Niche properties

Healthy Investments

Savvy brokers find the right property prescription for specialized medical tenants.

When southeastern grocery store chain Ingles Markets needed help subletting its 32,000-square-foot box in an ailing strip center, the prognosis for leasing to another retail tenant didn't look good. But John D. Spake, CCIM, president of Spake Real Estate in Asheville, N.C., provided a prescription for improved health: He leased the space to Pardee Hospital , which wanted to consolidate its urgent care, physical therapy, and imaging services in one location.

"I've done a lot of alternative uses for grocery stores because in smaller markets, there's no retailer to back-fill the boxes. In my opinion, [health care] is one of the more high-quality uses," Spake says. After originally inquiring about another building, the hospital ended up signing a seven-year lease in the strip center with 11 five-year renewal options.

Customer Service Focus

Leasing nontraditional locations to specialized medical tenants is a popular response to the health-care industry's current robust expansion trend. As hospitals add beds and specific treatment centers move off medical campuses, health-care tenants are focusing more on customer service and broadening their site selection parameters, such as looking for locations with more parking and access to major roads.

Hospitals, which have many service lines and often own medical practices within a community, are leading the way with this style of outreach marketing. But other providers, including independent physicians and growing health-care businesses, are employing the strategy as well. "They're trying to get closer to where the people reside," says Richard J. Abel, CCIM, vice president of Colliers International's health-care services group in Cleveland . "It's a riskier real estate investment though, because medical campuses are pretty safe bets."

Many health-care providers have decided it's worth the gamble. The number of diagnostic imaging centers, for example, has grown from 3,337 in 2000 to 5,771 in 2004, a nearly 73 percent jump, according to Verispan, a health-care information company in Yardley, Pa. Outpatient surgery centers increased nearly 21 percent, from 3,270 in 2000 to 3,955 in 2004, while cancer centers increased more than 36 percent, from 950 in 2000 to 1,296 in 2004. Dialysis centers increased about 11 percent, from 4,112 in 2000 to 4,580 this year.

Many physicians also want to own rather than lease medical office space. Low interest rates coupled with declining reimbursement rates and rising insurance costs makes real estate a healthy investment option. Larry E. Willey, CCIM, recently formed Weston Partners in Atlanta to capitalize on this trend. The group purchased a 9,000-sf single medical tenant building in Asheville and is redeveloping it into a multitenant office center, with plans to offer interested physicians purchase, lease, or lease-to-buy financing options. "We formed the company because we saw a trend of physicians wanting ownership interest," Willey says.

In other markets, commercial real estate professionals are finding specialized health-care tenants a cure for what ails their local retail economy. Sometimes it takes convincing clients to agree to the idea, but the advantages for both landlords and tenants make the two a logical fit, real estate experts say.

Retail-Style Site Selection

In today's profit-centered environment, medical practices and hospitals -- like retailers -- pay close attention to demographics and traffic flow when formulating their expansion plans. They tend to seek rapidly growing areas such as new, remote bedroom communities to establish outpatient facilities or outpost-style clinics as a way to draw patients into hospitals or larger physician groups.

Health-care providers also venture away from medical campuses in search of a key target demographic: mothers and wives, families' primary health-care decision makers. By placing themselves in the path of a person's weekly routine, doctors and clinics hope to put the convenience factor to work in their favor. "You pick sites that are more in line with everyday living. You try to think about the route of travel, like grocery stores and dry cleaners," says Brad Barker, a Dallas-based senior vice president in the health-care sector for RTKL, a planning and architectural firm.

Along with convenience, health-care facilities also look for exposure and access. Harry Jewett, CCIM, vice president of health care for Lauth Property Group in Denver , recently located a hospital on a 30-acre portion of a 600-acre mixed-use development. Along with the hospital, the project includes restaurants, retail shops, office space, and multifamily housing and is located off a major highway interchange near Denver.

The hospital's site selection strategy was consistent with the way retailers choose their locations. "There's a lot more emphasis placed on customer service and ease of access for patients. The traditional methodology was to build the institutions near the middle of town and make people come to them," Jewett says.

Like various retailers, medical specialties have different site selection needs. For example, while an imaging center might require the visibility of a free-standing location, destination services such as physical therapy, dialysis, dentists, and some physicians' offices are good fits in strip malls. Less reliant on ancillary traffic, such tenants may be satisfied with interior strip center locations because they offer more exposure than a traditional third-floor suite in a medical office building with no external signage. Retail centers also provide higher parking ratios, around five spaces per 1,000 sf of space versus standard office buildings' three per 1,000 sf ratio.

Steady Traffic

Because they don't rely on other users for business traffic, medical tenants are a good fit when a center has lost its retail strength. An established dermatologist or a dialysis center has a steady patient flow regardless of what's next door. At the same time, retailers in a substantially dark center may benefit from the increased traffic a medical tenant provides. This trickle-down effect can breathe new life into a retail location as patients and those who accompany them look for diversions just outside the office waiting room.

