COVER STORY, SEPTEMBER 2009

STEADY MOB SCENE
The Medical Office Building sector remains healthy.
Alan Blinder

Opened in August, the $19.5 million, 80,000-square-foot Sierra Medical Office Building is The DASCO Companies' second medical office building on the Parker Adventist Hospital campus in Parker, Colorado.

While many sectors of real estate are seeing low occupancy and suppressed investment sales rates, medical office buildings have remained a relatively safe bet, say speakers and panelists at the recent InterFace Medical Office Buildings conference, held in Chicago. “If there is going to be a darling [of real estate sectors,] healthcare will be it,” says Todd Varney, an executive vice president at Palm Beach Gardens, Florida-based Rendina Companies.

“It’s still a great business to be in,” says Gina Weldy, who directs finance and real estate at Chicago’s Northwestern Memorial Hospital. “We’re not a speculative business, so you haven’t seen us overbuilding. Therefore, our growth is going to have to continue.”

As with all commercial real estate sectors, fewer entities have been lending for medical office properties, though such projects have had an advantage over other initiatives. Lenders have been scouring the nation for quality properties in major markets. “If [lenders] have to change a plane in order to get there, they just won’t even look at the books,” says Vincent Cozzi, a managing director at Ventas Healthcare Properties. But, he continues, developers in smaller markets should still try to find support. “People get sick and need care in those markets, too. The challenge is finding the debt capital to go into those markets. Good financing sources will follow good people to good deals. It’s just harder to get them done today.”

Developers have been more selective about their projects recently, but, according to Varney, they are finding ways to get deals done for existing clients, which include medical-use buildings like hospitals, surgery centers and medical practices. In the rare instance that developers take on new clients, the three criteria that are the most important are long-term growth plans, financial standing and reputation of the owning entity.

Experts say that projects with financial support from hospitals have had the best chance of winning financing and moving ahead. The U.S. government has helped to trigger additional hospital involvement by expanding a program of the Department of Housing and Urban Development (HUD). The Federal Housing Administration, one of the department’s agencies, administers the Section 242 program, which provides financing for capital projects at the nation’s hospitals. Until recently, the application for a Section 242 loan was daunting, in many cases taking more than a year to process. However, in spite of the length of the process, hospitals often chose to move ahead, and HUD has provided $30 billion in mortgages to more than 400 hospitals.

Recognizing the broader economic benefits of expanding healthcare by expanding hospitals and building more medical facilities, the federal government has streamlined the application process. CB Richard Ellis’ Chris Bodnar says that the application process “has sped up quite a bit; it takes about 60 days to go through the application process today.”

Even with federal financing, hospitals and other medical development entities are still carefully managing their risks. Bodnar notes that buildings will often be 70 to 80 percent pre-leased before they are financed. “The success of the project is determined before it is constructed,” Bodnar says.

Careful risk management has paid off and it is now rare for healthcare properties to be distressed. If a property is distressed, Bodnar says, “I think you have to question whether that property should be in the healthcare sector going forward.” In Bodnar’s experience, he had some physician groups leave an older, less functional building, often because of a merger with a larger practice, triggering later distress. If a building is too dated to effectively serve healthcare needs, Bodnar argues that the landlord should consider converting the building into an office property.

It is not easy, conversely, to convert an office property for medical use. Weldy says, “It’s viable, but I don’t think you can kid yourself: It’s painful.” Weldy, who is currently overseeing one property conversion, notes that the infrastructure demands for medical offices are much different than traditional office properties. “It’s something that you can’t just do overnight. You really have to think about the use of the entire building before making these changes,” Weldy says. Varney notes that converting an office property to medical office may be the only option in congested downtown areas.

While medical office properties have endured the recession better than other property types, healthcare real estate investment trusts, like all REITs, have been down as of late. “Everything has been down and down really badly,” says Ventas' Cozzi, mentioning that the share price of his firm’s REIT has been down more than 65 percent. During a 12-month period, one healthcare REIT’s share price fell from $52 to $17. That price fluctuation may be more reflective of investors’ current view of real estate versus real property performance though.

