Rx for Success: Medical Office Buildings

The Time Has Come for This Overlooked Market.

As with many real estate markets today, the bottom line in medical office buildings (MOBs) is change-change in the way health care is delivered in this country. The acceptance of health maintenance organizations and managed care, the rapid advance of medical technology, and the overall emphasis on cost containment are causing health-care organizations to re-engineer the way they do business.

While hospital inpatient use is declining, the health-care industry as a whole is booming with new and different types of facilities: outpatient surgery centers, ambulatory care centers that provide sophisticated imaging procedures such as MRI and CT scanning, geriatric care centers, on-demand diagnostic care centers, primary outpatient service centers, and home health-care delivery systems. As the industry continues to grow, it will need a greater number and variety of facilities to house these new services.

The result is a changing MOB market, which is part of a larger, active medical real estate market. Difficult to track, medical is not one market segment but a combination of several; MOBs are a part of the office market, laboratories are part of the warehouse market, and some entities are in the retail market. While there are no nationally published statistics, some health-care industry professionals think that, when all the mergers and direct market deals are considered, more medical property will have changed hands in 1995 than in preceding years.

Commercial real estate professionals who understand the complexities of the medical market can find opportunities there. Purchasers, sellers, doctors, medical companies, and institutions can all use the services of informed commercial real estate practitioners.

MOB Market Overview
Generally, three items separate MOBs from typical Class A or B office buildings: location, tenant mix, and internal characteristics. Most MOBs are located close to hospitals, medical centers, or nursing homes. Most have large physician populations or related health-care tenants, and most are configured into exam rooms and waiting rooms.

There are three basic types of MOBs:

  • Class A: Modern, glass and stone exterior, recently constructed buildings located immediately adjacent to a hospital or a major clinic, usually developed for the hospital or leased from a parent corporation.
  • Class B: Low- to mid-rise, well-managed and well-appointed buildings located either on a hospital or a medical center's campus, or within close proximity. The owners of these buildings may be a hospital, physician partnership, or individual investors.
  • Stand-alone: Small buildings usually built to accommodate a single or group practice. Typically the physicians own the building.

Class A MOB Trends
In a continuing attempt to lower overhead, doctors find tremendous benefits in occupying shared facilities. In addition, access to technological advances in record-keeping as well as medicine offer a smoother, easier way to run a practice. Hospitals are using these amenities to lure physicians out of stand-alone buildings and into hospital-affiliated Class A MOBs.

Electronic Record Storage. Medical offices are making an effort to become paperless because file and record storage occupy expensive leased space. In addition, more medical records are being stored electronically for transmission to specialists by computer and satellite.

The modern-day Class A MOB is constructed as intelligently as a downtown office building, says Jim Venker, AIA, director of facilities development at the Alton Ochsner Medical Foundation in Jefferson, Louisiana. "In addition to the latest mechanical and HVAC systems, newer Class A MOBs have technology features such as computerized data information systems and automated medical record storage transferred from paper and X rays to CD-ROM."

Digital Imaging. Another unique technology now being implemented is the use of digital imaging via satellite. In the clinic of the future, a family practitioner will send a digitized X ray via satellite to an orthopedic specialist at the regional medical center for a more specialized opinion. Saving time and expense, this will eliminate the need for that patient to travel from an outlying area to a bigger city.

MOB developers should take note of these technology trends when designing facilities for future use. Considerations include increased wiring for electricity, telephone, modems, computer networking, and video teleconferencing, as well as space for individual computer workstations and printers.

Shared Clinical Procedures. William Piché, regional vice president for Paracelsus Healthcare Corporation in Pasadena, California, a multibillion-dollar international corporation, sums up the most successful MOBs as having "all the services required by the patient in one location." This mini-mall set-up-with pharmacy, radiology, laboratory work, and other outpatient services located in the same building as the physician's office-is not only convenient but offers more assurance to the doctor that ordered blood work or X rays will be done, because patients only have to travel to another floor or wing.

Shared clinical procedures reduce the amount of space each doctor needs; however the increase in the number of services offered on a outpatient basis tends to offset any space reduction. Class A MOBs often include ambulatory care services and outpatient surgical centers.

