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Medical Real Estate- An Asset Worth Investing!

Medical Real Estate- An Asset Worth Investing!

Abstract

Real estate is knitted closely in the delivery of healthcare services. Despite this, many physicians blacklist this practice-related asset in buy-ins. One good reason for this attitude is limited knowledge in property and investments with a core concentration on the delivery of effective patient care. Analogous to other investments in the healthcare industry, the medical real estate is also subjective to healthcare reforms and ambiguous forthcoming developments after implementation of Affordable Care Act. The investors and developers are designing medical office buildings to utilize space productively and simultaneously, without compromising on providing high-quality patient care. The profitability of medical real estate investment can be uplifted by monetization on the return of assets, embracing partnerships in investments and plant operations.

Keywords

Merger and Acquisition, Vacancy rate, Absorption rate, Retail clinics, Hub and Spoke, Lean and Green

At a Glance

  • Introduction
  • Real Estate and Healthcare in the US
  • Market Trends in Real Estate
  • Risks Involved in Real Estate
  • Common Myths Related to Investment In Medical Real Estate
  • Making the Investment in Medical Real Estate Profitable
  • Checklist for Investment
  • Summary

Introduction

Medical real estate is no buzzword in the healthcare industry. However, the sales of medical office buildings going up to $5 billion consecutively for the third year in 2014 indicates how the capital is accumulating in healthcare from real estate investors. Due to the capital pouring in from Real Estate Investment Trust (REIT), private equity buyers, and institutional healthcare realty investors, competition for healthcare property has broadened the market value of U.S. medical real estate.

According to Revista, the estimated value of 51,000 medical office properties is near $315 billion.

The stability in the trends over the past three years is the main feature that attracts investment from healthcare entrepreneurs in income-producing medical real estate property.

Figure: Segregation of investments for various sectors in real estate

                                                               Source: www.seekingalpha.com

Real Estate and Healthcare in the US

The following factors may play a major role in the increasing interests of the real estate investors in healthcare.

1. Healthcare reforms: The objective of healthcare reforms is to provide Americans high-quality and cost-effective health care. The study conducted by Brandeis International Business School and JLL reveals that healthcare reforms are a critical factor in redefining the healthcare real estate.

Following the enactment and implementation of the Patient Protection and Affordable Care Act, there would be an increase in demand for healthcare services. To account for a rise in demand for healthcare services, at the same time ensure high profitability ratio, a physician needs to carefully blend the commercial real estate trends into business decisions.

2. Baby boomers and their medical needs: The large share of America’s healthcare expenditure is contributed by baby boomers. Out of every $1 spent on healthcare, $0.50 is added by baby boomers. The current projections regarding the population of U.S. draw the attention to the rapid growth in people aged above 65 years from 40.2 million in 2010 to 54.8 million in 2020 and by 2030, one out of every five Americans would be a baby boomer. On an average, this cohort is estimated to pay 6.5 visits to a physician per year nearly double that of remaining U.S. population. These facts highlight the increase in demand for space in both medical offices and outpatient sectors.

3. Insurance coverage: By 2019, it is estimated that 92.7% of Americans will have health insurance. The uninsured and underinsured patients accounting for 4% of physician office visits per year and nearly 17% of emergency room visits will seek more convenient physician office and outpatient care after implementation of ACA. This increase in the number of patients demands an increase in the healthcare infrastructure.

4. Mergers and acquisitions: Though the number of mergers and acquisitions have come down to 53 deals in 2014 compared to 107 in 2012, there is substantial demand for mergers and acquisitions for the appropriate practices. Mergers and acquisitions result in bifurcated health care systems getting hold of best physicians and concentrating the patient base with powerful large hospitals.

The acquisition market for medical office buildings is dominated by REIT, investing in high quality properties; they contributed to 46% of buyer volume in 2014 as compared with 16% in 2013. Of all the acquisitions in 2013-2014, Ventas, Griffin-American Healthcare REIT III, and Healthcare Trust of America are the top companies.

