HOUSTON-Owners of medical office buildings have been reaping the benefits of one of the paradigm shifts brought on the Affordable Care Act: a need for larger leases. So says Transwestern in a report prepared by Brandy Bellow Spinks, medical leasing associate with the firm’s healthcare advisory services team in Houston.
“Hospitals and physicians have embraced one another to withstand recent transitions” arising from the ACA, which among other things diminishes reimbursements for both parties, she writes. “The legislation also requires physicians to spend precious capital to meet technology requirements, which have left many physicians in a precarious financial position. In a defensive maneuver, hospitals are preserving their admission revenue by acquiring physician practice groups.” However, “contrary to public perception,” the long-term effect on MOBs and healthcare facilities will be positive.
MOB landlords have been executing larger leases as hospitals combine multiple doctor practices, “with the average tenant increasing in size from 2,500 to 7,500 square feet,” writes Spinks. Further, grouping physicians has given rise to “an environment for cross-patient referrals and synergies among primary care doctors, specialists and sub-specialists. This promotes tenant retention, which mitigates risk.”
Historically, she writes, institutional investors were wary of the lack of credit behind medical leases. “The shift into physician employment with leases backed by hospital systems has improved the credit profile of many MOBs that are near hospitals or that possess a strong hospital affiliation.”
As a result, writes Spinks, “all types of investors that previously may not have considered medical real estate as a stable asset class are responding to this improved credit. This has increased sales volume and lowered capitalization rates in the healthcare sector.” Citing Real Capital Analytics data, Spinks notes that institutional investment in MOBs has increased 12% the ACA took effect.
On the other hand, the changing landscape of healthcare commercial real estate does pose some potential pitfalls for the investment community. A report from Fitch Ratings on the pending $2.8-billion merger between Brookdale Senior Living and Emeritus Corp. notes that healthcare REITs will be affected, with further consolidation in the REITs’ tenant bases a likely result. “While we expected operator consolidation, we believed it would be larger operators acquiring smaller, private, regional operators rather than a merger between larger peers,” according to Fitch’s report.
Fitch estimates the combined company will represent a significant percentage of revenues for HCP Inc., Ventas Inc. and Health Care REIT Inc. “Larger, more concentrated tenants have significant leverage when negotiating lease renewals given the pooling of assets into master leases,” according to Fitch’s report, written by associate director Britton Costa. “The downside potential from material tenant concentration will continue to be a focal point for healthcare REIT ratings.”
Historically, Costa writes, large-scale M&A activity in the for-profit healthcare sector has been spurred by “the financial benefits of scale and geographic diversification.” These factors are being reinforced by what the ratings agency calls “secular shifts in the landscape,” including growth in the consumer share of healthcare spending, regulatory reforms including Obamacare and a shift toward value-based payments. “These factors are resulting in lower payments to providers and pressuring profit margins.”