Satellite Offices. Though doctors may not make house calls anymore, they are making an attempt to meet patients at the end of the street. Many doctors rotate offices throughout the week in a quasi time-share arrangement (similar to office hoteling). With other doctors or hospitals, physicians go where their patients are-to downtown business districts during the work hours, to the suburbs for after-school and evening hours, as well as to one side of town one day and the other side the next.

For real estate developers and investors, this means an increase in downtown and neighborhood medical buildings. Because of the high cost of central business district land, many of these opportunities are rehabs of other properties. New construction is more likely to occur in suburban and city neighborhoods.

Class B and Stand-alone MOBs
In general, the Class B market represents those buildings immediately surrounding large institutions. In the smaller medical centers, Class B and stand-alones may be the only space available for medical tenants.

The benefits of Class B MOBs are usually better ingress and egress and more-independent practices. Many hospital-owned Class A MOBs do not want tenants that provide less-expensive alternatives to visiting the hospital. Even Fortune 500 companies providing medically related services often find themselves looking in the Class B market because many of them compete for outpatient services. On typical Class B MOB rent rolls, brokers may find such well-known health-care organizations as SmithKline Beecham, Roche, and Baxter. Such a list of tenants tends to pique the interest of the average investor.

While Class B MOBs continue to hold their own, the stand-alone MOB market is getting smaller, according to brokers familiar with this property. Responsible for this shrinking market are the benefits of Class A and B MOBs, which draw physicians out of their own buildings and into hospital-affiliated buildings; the Tax Reform Act of 1986, which took away most of the tax incentives of ownership; and the demand to decrease overhead.

Of course, physicians can often afford down payments and can qualify for commercial loans. Moreover, general practitioners and certain specialists may not need elaborate services provided by Class A and B MOBs. Financially savvy, they may be interested in an investment such as a multitenant building that generates positive cash flow and offsets rental costs.

But the relocation of doctors into hospital-owned buildings may have more to do with the change to managed health care and other attempts to control medical costs. Tim Trivers of Carter Healthcare Facilities in Atlanta, Georgia, a company that specializes in developing and servicing MOBs for medical institutions, says that an association with a specific health insurance alliance may also mandate when and where a doctor sets up shop.

Making MOB Deals
Carter has defined a unique niche in the MOB market, offering everything from design and construction to marketing, leasing, and managing MOBs. For example, in suburban New Orleans, Carter has a project slated to come out of the ground in mid-1995, essentially a medical group syndication that is building a first-class facility immediately adjacent to a fast-growing medical center.

The physicians own 95 percent of the limited partnership that owns the building. Carter acts as a general partner and receives "sweat equity" of 5 percent.

In return, doctors get a proportionate share of the syndication profits based on dividing their amount of leased space into the building's total square feet. A master lease from the adjacent medical institution on the balance of the unleased space allows the project's construction without having it 100 percent preleased.

MOBs and Other Medical Opportunities
The medical market contains such opportunities for developers, leasing agents, property managers, investors, and brokers. Informed real estate professionals can translate trends into business transactions.

Advising and Consulting. Because of declining inpatient use, hospitals are under the gun to reduce costs and make better use of their assets. Many hospitals own or lease extensive real estate, yet they lack the ability to manage their resources effectively. They may not even be aware of the extent of their holdings and may require a property inventory as well as guidance as to the most effective use or disposition of their assets. Ground leases, sales and leasebacks, and developing facilities for non-medical uses are all possibilities that a well-informed real estate advisor might offer as methods to consolidate hospital holdings.

Property Management. Another cost-cutting measure hospitals use is contracting with real estate companies to provide property management and related services. In some cases, Piché says, outside property management is actually preferred. Most MOB building engineers, on whom the task of management may fall, may not have the necessary skills or training to manage the property. A qualified property manager who can handle tenant complaints, hot and cold calls, expansions, and other tenant demands is often what a building needs.