5. Employment in hospitals: The increase in the number of physicians employed by regional hospitals and health systems create a strong influence on bifurcation of healthcare. According to a survey conducted by Jackson Healthcare, hospital systems have used 20% of primary care physicians in 2014 when compared to 10% in 2012.  The employment in hospitals is insignificant in comparison with 4%-6% expansion in convenient out-patient care and delivery of care at home at low-cost.

6. Medical tourism: There has been a seven-fold increase in the medical tourism since 2006, and about 979,000 Americans travelled abroad for healthcare services. Globalization of U.S. healthcare is driven by a push from fee-for-service to value-based-services; use of technology such as fit-bit to monitor the health of patients, and practice of telemedicine has lowered the cost and at the same time brought services closer to the consumers.

Market Trends in Real Estate

1. Vacancy rates

Despite the demand for well-located and high quality infrastructures, vacancy rates in the medical real estate have decreased and reached 11% after the recession. The reduced figures in relocation also are due to long term lease agreements, high cost, and time required for establishment of practice. The medical office buildings constructed before 1990’s that became outdated display higher vacancy rates than those open-ended models constructed during 1990-2000.

                              Figure: Percentage change in the vacancy rates in 2011 and 2014

2. Absorption rate

Positive absorption trend is observed in medical real estate since 2009 reaching greater than 1.7msf in the first half of 2014. The Houston market that includes Texas Medical Centre accounts for one-fourth of absorption in 2014.On an average, less than 5million square feet of new space have been delivered per year in the past three years.

3. Space utilization

Based on the data published by the National Real Estate Investor on medical real estate in 2010, each insured patient requires 1.9 square feet of medical office space for primary care in outpatient setting. This fact implies the need for 600-1000 additional supply of space in next six years to meet the healthcare demand for ACA assured, newly insured 32 million Americans.

Going by the benchmark standards in the healthcare industry, on an average, every physician requires 1000-1500 square feet for medical office. Nonetheless, there is a shift of many hospital-based procedures such as digital imaging, radiation, minor surgical procedures, etc to delivery at medical office. This factor added with the surge in usage of physician extenders, increased the demand for square feet per physician influencing the utilization of space and designing of medical office buildings towards efficient, flexible, and synergistic layouts.

4. Construction

A downfall is observed of space under construction from 7.7 msf in 2009 to 3.7 msf in 2014, furthermore, completions decreased from 6.6 msf in 2009 to 2.4 msf in 2014. However, an uplift in construction of new medical office buildings is possible in near future owing to revised healthcare systems and targeted population. The escalation of demand for healthcare services and the correlated market in certain localities, particularly in Southeast U.S. can be evidenced by bulk constructions in healthcare facilities.

5. Retail

The consumer’s demand for flexible, cost-effective, and accessible care substituted the traditional hospital and medical office buildings with retail, walk-in clinics in strip malls, apartments, etc. attracting investment in medical real estate from pharmacies, groceries, fitness centers. A study forecasts 22% increase in the outpatient services from 2009-2019 in comparison to 1.7% increase in inpatient services. This shift to outpatient care provoked the healthcare providers to invest in retail locations to help provide convenient, cost-effective care while expanding the market share.

  • A 47% waning in the number of beds per thousand U.S. populations from 5.5 in 1980 to 2.9 in 2010 is indicative of growth in outpatient volume. At present, outpatient care revenue accounts for nearly 60% in comparison with 10-15% in the 20th century.
  • According to the study conducted by RAND Corporation in 2011, there is a tenfold increase in the walk-in clinics providing vaccination during 2007-2009. The surge in the urgent care clinics and dialysis centers at the suburban shopping malls provide outpatient care at transparent prices than traditional hospital settings.
  • Minute clinics spread across 900 locations, and an additional 600 are expected to come up by 2017. Texas Health Resources recently announced an alliance with CVS minute clinics in Dallas-Fort Worth. Kaiser Permanente also announced a partnership with open clinics to deliver high level services in obstetrics, gynecology, and pediatric primary care at retail strategy.
  • According to IBIS World, wellness and holistic healthcare clinics are growing at a rate of 3.1% annually because of proximity to consumer base adding revenue of $12 billion in 2014.

