Medical Office Trends
Hospital affiliation is a strong indicator of MOB asset value.
The U.S. demand for medical services is expected to skyrocket over the next decade
due to demographic trends and new healthcare legislation. As baby boomers retire, the
over–65 age bracket will grow by 36 percent and that age cohort traditionally
consumes three times the medical services of younger people. Additionally, under the
Patient Protection and Affordable Care Act, signed into law in 2010, 32 million
additional Americans will have health insurance. This represents an 11 percent increase
by 2019, according to an Urban Land Institute report. Job creation among healthcare
practitioners will likewise mirror this expanded patient base.
These and other factors will increase the demand for medical office buildings by 19
percent by 2019, according to ULI. The need for an estimated 64 million square feet of
additional MOB space in the coming decade dwarfs the 6.3 million sf that will deliver
this year. Therein lies the conundrum of the MOB market: As vacancy rates dip below 11
percent and occupancy tightens, development is moribund. Why does a cautious attitude
afflict the office market's strongest subsector?
Physicians vs. Hospitals
In addition to broader economic factors affecting all commercial property types,
healthcare real estate is impacted by increasing levels of regulatory compliance; in
particular, PPACA was upheld by the U.S. Supreme Court in late June. This legislation
has fostered significant marketplace uncertainty, profoundly influencing how tenants
(physicians) and MOB owners (hospitals and equity investors) are approaching their real
Physician practices are hedging their options by "waiting it out" and taking
more–measured, conservative approaches to their MOB space requirements.
Specifically, healthcare tenants are frequently remaining in place, minimizing
relocations and facility expansions, and opting for shorter–term lease renewals
of 12 months to 24 months. Their approach is predicated upon the numerous unknowns of
healthcare reform: anticipated decreases in insurance reimbursements, increased
compliance costs, and the reality they may soon become salaried employees of larger
Conversely, hospitals and affiliated health systems are operating as if healthcare
reform will proceed either partially or wholly intact. These entities frequently have
large geographic footprints, own significant real estate portfolios, and cannot afford
a wait–and–see approach, given the need for longer lead times and
bureaucratic realities of large organizations. Generally, hospitals are taking a more
aggressive posture, pushing forward with distributed networks of healthcare facilities.
Well–located MOBs, strategically positioned throughout patient communities, are
highly desirable as they can achieve operational efficiencies and lower operating
Yet, physicians' and health systems' real estate requirements for
hospital–affiliated MOBs are converging due to increasing numbers of
hospital–employed physicians. With the uncertainties surrounding healthcare
reform, this trend provides mutual safety and economies of scale. Physicians gain the
security of a consistent salary and lose the cost of tracking down third–party
payments and covering insurance risks singlehandedly. Conversely, hospitals gain
increased market share and improved cost containment.
MOB Asset Value
As more physician practices move to hospital ownership, an MOB's hospital
affiliation, or lack thereof, is an increasingly important indicator of asset value.
From the perspective of MOB investors, hospital affiliation may provide greater overall
tenant stability and credit ratings as the hospitals themselves become the lessees.
This trend is enhanced by healthcare systems' push for strategically located MOBs to
form the backbone of their increasingly dispersed facility networks. In addition, real
estate investment trusts and institutional investors, which accounted for 45 percent of
2011 MOB sales volume, specifically target health system–affiliated properties.
Therefore, the investment community, physician tenants, and capital market participants
increasingly favor hospital–affiliated MOBs.
Hospitals, in recent years, have gravitated toward the prospect of MOB ownership;
however, their perspective in many cases may be shortsighted. In essence, they own the
practices/occupants, so why not own the real estate? Some argue that hospitals have
purchased and sold physician practices in the past and the pendulum will again swing
away from owned physician practices, making long–term real estate decisions based
upon short–term trends a costly mistake.
The recurring uncertainties of healthcare reform have curtailed
physician–owned development projects over the past few years. Physicians continue
to look for more flexible and fluid occupancy alternatives, with shorter–term
lease options providing the desired flexibility. The same uncertainties have also
affected the investment market for physician–owned, non–affiliated
properties. Due to institutional investors' requirements for creditworthy tenancy,
private investors with greater risk tolerance encounter infrequent competition from
institutional investors for non–affiliated MOBs.
In addition to MOBs, other non–medical real estate properties are becoming
important components of hospitals' comprehensive approach to building networks of
healthcare facilities. In particular, spaces and pad sites within well–located
retail centers are forming health systems' increasingly brand–specific,
This shadow space effect seems to have some appeal to both physicians and
hospital–affiliated practices. These users are particularly taking advantage of
smaller spaces, ranging from 10,000 sf to 20,000 sf, that were formerly occupied by
banks, video stores, and furniture stores. Cost–effectiveness together with the
abundant parking ratios of many retail facilities can provide an economical space
option for healthcare users. Additionally, the access, visibility, and branding
opportunities of these retail sites offer healthcare providers a much–needed
CCIMs can benefit by embracing the role of ongoing, trusted adviser to hospitals and
physician practices alike. Specifically, CCIMs can help protect and enhance the MOBs'
underlying asset valuations by validating fair market value lease terms as well as
navigating the potential impact of lease accounting changes. These proposed changes
will place real estate leases onto hospitals' balance sheets, thereby increasing
reported occupancy expenses. Healthcare organizations will be required to recognize
both liabilities for future rent obligations, and assets reflecting their right to
utilize the underlying real estate. Additionally, hospitals that own land but not the
real estate residing on it may have to account for these properties as both assets and
liabilities. The net impact to hospitals' perceived financial performance could be
significant and influence their credit ratings.
There are significant advantages to specializing in healthcare real estate in a
mature secondary market. Midsize markets are large enough to support specialization and
encompass significant MOB inventories that attract local and regional investors as well
as institutional capital, including large REITs. This broad investor
cross–section provides opportunities to work with and represent a variety of
owners with varying investment objectives. These relationships, in turn, enhance
healthcare tenant advisory services.
Some of the greatest opportunities and challenges for a healthcare real estate firm
include expanding geographically to other metropolitan areas. In particular, tertiary
markets are a compelling opportunity. Service providers in smaller markets frequently
cannot afford to specialize, which allows a larger more–specialized company to
bring significant expertise in healthcare–related property management, property
marketing and leasing, tenant representation, buyer and seller representation, and
acquisition and development consulting to otherwise underserved markets.
Patricia Wassik, CCIM, CPM, is president and Deborah
Carlson, CCIM, CPM, is chief operating officer of Health Connect Properties, a
Denver–based healthcare–related real estate services firm. Contact them at
pwassik@healthconnect properties.com and dcarlson@ healthconnectproperties.com.