Just What the Doctor Ordered?

Sometimes the stars align when it comes to investment and development opportunities. That just might be the case for the US healthcare real estate market, which is becoming a major, sought-after business.

Estimates are that 79 million baby boomers are heading toward retirement. As people age, they require more medical services, which translates into the need for more medical space. Add to that the fact that healthcare reform is expected to insure millions of previously uninsured or under-insured individuals. As it stands pre-election, President Obama's Affordable Care Act would be phased in over the next few years, and some experts predict this alone could spur demand for as much as 60 million square feet of additional healthcare space.

These factors, along with major advances in healthcare technology, are the driving forces behind the need for more technologically advanced medical space. Experts say this will be a combination of medical office buildings, clinics, inpatient facilities, seniors housing and long-term care facilities and outpatient centers, such as ambulatory care, cancer, diagnostic imaging, cardiovascular, dialysis, urgent care and rehabilitation.

Industry reports peg healthcare real estate as a $700-billion to $750-billion market, and it only continues to grow; approximately one-quarter of that market consists of medical office buildings.

Reis Inc. reports that the national office vacancy rate in third-quarter 2012 was 17.1%, whereas market reports indicate that the medical office vacancy rate could drop to 10% by year's end. Medical real estate has proven a more stable asset class during the recession because physicians, hospitals and practice groups tend to sign very long-term leases. They don't move around easily due to expensive buildouts and patient bases.

"Leases could run 10, 20 or sometimes 25 years or beyond, so a real estate owner can really bank on long-term returns," says Laca Wong-Hammond, head of healthcare real estate investment banking for Raymond James|Morgan Keegan in New York City. She works with public and private owners and operators of healthcare real estate; Raymond James|Morgan Keegan closed $600 million of medical office transactions in the past year.

Also impressive is the fact that healthcare expenditures are increasing. "Stats from the Centers for Medicare & Medicaid Services show that national healthcare expenditures in 2012 were nearly $3 trillion and are expected to exceed $4.5 trillion by 2020," Wong-Hammond says. "That's really profound, and this trend is further supported by our aging population; with longer life spans, there's the need to maintain health. The focus on wellness and preventive care has led to more emphasis on the development of lower-acuity healthcare facilities, so investments will be available all through the sector, from wellness centers to hospitals to end-of-life care and nursing homes."

A significant amount of capital has been raised for healthcare real estate in the past couple of years. Investors and capital providers are aggressively seeking medical real estate because they see the writing on the wall: more than 3.5 million baby boomers turn 55 every year, 5.6 million healthcare-related jobs are expected to be added by 2020 and healthcare spending has increased 10% annually over the past 40 years and now represents roughly 18% of GDP.

"There's a lot of cash available—probably more cash than properties," says John Wilson, president of Chicago-based HSA|PrimeCare, which partners with healthcare institutions to build, lease and manage medical facilities. Its 1.1-million-squarefoot portfolio includes ambulatory care facilities, specialty care hospitals and medical office buildings.

"With the slowdown of some of the other assets, the medical office sector really attracted more attention and dollars, so newer players have come into the market with additional cash," Wilson says. "It's become more competitive over the last 24 months."

Healthcare REITs, focusing on medical office buildings and senior housing, continue to outpace capital raised by REITs in other property sectors. According to the Healthcare Capital Markets group at Jones Lang LaSalle, the capital raised by healthcare REITs through midyear 2012 set a record at more than $7.5 billion.

Institutional investor interest in the space is skyrocketing, resulting in consolidation in the REIT industry. Since mid-2010, healthcare and senior housing trusts announced more than $20 billion in consolidations and partnerships.

"The public markets are very receptive of healthcare real estate investments. Most healthcare REITs are trading at or near their 52-week high," Wong-Hammond says. The list of powerhouse healthcare REITs includes HCP, Health Care REIT, Nationwide Health Properties, Healthcare Realty Trust and Ventas Inc.

Chicago-based Ventas is one of the largest healthcare REITs in the country and also one of the largest owners of seniors housing and healthcare assets. With more than 1,400 properties in the United States and Canada, Ventas is also one of the biggest owners of medical office properties, with more than 21 million square feet in the US. "Healthcare REITs benefit from basic supply/demand fundamentals: an aging population that will demand more of the services provided by our healthcare assets while supplies of seniors housing and skilled nursing facilities remain constrained," says John Cobb, Ventas' senior vice president and chief investment officer.

Cobb says senior housing, which is driven more by need than choice and therefore has proven to be recession-resistant, has performed extremely well during the economic slowdown. In addition, as the healthcare systems seek ways to contain costs, many procedures will move to the lowest cost, most clinically appropriate setting, which is often the medical office building, increasing demand for that kind of healthcare real estate. "Procedures that traditionally were done in a hospital setting can now be found in other kinds of care facilities," Cobb says.

Cobb is seeing more competition for properties—an average of five to six bidders on a portfolio. He's seeing interest across the board, including from other REITs, private equity, pension funds and high-net-worth individuals. "Our advantage is our low cost of capital," Cobb says, "which means we can pay more for the right transaction. We're disciplined in our deals, have great relationships and also offer extensive experience as a reliable counterparty."

