As the healthcare industry adjusts to a new mode of service delivery, the effects of the Affordable Care Act, and the growth of the 65-plus demographic - traditionally the largest users of healthcare services - the medical office building niche is adjusting as well. As of midyear, $11.9 billion in healthcare real estate easily surpassed 2014's final total of $9.8 billion, with real estate investment trusts and institutional investors responsible for almost half of the volume, according to Real Capital Analytics. Private equity accounts for about 40 percent of transactions, while owners and occupiers traded about 13 percent of deals.
To get an understanding of the investment sale and leasing trends in the MOB market, Commercial Investment Real Estate magazine surveyed CCIM experts representing all sectors. Participating in the roundtable discussion are:
Mark Alexander, CCIM, national chair, Medical Office Council, Sperry Van Ness, Miami Beach, Fla.;
Jecoah Byrnes, CCIM, managing principal, National Healthcare Realty, Denver;
Steve Cannariato, CCIM, broker manager of Hawkins and Cannariato, Boise, Idaho;
Michael Davis, CCIM, managing director, Cain Brothers, Chicago;
Michael Honeycutt, CCIM, vice president, Realty Trust Group, LLC, Knoxville, Tenn.
What type of MOB transactions are you involved in?
Mark Alexander, CCIM: Most of my business is brokering sale/leaseback transactions for doctors who own the MOB where they practice. I also sell multi-tenant MOBs. Throughout my career, I have sold 91 MOBs in the Southeast, Illinois, and Texas. Currently I have a $12.6 million listing for two-story multi-tenant building that includes a surgery center. In addition, for the past 10 years, I have been hosting a monthly MOB webinar for SVN advisers, teaching them how to work with doctors on MOB sale/leaseback transactions.
Jecoah Byrnes, CCIM: The majority of my business focuses on acquisition, disposition, and development services for MOBs. We work with private physician groups as well as hospitals and healthcare systems that wish to maximize revenue opportunities for their medical practices by leveraging their real estate holdings. We specialize in single-tenant and multi-tenant MOB transactions.
Steve Cannariato, CCIM: I've completed more than 100 transactions with hospitals, doctors, dentists, chiropractors, and related professionals. I've developed MOBs on or near several hospitals. I've performed lease vs. own analysis for many doctor groups. I currently own an MOB on the campus of a local hospital.
Michael Davis, CCIM: In 2015, Cain Brothers has handled MOB portfolio sales ranging from 200,000 to 1 million sf, credit tenant lease financing for existing and to-be-built medical clinics, ambulatory facilities, and MOBs. Recently, we sourced CTL construction and permanent financing for 80,000-sf VA clinic.
Michael Honeycutt, CCIM: Realty Trust Group focuses exclusively on development, acquisitions, dispositions, and landlord and tenant rep leasing of MOBs and ambulatory care centers. We are currently involved in four significant MOB development projects in the Southeast ranging from 50,000 to 150,000 sf. Three are hospital-sponsored MOBs, while the fourth is a physician-sponsored MOB that includes medical office and surgery center. All four projects include third-party developers.
How would you characterize your MOB sales market for 2015?
Davis: There's been a major inflow of capital from institutional investors that are yield starved, driving valuations, and paying premiums for portfolio transactions.
Honeycutt: The major healthcare REITs continue to be extremely aggressive in both acquisitions and development. Other investors are responding, creating some attractive third-party capital options, which allow healthcare providers to preserve internal capital for other initiatives. Buyers and investors are also expanding into secondary and outlying markets seeking opportunities. In the last year alone, we've seen major MOB investments by a large REIT in Knoxville, with another local MOB portfolio currently being marketed.
Alexander: So far, 2015 is the best year in the past two-plus decades of selling MOBs. Investor demand for MOBs has been steadily building due to solid business fundamentals, healthcare reform, and baby boomer retirements. Along with REITs and private funds, private investors have also increased their appetite for triple-net-leased MOBs. I have even witnessed crossover buyers jumping into MOB acquisitions.
Although REITs grab a lot of headlines in the MOB market, REITs today own less than 20 percent of all the MOBs in the country. The vast majority of MOBs do not fit REIT acquisition requirements.
Byrnes: MOB sales in 2015 have been brisk and continue to outpace 2014 activity. We are completing transactions that are more than $400 per square foot. Demand remains strong, and prices for multi-tenant MOBs have now caught up with single tenant MOBs.
Cannariato: The demand for leased MOB investments is strong, but finding quality MOB projects with up-to-date finishes and stabilized occupancies is the challenge. In my market, construction and land costs have risen faster than rents. Therefore, it is difficult to justify building new space.
What is the biggest change in your MOB/healthcare market in the last couple of years?