6. Investment

Healthcare industry is witnessing a torrent of capital inflow along with demand for high-quality assets as a result of demographics, favorable environment, and low-interest rates indicative of rebound sales during the recovery period. The providers are monetizing the assets to acquire capital by an effective sale-leaseback transaction. According to Real Capital Analytics, the average capital for the assets trading in the top quartile is 2.5% whereas, for that in bottom quartile was 11.5% in 2014.

  Figure: Investors in medical office building capital

Risks Involved in Real Estate

A capital pool is necessary for a physician to purchase than to lease space or medical office building. A physician owning the medical office building has to invest not only in interiors and infrastructure that are normally arranged by the land owner in leasing model, but also in procuring equipment to enhance the practice. Like any other business, the medical real estate is also subject to market risks and fluctuations in a market may increase or decrease the value of investments. The market is dependent on factors such as demographics of a locality, use and non-use of the building, etc.

1. The physicians may own the office space for themselves or may lease a portion of it, and may hold the have to be responsible for as maintenance, up gradation, and amenability with building codes, avoiding vacancies, responding to complaints of tenants, etc. A leasing agent could be of use but their performance, in turn, is the responsibility of the physician.

2. Lack of liquidity, high transaction taxes, legal taxes, etc place medical real estate as an exorbitant property for a physician’s investment.

3. Sometimes partners feel there is exploitation of economic interest of others creating conflicts of interest among the physicians having ownership and the remaining partners. It may adversely strain the practice.

4. The success of a medical real estate investment is weighed against the return at the exit of practice; that in turn is influenced by demographics of locality and approach of medical practice.

Common Myths Related to Investment In Medical Real Estate

Most of the physicians have misconceptions regarding the investments in medical real estate.

1. Too pricey: Most of the times, real estate around successfully running hospitals are overpriced leaving them no choice than to rent space in hospital-owned buildings. It is a market strategy to restrict competition in field, but there are plenty of opportunities available for a physician to explore in medical real estate.

2. Too risky: Is it riskier than share market? Banks are not willing to sponsor investment in shares, but banking sector is ready to sponsor 80% to 100% of a building’s value in constructing a new medical office building. They understand the physician’s hard work, focus on business goals, and attitude to continue their reputation at a fixed locality that attracts investments in a medical practice real estate.

3. Shortage of cash: It is not mandatory for the physician to invest in total, many investment groups are interested to partner in medical real estate. A physician with a track record of success, good credit score, and reputation can easily draw finance from investors for a valuable medical office building.

4. Hang up in debts: The balance sheet of even the smartest and successful physician ends up most of the times in liabilities and assets which do not generate income due to poor management and investment of income. Early investment in a medical office building, especially on account of reduced interest rates, is fruitful over long-term to the physician.

Making the Investment in Medical Real Estate Profitable

1. Retail outlets

According to the data furnished by Avanza Healthcare Strategies, outpatient services account for 65% of total hospital revenue. The shift from traditional hospital care to retail outlets close to consumer base such as malls, shopping centers, work place, residence, etc. will reduce the overall capitation risk.

CVS Minute Clinics occupying 100-300 square feet have delivered care to closely 20 million patients at a rate of 95% consumer satisfaction. It provides evidence that small investment in real estate can provide effective and transparent treatments such as health screenings, diagnosis and treatment of minor problems, monitor chronic problems, and provide vaccination at a reasonable cost.

To keep at par with the shift from physician-centric to patient-centric models, many popular hospitals such as Mountain Star Health are adopting “hub and spoke” model of healthcare delivery to maintain proximity to the patient base. They have an 80,000 square feet hospital that act as a hub rendering highly specialized services. Meanwhile, an ambulatory service centre operates as spokes delivering expanded services.