Medical tenants usually are good credit risks and sign longer leases to amortize build-out costs over a longer time period. A medical lease may be between seven and 10 years, double the typical retail lease. "Part of it goes back to the loans. The lender wants the payment to be manageable," says Jan Friedlander, CCIM, senior vice president for Coldwell Banker Commercial R.E.S.I. in Denver .

Of course, landlords can charge higher rents if they pick up the tab on build-outs, and medical space, which requires more renovation to accommodate plumbing, electrical, and technology needs, often commands higher lease rates. Paul McArthur, CCIM, president of Trillium Realty Advisors in Hopewell, N.J., says his investment group bought an obsolete center and partnered with a local hospital to purchase the space slated for medical use. After a $9 million renovation, McArthur now charges about $16.50 per square foot triple net for medical tenants and about $12 psf triple net for retail. Rates depend on the market, and on the medical side, rental rates depend on who pays for the fit-out," he says.

Issues to Consider

While medical tenants are a good fit for many struggling retail locations, there are still points to negotiate. Medical tenants often want prime visibility in malls, while landlords would prefer to put them upstairs, off the beaten path. "They try to reserve the lower space for the higher-paying tenants," says John Carrick, managing director of Julien J. Studley in Los Angeles . At the same time, physicians or dentists don't want to be stuck next to low-rent tenants. "It affects the health-care provider's image to be next to a nail salon on the second floor," Carrick adds.

A medical tenant may land a higher-visibility, first-level location, but those spaces are usually small -- between 2,500 and 3,500 sf -- and shaped like bowling alleys. Tenants who opt for the first-floor space may find themselves wedged between two retail tenants with little chance for expansion.

Even though landlords can charge higher rents once they renovate the space to accommodate medical or dental uses, most transfer final tenant improvement costs to tenants. In health care, that can get expensive; TI costs for dental practices run an average of $100 psf, while costs for medical businesses can vary drastically, Friedlander says. A family physician practice might only see build-out costs of $40 psf, but a surgery center may be looking at $200 psf, she says.

Even without assuming TI costs, landlords make a substantial commitment by renting retail space to medical tenants. Because of the work involved in developing the space, a suite renovated for medical use isn't a prime candidate for many different uses later. "It won't change from a restaurant to a bank to a medical office and back to a restaurant," Carrick says. Landlords also may face the need for extra security during the early morning hours when the facility is open and strained parking in the evening as patients and shoppers compete for close-in spaces.

But when retail options are limited, income trumps nuisance concerns or future uses any day. "Some places haven't been able to fill their needs as retail," Abel says. "Having health care in there instead isn't a bad deal."

Mike Norbut

Mike Norbut is a Chicago-based freelance writer. Specialty Hospital Development on the Rise Nearly two-thirds of the existing 100 U.S. specialty hospitals are located in Texas , with the rest concentrated in Arizona , California , Kansas , Louisiana , Oklahoma , and South Dakota , according to a 2003 U.S. General Accounting Office study. Although specialty hospitals are a source of controversy in the medical community because they concentrate on lucrative niches such as surgery, cardiology, and orthopedics and often lure physicians and less-acute patients away from community hospitals, 26 new projects were under construction in 2003. Approximately 28 states have at least one specialty hospital, and nearly 90 percent of these small, 20- to 40-bed hospitals are in-part physician owned. -- Sara Drummond is senior editor of Commercial Investment Real Estate. photo: Pardee Hospital When North Carolina-based Ingles Markets closed a retail box location (below), John D. Spake, CCIM, leased the space to Pardee Hospital, which transformed it into a specialized urgent care, sports therapy, and imaging services facility (above). photo: Spake Real Estate Location Is the Backbone of Success Anyone who doesn\'t believe specialized health-care facilities are a growing commercial real estate segment should meet Andy Gagnon, CCIM, who puts his real estate skills to work for a budding pain management company. Gagnon is executive vice president for Back 2 Backs, a national company founded in the 1990s that provides treatment for chronic back pain. Among other duties, Gagnon handles the company\'s site selection and lease negotiations. Calling the company\'s growth plan ambitious is like calling a slipped disc annoying. Back 2 Backs, which started with fewer than 10 clinics at the beginning of the year, is projecting 50 clinics by the end of 2005. Before he joined the company full time, Gagnon was a consultant for Back 2 Backs, which struggled to choose new clinic locations. "They literally were putting pins on a wall map," he says. Through Gagnon\'s guidance, the company defined its target patient population -- men and women between ages 45 and 75 -- and its office space needs. Gagnon uses CCIM Institute\'s STDBOnline to investigate market demographics and drive times, then narrows down specific sites within a ZIP code based on criteria such as accessibility, affordability, and how much parking, particularly handicapped, is available nearby. The Reno, Nev.-based company followed its demographic information to Florida this year and is expected to open nearly 10 clinics at sites ranging from office buildings to retail centers. "We\'re looking for ease of finding the office. It doesn\'t have to be prime. I try to balance the site identification with the budget," he says. photos:Trillium Realty Advisors Paul McArthur, CCIM, partnered with a local hospital in Phillipsburg, N.J., to turn a former Staples office supply store (below) into Hillcrest Professional Plaza (above).

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