A Healthy Disposition

Healthcare systems are capitalizing on increased demand to diversify assets and free up cash.

Medical office buildings enjoyed healthy transaction activity in 2010. Sales volume increased by 80 percent over 2009, according to Real Capital Analytics. MOB acquisitions totaled more than $3.1 billion in volume by year-end.

MOBs have attracted a great deal of attention from investors at all levels. Some of the transaction volume is driven by healthcare systems deciding to get out of the business of owning and leasing MOBs. Understanding how hospitals view their MOB investments can provide insight into how commercial real estate professionals can assist them.

Medical Office Values

Different Considerations

Doctors often purchase their own medical facilities as a long-term investment. Doctors can build equity owning MOBs during their careers, with an expectation to cash out equity near retirement by selling to a practice partner based on a market appraisal, or by structuring a sale-leaseback transaction with an investor to create a higher net present value of the MOB asset.

Hospitals typically have more-complex issues to assess. Most have an investment portfolio consisting primarily of equities. Some hospitals consider MOBs to be part of their investment portfolio. Other healthcare systems view their MOBs strictly from an accounting standpoint as an operating asset. A hospital system typically owns the buildings it occupies as well as other MOBs rented to doctors and other healthcare providers.

Hospital-occupied MOBs are good candidates for sale-leaseback transactions to monetize value in cases where the hospital has limited access to capital for property improvements or expansion or to free up cash to fund operations. However, not all healthcare providers need to monetize owner-occupied MOBs if they have strong credit with good access to capital at reasonable rates.

Tenant-occupied. Hospital-owned, tenant-occupied MOBs have recently become a higher priority to sell for several reasons. MOBs are investments that tie up hospital capital that could be utilized more effectively on other strategic investments. Due to soft office market conditions across the U.S., many hospitals have increased vacancies with the opportunity cost of this capital tied up in their MOBs.

The estimated value of MOB holdings is added to the healthcare provider’s investment portfolio. When the ratio of MOB holdings as a percentage of total portfolio assets increases, portfolio risk also increases from an investment perspective due to the lack of geographic and industry diversification inherent in MOBs. This is especially true if patient volumes decrease as is the case currently in many markets. Significant concerns about the slowly recovering economy combined with new political challenges to healthcare reform may cause hospitals to reassess the risk of holding a high percentage of MOBs in their overall investment portfolio.

Sale-leaseback of select hospital-occupied buildings and/or straight sales of tenant-occupied buildings can provide that asset diversification and improve the cash positions at a time when cash can be utilized to take advantage of more strategic opportunities. For example, Carle Foundation Hospital sold its 92,000-square-foot MOB in Bloomington, Ill., for $24.25 million, or $264 per square foot, at an 8.5 percent capitalization rate, according to Robert Tonkinson, former CFO of the Carle Foundation based in Urbana, Ill.

Other Concerns

Two new statutes enacted by Congress in 2009 may bring greater governmental scrutiny and action for hospitals and healthcare systems. The 2009 Fraud Enforcement and Recovery Act and the Patient Protection and Affordable Care Act affect a hospital’s decision to self-disclose Stark Law violations related to hospital-physician leasing arrangements. (MOB leases are considered financial arrangements that fall under the Stark Law, which prohibits physicians from referring Medicare patients to a healthcare facility with which they have a financial relationship.)

The impact of these rules on MOBs could be significant and cause many healthcare firms to sell their MOBs to third parties, if only to avoid the potential risks. Hospitals that wish to retain their MOB interests may consider outsourcing MOB management to commercial MOB specialists as an added layer of insulation from Stark Law liability.

The most transparent way out of this newly heightened government scrutiny, however, may be to monetize MOBs with sales or sale-master leasebacks. This avoids the inherent potential conflict posed by a doctor who refers patients to a hospital, and later asks the same hospital for six months free rent to sign a new lease. In this situation, the negotiation is driven by federal health care regulations with heavy fines levied on hospitals that don’t follow the rules. When a doctor asks a private MOB owner for six months free rent to sign that same new lease next to the hospital, it becomes a simple business decision driven by market forces, without the negative baggage of perceived conflicts of provider-owned MOBs.

MOB Values Up

There is exceptional demand today supporting stronger-than-ever values for large MOBs with healthy credit tenants on long-term leases in major U.S. markets. For example, Healthcare Trust of America purchased more than $800 million in healthcare assets in 2010, including 53 MOBs. More than half of those purchases were made in 4Q10. One purchase was the Deaconess Clinic of Evansville, Ind., a five-building sale totaling 260,500 sf for $45.26 million, or $174 psf, at an 8.25 percent cap rate in March 2010 using a 14-year term master leaseback.

The average annual price for MOBs in sales larger than $5 million has risen steadily from $140 per square foot in 2002 to $218 psf at the top of the market in 2006 to $239 psf by the end of 3Q10, according to RCA.

But what about smaller MOB deals in smaller markets? I personally brokered the sale of 53 MOBs with an average sale price of approximately $1.03 million per transaction, located in tertiary markets in Florida, North Carolina, South Carolina, Georgia, and Illinois from 2002 through 2Q10.

The accompanying charts compare the annual prices of deals over $5 million tracked by RCA and my deals. From 2002 through 2005, there was an average MOB price difference of only $20 psf between the big deals/big markets and the small deals/small markets.

In that same period, cap rates for large transactions averaged only 0.6 percent lower than those for small deal/small market prices. But the gap started to widen from 2006 through 2008, when the big MOB deals averaged $30 psf higher and the cap rates for big deals compressed to average 1.5 percent lower than the cap rates for the small deals.

There was a striking difference from 2009 through 2Q10 as big deals in big markets pulled away and averaged $80 psf higher than the small deals in small markets, with the cap rate differential moderating to only 1.1 percent. This condition over the last two years reveals an interesting trend. The more sophisticated investors (like hospital systems) that own big MOBs in big cities realized that, in addition to the other good reasons, the top of the market is actually now, so they are selling.

Doctors predominately own smaller MOBs in smaller markets and are somewhat isolated from the realities of the current favorable market condition for MOBs. They have tended to remain on the sidelines during these last two years believing their MOB values are down like the rest of the real estate market, when in fact the opposite is true. The majority of small MOB sales over the last two years were mostly distressed, vacant properties that sold at very low prices, creating the disparity of $80 psf between large ($5+ million) and small ($1 million) recorded MOB transactions.

This should change, however, in 2011 as the gap between large and small MOB deals narrows when doctors in smaller markets realize MOBs have escaped the declines of other segments and that now is one of the best times ever to sell medical office space at strong valuations.

Mark Alexander, CCIM, is a senior medical office adviser for Sperry Van Ness in Fort Myers, Fla. Contact him at


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