Health Care REIT also invests in seniors housing and, as its name indicates, healthcare real estate. It owns senior-living communities, medical office buildings, inpatient and outpatient medical centers and life science facilities. The Toledo, OH-based firm has a pending $3.2-billion acquisition to acquire Sunrise Senior Living. REIT officials cannot comment on the transaction because they're under a confidentiality agreement.

Dan Klein, vice president of the medical facilities group at Health Care REIT, believes it's an exciting time for this segment of the real estate business. "The sector is getting newfound attention and with that come new entrants and competitors," says Klein, adding that it's important to differentiate yourself as a player.

"We stand behind our lengthy track record," he says. "Our investment strategy is built upon our relationships. We have a long-term outlook. We consider our operators and tenants to be business partners. We believe this philosophy differentiates us."

Klein says Health Care REIT is actively pursuing investments that align with their strategic plan. "Every week, we look at opportunities to add to our portfolio accretive, quality assets affiliated with the best health systems and seniors housing operators in the market," he says. Those are typically high-quality assets in markets with strong demographics and barriers to entry, in locations along the coasts and in the top 31 metropolitan statistical areas.

There are barriers to entry, though, since healthcare real estate is a very sophisticated, expensive market. Its specialized characteristics themselves require a specific skill set; regulatory approvals also restrict supply. Many developers partner with hospitals and healthcare systems on projects.

"These buildings are healthcare first, real estate second," says HSA|PrimeCare's Wilson. "It's really understanding the delivery care model of the healthcare provider you're working with, and the facility is a reaction to that. We got into the market in the mid-90s and our experience over the past years has benefited us at this time when there's a lot at stake for healthcare providers. Real estate is a major component, but not the driving one. I think our understanding of the operations of healthcare and the cultures and the governance are all benefits to us partnering with providers. It's not only the real estate; you have to decide to be in this business."

Wilson recently completed several projects including the Loyola Gottlieb Center for Immediate Care, a 9,800-square-foot urgent care facility occupied by Loyola Gottlieb Memorial Hospital in River Forest, IL that opened in February 2012. It also wrapped up the University of Chicago Medicine Comprehensive Cancer Center at Silver Cross Hospital in New Lenox, IL. The state-of-the-art, 22,500-foot outpatient cancer-treatment facility opened this past August.

Outpatient centers are among the biggest trends in medical real estate development. More medical procedures are moving to outpatient facilities because they're significantly less expensive locations than hospitals and more convenient to patients.

Joseph Simone, president of Bronx, NY-based Simone Development Cos., says healthcare systems are adopting strategies to provide healthcare off campus and closer to patients. "Hospitals are learning that they have to be where the patients are, and they're waking up to the fact that they have to get there before the next group does," Simone says.

"Hospitals," he adds, "are under huge pressure. One of the biggest game-changers is technology. Hospitals have huge overhead so it's hard to do certain procedures and be able to afford them, and insurance companies are tired of reimbursing hospitals for those expenses. That's putting pressure on hospitals and the medical world to find cheaper alternatives to give healthcare Therefore, if you do a procedure in a modern outpatient facility, you can do that at a lower cost than you can anywhere else." He also says people are very time-conscious today. They want to go to a convenient facility with good access and parking so they can get in and out.

Simone Development specializes in the development of outpatient facilities. It works with hospital systems in the Northeast, especially the New York Tri-State area, on their facility needs. It has more than one million square feet of medical space in its portfolio, with another 500,000 square feet of healthcare space under way.

Simone's recent developments include the expanding Hutchinson Metro Center complex in the Bronx, which has become a hub for medical practices in the region. Among the more than 30 healthcare tenants at the complex are Montefiore Medical Center's Orthopaedic Specialties Department, ENT & Allergy Associates and University Diagnostic Medical Imaging.

Simone also has several projects under way, including a 280,000-square-foot ambulatory surgical center and medical office building for a major hospital in the New York Tri-State area and two outpatient medical facilities for a hospital on Long Island's South Shore.

Trammell Crow Co. is another private developer that's very active in healthcare real estate. It has completed or is under development on $4.1 billion in such projects, including freestanding hospitals and healthcare facilities, such as ambulatory surgery centers, medical office buildings and specialized medical facilities.

In 2004, the company created Partners Health Trust, a medical real estate fund that has been used to acquire strategic real estate and fund development. The firm also recently completed a medical office building in Plainsboro, NJ, for the Princeton Healthcare System and two medical office buildings in San Antonio, TX, on the Christus Santa Rosa Campus.

Eric Fischer, managing director overseeing Trammell Crow's healthcare development and investment efforts for the Eastern US, is excited about the future of healthcare real estate. "The Affordable Care Act is going to open up a lot of pathways and create greater interest in the need for medical space and services," Fischer says. "I've heard we'll need as much as 100 million square feet. In the end, it's going to be on a state-by-state, city-by-city basis and it's going to be positive for the real estate industry. It will force systems to think more strategically about how to deliver services and, as a result, that may mean more outpatient facilities, clinics, low-care emergency rooms and centers of excellence.

"We have never been busier," he adds. "We have a great pipeline of business. Sometimes I think we're drinking from a fire hose and that's a great thing. I feel really bullish about the space."