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[IMGCAP(1)]Real estate experts have widely touted medical office buildings or medical office space as a recession-proof investment or near inelastic sector of the real estate market. Historically, this proposition has remained true, however, the MOB market recently has shown signs that it may not be impervious or unsusceptible to the impact of a slumping economy. Market experts such as Cushman & Wakefield and Grubb & Ellis are beginning to take the position that medical real estate is more recession resistant than recession proof.

Since the late 1980s, the landscape for medical office space has been marked with a growing demand, in part, because of the rise in specialty medicine and ambulatory surgical centers. While some of this demand relates to the real estate bubble that was driven artificially by low interest rates and bank’s lax lending policies, identifiable characteristics of MOB have also influenced its demand and sustainability.

[IMGCAP(2)]By way of background, the MOB market is best described as real estate which is designed or outfitted for the unique business needs of medical professionals. The uniqueness of the MOB can vary depending on the nature of the medical specialty and the necessity for integrated technology in that specialty. Some physicians require medical space equipped with highly specialized technology, equipment and fixtures, while others may require that their MOB meet only minimum state, health and public safety requirements. Regardless of the degree of customization, medical tenants require real estate that is distinct from typical commercial space.

MOBs also tend to have less tenant turnover not only because of the degree of customization required by tenants but also because medical practices typically rely on location, proximity to patients and local reputation, and require large capital set up costs. These factors ultimately translate into monetary value in the form of good will if the physician decides to sell the ASC or location itself.

In addition to the significant investment, lease and purchase negotiations require coordinating large working groups that include engineers, architects, landlords and state and local inspectors. The technicality of the design makes inspection and due diligence more rigorous and more elaborate than generic commercial space, and can in turn result in longer lead times and tighter time schedules. For all of these reasons, medical office tenants once established are less likely migrate elsewhere.

While these factors have fueled MOB market and its sustainability, in the past two years, construction of new MOBs has fallen by more than 10% in terms of square footage and vacancies have risen according to a Medical Office Update by Randyl Drummer of the CoStar Group. By comparison to other real estate sectors, the MOB market appears to be relatively stable and experts believe that any loss in occupancy will be restored by early 2010.

Similar to other real estate sectors, MOBs are being affected by stricter lending policies and a scarcity of liquidity in the market. This sector of the real estate market, however, is more poised for recovery because of its unique reasons stated above. Relative steady pricing and the recent reduction in construction cost may also help in attracting new buyers.

In New Jersey, recent legislation, like the Codey Law, may further spark new life into the MOB market, and create new demand. On Mar. 23, 2009, New Jersey Gov. Jon S. Corzine signed into law S-787, Senate president Richard J. Codey’s bill amending his 1991 legislation banning physician self-referrals (the Codey Law). The 1991 Codey Law represents New Jersey’s attempt to mirror or codify the Federal Stark Law.

By way of background, Section 1877 of the Social Security Act, often referred to as the Stark Law, prohibits a physician from referring Medicare patients to an entity for certain designated health services if the physician has a financial relationship with the entity unless an exception applies. Similarly, the original Codey Law prohibits referrals for healthcare services by practitioners to entities in which they, or their immediate family members, have a financial interest.

The amendments to the 1991 Codey Law increase regulatory oversight of the entire ASC industry by requiring, by Mar. 22, 2010, that all unlicensed one-room ASCs must become “registered” with New Jersey Department of Health and Senior Services and all licensed ASCs must become accredited by an “accrediting body recognized by Medicare.”

The conditions of unlicensed one-room ASC registration include the requirement that these centers obtain Medicare certification or accreditation from an Accrediting Body. Further, only existing unlicensed ASCs, as well as those that have construction plans filed by Sept. 17, 2009, will qualify for registration and therefore the ASC self-referral exemption contained in the amendments.

The amendments also permit registered centers to transfer ownership and relocate within 20 miles or to a “Health Enterprise Zone” (provided there was no expansion in the registered ASCs scope of services). Finally, the amendments do not subject registered ASCs to the ambulatory care facility assessment (currently 2.95% on gross receipts and capped at $200,000 per year).

With regard to the future development of licensed ASCs, the amendments prohibit NJDHSS from issuing new ambulatory surgery facility licenses unless one of the following scenarios apply: ASCs in development–meaning, entities that have filed architectural plans by Sept. 17, 2009; the transfer of ownership in a grandfathered ASC; the relocation of a grandfathered ASC provided the relocation is within 20 miles or in a “Health Enterprise Zone,” and that there is no expansion in the relocated ASC’s scope of services; new ASCs that are owned in whole or in part by a New Jersey hospital; or new ASCs that are owned in whole by a medical school. The New Jersey Codey Law imposes filing requirements for solely physician-owned ASC which need to be submitted by Sept. 17, 2009.

New Jersey physicians have added incentive to enter the medical office building market because of this new regulation and deadline. Physicians may enter the market in order to identify medical office space to purchase or lease for a new ASC or to expand an existing ASC. As a result in the short run, the MOB market in New Jersey may see an increase in interest by physicians who are scurrying to identify MOB in order to submit plans and gain approvals for a future ASC.

What remains to be seen, however, is whether this interest translates into actual sales and executed leases for New Jersey MOBs. Bank’s lending policies remain relatively conservative in light of the securitization debacle, however, banks have continued to show confidence in lending to ASCs.

Real estate experts continue to suggest that the current lag in MOB can best be explained by the limited access to equity and financing. Further highlighting this lag is the uncertainty created by the lingering talks of health care reform that have reached the forefront of domestic policy talks, and its potential impact on the health industry.

Limited market liquidity may be forced New Jersey physicians and other medical players to use their personal funds to finance the purchase or lease of MOB, and pay for related architectural plans and improvements so as not to be foreclosed from participating in New Jersey’s ASC market. In order to meet the impending Sept. 17, 2009 deadline, physician investors will first need to consult those knowledgeable in real estate, health and local government to expedite the identification of a MOB location, negotiate terms, design and form a future ASC.

The recent legislative changes raise a plethora of issues for physicians, hospitals, licensed ASCs and surgical practices. Such parties may wish to obtain the advice of legal counsel, who are well-versed in the amended Codey Law and other state and federal healthcare laws including but not limited to the Anti-Kickback Law and the Stark Law, to evaluate their existing operations and anticipated endeavors. A firm with a strong presences in New Jersey real estate would also help facilitate meeting the impending Codey design deadline.

John D. Fanburg, Esq. is the managing member and an attorney in the health law practice group at Brach Eichler LLC, a law firm located in Roseland, and Joseph B. Vas is an associate in the group. The views expressed here are the authors’ own.

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