Honeycutt: The transition to outpatient service is a fundamental shift in healthcare delivery. Providers have reversed the traditional “hub and spoke” model, pushing services out to the patient base. Both locally and nationally, we have seen a marked increase in the size of new MOBs, with hospital-sponsored MOBs commonly exceeding 100,000 sf to accommodate growing outpatient services. This same outpatient shift has altered the traditional MOB investment strategy. While on-campus MOBs were once the most prized assets, many REITs and other investors are shifting their attention to well-positioned, off-campus MOBs.
Cannariato: More than any time in my career, physician practices have been forced to manage costs and adjust to the additional requirements of the ACA. For many, their ability to pay the rents needed to justify building new, expensive clinic space has been diminished. And yet, the expectation to practice in state-of-the-art facilities remains very high.
Alexander: Private practice doctors who own their own MOBs are now turning to sale/leasebacks as part of their eventual exit strategy to retire in five to seven years. Hospitals are buying medical practices to expand their employee base and renting MOBs for their expanded employee base.
An interesting phenomenon occurs when a hospitals buys a medical practice that has sold and is leasing back its MOB. The investor who owns that MOB now sees his tenant quality increase from a group of doctors who provided personal guarantees to a national credit hospital tenant. That, of course, leads to further cap rate compression for MOB values.
Byrnes: One of the biggest changes is that the MOB sector is now perceived as low risk. Many new and traditional investors consider MOBs a necessity asset class, and the necessity often outweighs the lack of credit. Many noncredit transactions are now getting completed in the 6.0 to 6.5 percent cap rate range, pricing that historically has been reserved only for the highest quality investment grade tenants.
Davis: Investors buying hospitals - operating companies and real estate assets - is a major shift in investment strategy for institutional healthcare investors. Recent examples include Ventas and Equity Group Investments purchase of Ardent Healthcare Services and Medical Properties Trust's acquisition of Capella Healthcare. This favorable trend for the capital constrained healthcare industry also benefits the health systems as sellers, because real estate investors are more aggressive in enterprise valuations than strategic or financially oriented buyers. Yields for the real estate investors upon completion of these transactions are 100 basis points or more above outpatient properties, which is attractive to yield-starved investors and shareholders.
What are the challenges for MOB sales going forward?
Honeycutt: When interest rates and construction prices rise, margins will suffer or rental rates will rise to compensate. Interest rate risk is a national concern. Construction price escalation is more regional and is a real concern for new projects in major markets, such as Atlanta, where there is a high volume of new projects underway or slated to begin.
From the provider and tenant credit perspective, several variables are at play. High levels of competition among major providers, competition from nontraditional providers such as Walmart and CVS, and payment reform all have major impacts on the financial well-being of healthcare providers, and, in turn, their creditworthiness as tenants. The impact of proposed lease accounting treatment is crucial for healthcare systems considering a potential MOB sale or major lease commitment.
Alexander: Today's MOB environment has become frothy. On the supply side, there are only so many hospital credit tenant MOBs for REITs to chase, so they are finally starting to look at less-than-credit-type tenants with less than 100 percent occupied MOBs in off-campus settings. It contributes to cap rate compression. For example, I sold an orthopedic MOB sale/leaseback in 2013 for $12 million or $329 psf at 8 percent cap rate with a 10-year NNN lease and eight M.D. personal guarantees. It resold 16 months later for $14.8 million or $405 psf at 7 percent cap rate with eight-plus years remaining on NNN lease.
Byrnes: MOB investors that have found it difficult to secure MOB acquisitions are now beginning to pursue post-acute transactions where cap rates are more attractive, and there is an abundance of supply. Post-acute transactions include skilled nursing and short-stay rehabilitation facilities.
In addition, the MOB of the future is beginning to emerge as a mixed-use facility that contains hospital-based services, such as imaging, lab, and a free-standing emergency department, with adjoining medical office space for physician practices. These new micro-hospital/MOBs are beginning to sprout up in many metropolitan areas as a strategy for hospitals to penetrate new markets hand-in-hand with their physician partners.
Davis: Pre-2000 MOBs are obsolete and require repurposing. Telemedicine and e-visits could displace demand for physical outpatient space or be part of the repurposing of outpatient facilities.
Cannariato: The allure of physicians owning their own space has not disappeared. However, whenever I work with groups interested in acquiring space in which the doctors might have ownership, I always show them photos of 15- to 20-year-old MOBs and ask them if they'd like to locate their practice in this kind of space. They get the message. Unless no other viable options are available, most practices want new, state-of-the-art space. Many times, leasing is the better choice, as it gives the practice the flexibility to move to updated space every 10 years, and avoids having to peddle a tired worn out clinic space.