But the healthcare office market may be changing as large corporations explore ways to maximize employee productivity. Bodnar says that some large companies, looking to more carefully manage care and reduce the number of hours employees miss while going to medical appointments, are building medical centers into their office complexes. He cited the recent work of technology giant Cisco Systems, who built a 24,000-square-foot on-site medical center in its headquarters in San Jose, California. Cisco is not the only company to provide primary care on site; Intel and Pitney Bowes are among other corporations that have opened facilities on site.

As hospitals build, they are primarily constructing outpatient centers and diagnostic facilities with capabilities such as magnetic resonance imaging (MRI). They are also dealing with balancing growth goals with responsibilities as healthcare providers.

“As the economy worsens, we will inevitably see an increase in the uninsured and underinsured. That is something that we can try to manage and plan for, but it is not something we can control. When patients come into your facility, you treat them,” says Weldy. Such obligations put pressure on our hospital developers’ plans, she adds. “A hospital has to balance its financial goals with its operational goals.”

 Even as costs and pressures rise, hospitals continue to plan for the future. “Our big plans haven’t changed,” Weldy says. Because of the economic slowdown, though, Weldy says that hospitals are having to be more creative in finding ways to make those plans come to life. “We are looking at alternative ways to partner to get some of that work done.”

To keep growth plans on target, “the smart hospitals are looking past the headlines,” Varney says. “The savvy hospitals are putting the plans in place, using their finances on their core business and bringing in third-party developers.”

He also argues that hospitals beginning projects now can be a positive economic force in the short-term and a strong competitor in the future. “Healthcare is doing nothing but growing, so let’s not put our head in the sand right now and further depress the construction and labor markets. Let’s go out there and expand our services so as the economy turns, our buildings will be coming online and we’ll be ahead of the competition.”

The experts at the InterFace Medical Office Buildings conference urged investors and others to keep faith in the sector. One noted that, even with the recession, the healthcare industry has not shrunk, accounting for 17 percent of the gross domestic product. “It’s a great business,” Varney concludes. “Like anything else, there are challenges, but we just need to dig in and forge ahead because all of the statistics are out there for success in the future. We just need to get through those short-term blues.”

A HEALTHIER DESIGN PROCESS A New Review Method Reduces Construction Time and Costs for Healthcare Facilities in California. Clovis Community Medical Center in Clovis, California California healthcare construction costs are among the highest in the nation, with $2.5 million the average cost per bed for new hospitals. Construction and material costs increase at an average annual rate of 8 percent. Since all healthcare buildings that house patients for more than 24 hours must be reviewed and approved by the State of California’s Office of Statewide Health Planning and Development (OSHPD), project reviews can take between 12 and 24 months, increasing costs due to a continuous cycle of reworking. That is why healthcare leaders in California are now piloting a program called Phased Plan Review (PPR) for several large construction projects underway, including the current expansion of Clovis Community Medical Center in Clovis, California. Here are three ways PPR decreases the time it takes to design and build new hospital facilities:  1) Creates design milestones: In PPR, the OSHPD review process begins at the outset of the project, rather than waiting until implementation documents are completed as with the traditional review model. The architect submits project segments in defined milestones on a set schedule agreed upon by the design team and OSHPD. 2) Decreases the element of surprise: Once OSHPD reviews and approves the milestone, no changes can be made. This not only allows progress through a solid agreement between OSHPD and the design team, but also mitigates surprises that may occur if OSHPD disapproval results in redesign and rework. By having structural and fire life safety approved first at Clovis Community Medical Center, for example, many of the other design components could move ahead on a quicker schedule. 3) Increases collaboration: PPR encourages design work and the OSHPD review process to progress in a more efficient and targeted way. There is a continuous dialogue with the owner, design team and OSHPD. As a result of PPR, the Clovis Community Medical Center project is expected to shave up to 12 months off of the traditional OSHPD review process. PPR is also being piloted for several other proposed hospitals in California. Clearly, PPR can give California healthcare leaders some relief from prolonged construction timeframes for their future facilities. Bonnie Walker is vice president and Healthcare Practice Group leader for the Sacramento office of HGA Architects and Engineers.

©2009 France Publications, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 554-6054.