Leasing and Sales. Medical institutions may buy or build Class A space for future expansion or may acquire it through mergers and consolidations. A qualified leasing agent can provide valuable assistance in renting that space. The hospital administrator in charge of leasing a property may not be familiar with such terms as gross versus net leases, expense stops, common area factors (load factors), indemnity clauses, hazardous and biohazards provisions, waiver of subrogation, and other lease language. To pay a broker a standard leasing commission is usually money well spent.

Leasing and sales brokers should also concentrate their efforts on smaller Class B and stand-alone properties, says Lane Hindermann, a commercial Realtor and owner of Real Estate Consortium in Metairie, Louisiana, who specializes in MOBs. More often than not, stand-alone MOB properties are owned by doctor partnerships or individuals who realize that a professional commercial agent can help them get the best deal for leasing or sales.

As medical centers draw physicians into their own large facilities, the organizations may acquire physicians' old buildings. In some cases the hospitals may have a use for the properties, but in most cases they will need help selling or leasing the properties.

There are some great opportunities for these stand-alone buildings among newer health-care service providers, according to Barry McGee, CCIM, of Latter & Blum, Inc., in Baton Rouge, Louisiana. Home health-care offices, dermatologists, chiropractors, optometrists, and other groups are finding the buildings that once serviced orthopedic surgeons, internists, and obstetricians suit their needs perfectly.

Investments. Medical institutions are staffed with accountants who speak the language of real estate. If they see the financial benefit to an investment and the CEO has the money, the two biggest obstacles to qualifying a purchaser have already been overcome. However, when presented with an investment opportunity, institutions will need to present the upside to their respective board of directors. Additionally, because most institutions pay cash for the investment, as well as the fact that a higher rental rate is capped, often the sales are at the high end of the market in terms of dollars per square foot.

As investments themselves, health-care real estate properties are relatively stable and therefore attractive to investors. Health-care REITS have proven popular in recent years. Many have assets ranging from hospitals to MOBs and nursing homes.

MOB Risks
Opportunities for making money in MOBs are tempered by the risks and realities of the market. High construction costs are a serious concern for developers and investors. Upgraded electrical, plumbing, and HVAC requirements needed by health-care services can add $20 to $40 per square foot for new construction. MOBs often require more parking, a higher quality finish, additional plumbing for sinks in every exam room, and added electricity for X rays and lighting. In addition, medical buildings have accelerated wear and tear due to constant public use, and floors, countertops, and walls must stand up to the daily use of disinfectants.

Though doctors are usually stable tenants, they also have a reputation for being difficult. They expect a high level of management service and usually get what they want.

Finally, medical space can be difficult to re-lease. Interior space is often divided into small exam rooms and an oversized waiting room. It may take extensive rehab to make it suitable for other, non-medical uses.

Brokers Shut Out? For various reasons, brokers tend to see the MOB market as closed. Unfortunately, most syndicators like Carter Healthcare Facilities structure a bottom line investment to doctors and unless the doctors are willing to pay for brokers' services either out of their own pockets or by adding it to the lease deals, there is simply no room to pay brokerage fees.

Hindermann points out other reasons that brokers are shut out of the process. "Some MOBs are limited partnerships that doctors buy into and attorneys structure the leases in conjunction with creating the partnerships. The services typically provided by a broker are just part of the bigger picture."

In a recent survey of the Baton Rouge, Louisiana, market, McGee found one million square feet of Class A and B MOB buildings that did not appear on standard office market surveys-in addition to about 5 million square feet that was counted.

"Baton Rouge is a prime example of a city that is becoming recognized as a regional medical center," says McGee. "There is a market almost 20 percent the size of the office market that the average broker may not realize exists."

In the near future, MOBs will remain an active market that brokers and other real estate professionals should not overlook. As regional medical centers grow, as the corporate structure of hospitals and managed care facilities change, and as the field of specialty medicine continues to grow, the medical office building market will continue to offer opportunities to investors and real estate professionals.

Richard E. Juge, CCIM

Richard E. Juge, CCIM, is the broker and owner of RE/MAX Commercial Brokers, Inc., in Metairie, Louisiana. He can be reached at (504) 838-0001, or on CompuServe at 72062,1301.