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
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.
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
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
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
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 email@example.com.