare better this time around. It’s not going to do as well as it did the last time, but it should do better. But I think we’re going to be in this for a long time, and this is going to have a serious impact on our economy…”

“This business has come a long way when you think about it now, that MOBs are probably the darling child of the industry when you consider us versus, certainly, hotels, retail and office,” said Mr. Sina. “So, I think overall we’ll continue to see some consolidation of physician groups, of hospitals as well.”

Those consolidations could present additional risks for MOB investors, according to Mr. Cooper of HRE Capital.

“I think the biggest impact in our business is going to be a result of how providers are pretty severely impacted financially,” Mr. Cooper said. “And as a result, I think we’re going to see more consolidations and mergers, and when you tend to have mergers, all of a sudden a lot of your real estate assets become superfluous, or I should say, they tend to consolidate those as well.”

During the underwriting process, investors will need to pay attention to such possibilities, he noted. “So, I think that may be something that may impact our industry and is something to watch out for, even though our general asset class is quite strong.”

“As we’ve heard many times, the medical office sector is not immune to this (type of crisis),” said Mr. Bodnar of CBRE. ”However, we truly believe it will be one of the quickest sectors to rebound, even though what has happened will impact the psyche of consumer behavior.

“Going to restaurants will look different, movie theatres are going to be less crowded, less people will be visiting hotels and more vacations will likely be postponed. Even manufacturing will take some time to recover. But the word that is being used now for elective procedures is ‘surge’ capacity.  This is evidence that patients are still going to demand care.”

Mr. Klein of Physicians Realty Trust noted that in moving forward and looking to the future, the country and the healthcare industry might want to plan for a similar, major disrupting event “every five to seven years – and this is my opinion, not necessarily of our company.

“I don’t know if it will be a pandemic, a terrorist attack, a financial crisis, what have you, but this won’t be the last of this type of thing to happen. And we need to keep working on a nest egg and dry powder and emergency plan and all of those things to guide us through the tough things when they happen.”

As for senior housing, Danny Prosky, president and chief operating officer for the non-traded Griffin-American Healthcare REITs, noted said the company’s “assisted living portfolio has actually held up pretty flat, which is unusual but it’s a little bit misleading because we have a couple of portfolios where we switched out operators late last year – and they’re really good and they’re kind of carrying the rest of the portfolio.”

It’s in the REIT’s skilled nursing portfolio, Mr. Prosky said, where the company had seen the “biggest impact, and it’s on the higher acuity, post-acute Medicare, private pay – that segment’s down about 10 percent, and it’s mainly because of elective surgeries that have been put on hold. So, when that bounces back things should be better.”