Medical Office Momentum
Affordable Care Act takes some risk out of healthcare property investment.
The re-election of President Barack Obama and last year’s
favorable Supreme Court ruling on the Patient Protection and Affordable Care
Act have removed some uncertainty as to whether or not the healthcare law will
take effect. While some provisions have already been implemented, the majority
of them are scheduled to begin Jan. 1, 2014.
This outcome has created greater clarity for healthcare providers,
who continue to adjust not only to new rules but also to changing preferences
among consumers. Additionally, this situation creates considerable
opportunities for real estate investment in the healthcare sector, and transaction
volume is likely to remain lively in the near term.
The private sector spent almost $30 billion on all types of
healthcare construction in 2012 according to the U.S. Census Bureau, up 4.1
percent from 2011. Although construction slowed late in 2012 as healthcare
providers waited to see the outcome of the election and the Supreme Court’s
decision, the sector in general and medical office buildings in particular are
poised for growth as these same healthcare providers push forward on needed
expansions. Several factors are driving this growth.
Development Model Shifts
During the last several years, there has been a fundamental shift
in the way many medical providers deliver care. Instead of housing all
healthcare functions under the roof of an acute care hospital or on its campus,
many services — such as outpatient visits, blood tests, imaging,
rehabilitation, and some surgeries — are now performed in medical office
buildings, often away from the main hospital campus.
These facilities are more cost-efficient for providing outpatient
services. They also allow hospitals to have greater reach when it comes to
referring patients to the more expensive and ever more specialized acute care
hospital. MOBs are typically found in suburban communities where the population
of privately insured individuals is growing. Often insurance plans for these
patients provide higher-margin revenue sources when compared to Medicare and
Medicaid programs. For some health systems and providers, having a high number
of private-pay patients can make a meaningful difference on the bottom line.
As such, MOBs become the “spokes” that surround a hospital campus
“hub,” and help health systems to both capture higher patient volume and also
provide a greater continuity of care.
Under the hub-and-spoke model, healthcare systems often work with
third-party developers or construction groups to build medical office
facilities because standard office space is typically not designed with
appropriate structural support systems to handle clinical services. The
majority of space in these buildings is used by physicians’ practices and
healthcare service providers connected to the system building the facility.
However, space may also be leased out to other complementary healthcare
providers such as pharmacies, imaging centers, and physical therapy groups.
To help fund non-real estate initiatives or make other capital
investments, healthcare systems are often willing to construct and then sell
medical facilities to real estate investment trusts or private equity groups
while continuing to use the facility. When third-party development groups build
these facilities, they will often look to sell the asset so they can redeploy
the capital into new projects. Hospitals will often give themselves some level
of control over future ownership decisions through the use of ground leases or
Accelerating the Pace
While this change in the hospital business model began long before
the Affordable Care Act was signed, this law changes the medical landscape
significantly and accelerates the pace of pushing outpatient services away from
acute care hospitals. With the expansion of access to healthcare, more patients
will be seeking outpatient medical care in the coming years, increasing demand
for many of the services typically located in MOBs. This means the demand for
these types of facilities will continue to grow for the next several years.
Changes in how care is administered and paid for as a result of
the law could also create more MOB demand. For example, under the new law,
hospital systems could receive higher government reimbursements if
patient-readmission rates decline. Many hospitals are aligning themselves with
other healthcare providers to focus specifically on the care patients receive
when discharged. Post-acute care providers and physicians will have incentives
to improve and maintain quality outcomes as well.
That means healthcare systems are under pressure to ensure that
patients follow their doctors’ instructions after in-hospital procedures, for
example, making sure a patient undergoes rehabilitation following an inpatient
surgical procedure. To make rehabilitation more convenient for patients (and
hence lower the risk of an unreimbursed readmission), a hospital may offer
rehabilitation facilities at several sites, each close to hospital-owned
MOBs make attractive investment opportunities for many reasons.
The Affordable Care Act is not the only factor driving growth in
the healthcare sector. The aging U.S. population, with an average of 10,000
baby boomers turning 65 each day, is also increasing demand for medical
services. According to the Centers for Medicare and Medicaid Services, $2.7
trillion was spent on healthcare in the United States in 2011; this is expected
to reach nearly $4.8 trillion by 2021.
Investments in healthcare facilities are not geographically
restricted. Healthcare continues to be a business most influenced by local
market needs. As long as the medical practices located in the building are
affiliated with a healthcare system or well-capitalized healthcare practice
that has a strong area market share and a good mix of private-pay patients, the
size of the market is less important.
MOBs also tend to have low tenant turnover. Because most
physicians’ practices need specialized space, depend on being conveniently
located to patients and other related practices, and value continuity of
location for marketing purposes, there is a higher renewal percentage than is
typically seen in commercial office buildings.
Of course, this is not to say that MOB investments are without
risk. If a community’s demographics shift or if expected residential growth
fails to materialize, tenants in an MOB may not see the demand for services
they had expected. As a result they may relocate to a more desirable site
closer to their target population.
Historically there has been lower investment pricing volatility in
the medical facilities real estate market. Regardless of the economic
conditions, people will always need healthcare services.
Asset prices in the MOB sector are reflective of the high levels
of tenant retention and demand for space, as well as credit enhancement from
hospital systems, as investors compete for the properties that will provide the
strongest returns with the lowest volatility. Acquisition cap rates for
traditional MOBs are typically between 6.5 percent and 8.0 percent for
facilities with material hospital tenancy and longer-term leases, though higher
yields can be found in higher acuity and special-purpose buildings.
With the U.S. population aging, the Affordable Care Act remaining
in place for the near future, and healthcare providers highly motivated to
reduce the cost of healthcare delivery while improving quality and customer
experience, it seems likely that medical office facilities will continue to be
Stephen H. Mauldin is the president and chief executive officer of CNL Healthcare
Properties. Contact him at Steve.Mauldin@cnl.com. Kevin Maddron is senior managing director of fund management for CNL Financial
Group and oversees CNL’s senior housing and healthcare investment and asset
management activities. Contact him at Kevin.Maddron@cnl.com.