Other services delivered at the retail outlet are:

  • Smoking cessation programs
  • Annual wellness visits
  • Employee-sponsored wellness programs
  • Exercise and nutrition education

2. Space Utilization

The need to lower the space utilization, at the same time provide quality care and improve productivity, has led to the development of “Lean and Green” model of sharing spaces and standardizing rooms. This model utilizes around 400 square feet per room with 3000 inpatients per room in a year accounting for 33% increase in productivity.

3. Partnership

 To eliminate fragmented delivery of services and create a larger system, healthcare organizations are adapting a concept of “co-operation” that brings in effective sharing of resources, focused and appropriate delivery of care to the regional population.

Utilizing the leverage of debts from third party investments, in addition to their own equity in acquiring large assets provide a chance to share the capital and interest rates. However, careful planning of exit strategy using the equity in “like kind of exchange” allows the investors to benefit from capital gain.

                                                 Figure: Merger and Acquisition trends in 2014

4. Monetization

The increase in resources allocated to equipments, property, and plant along with reduction in profitability resulted in reduced Return on Assets (ROA). According to Moody’s study, there is a decrease in the ROA from 4.6% in 2011 to 4% in 2013.

Monetization of assets will raise the capital in the hospital balance sheet and also eliminate the future capital investment for maintenance and tenant retention. In the past few years, many healthcare organizations such as Aurora Healthcare, Pinnacle Health System, Novant Health, etc. have monetized the medical office building and another real estate. The medical real estate accounting for 85% of healthcare real estate is one of the valuable assets to measure business and financial health. Healthcare is the largest capital involved REIT nearly $59.3 billion in 2010-2014.

Sale-leaseback is a safe option to monetize the real estate of a practice. It is an agreement of selling the property to an investor who in return will lend the same property to the provider on lease and maintain control over operations of clinic.

Figure: Sale-leaseback trends in 2014

5. Plant operation

Both the plant facilities and the management workforce are aging, thereby creating an exponential gap between supply and demand of managing infrastructure; this will further compromise on the quality of patient care. According to a study conducted by Moody’s, the average age of the plant increased from 9.8 years in 2009 to 10.7 years in 2013.

Based on the study conducted by CoreNet Global Occupiers, facility management is one among the top three outsourced services. A flexible mobile engineering team can increase efficiency, at the same time optimize staff productivity. It can also bridge the gap between the plant operations and new model of delivering care. Partnership with organizations that influence the tools, training, and resources for staffing will provide core competency in operations of the plant.

To harness energy as cheaply as possible, a comprehensive energy management program that can track and adjust the energy usage can be useful. It is estimated that approximately $3.7 million can be saved in 3-4 years by implementing sustainability project.

Checklist for Investment

Before investing, financing, or developing a real estate property, a due diligence investigation into the property is necessary to ensure legal and financial feasibility. A checklist will guide the buyer to conduct proper due diligence investigation. This period provides the advantage to the buyer in walking away from the property if the required expectations are not delivered from the seller.

  • Purchase and Sales agreement and the terms and conditions between the buyer and seller
  • Documents for sanction of loan
  • Type of property the buyer is acquiring
  • Restrictions on transfer of property
  • Eco-friendly concepts in the property
  • Property encroachments, if any
  • Copies of state licenses, Certificate of Need, HIPAA compliance policy
  • Third party debt documents

Summary

In the face of ongoing healthcare reforms and implementation of Affordable Care Act, the intensity of investing in the medical office property is at peaks. The affirming environment for investments such as low-interest rates and high inflow of capital is capturing the already existing investors such as private buyers and REIT along with new investors. A physician turning to own a medical office building could have control over the location along with appreciation of the asset. It is critical for developers, providers, and investors to be aware of market course and adapt accordingly to make profits and also convey cost-effective and high-quality care.

References

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