Arguably, white hot."
That's how one healthcare real estate executive, Jay Flaherty, president and chief executive officer of Health Care Property Investors (HCPI), recently described the market for medical office buildings during a conference call with investors.
Indeed, hospitals that decide to offload medical office buildings from their balance sheets are enjoying premium prices and favorable terms. Historically low interest rates have driven down the return rates that investors expect-called cap rates. Those lower cap rates correlate with higher prices for properties.
Cap rates for medical office buildings have hovered at less than 10% for the last two years and fell to a low of 9.26% in the first quarter, according to Real Capital Analytics, New York. The average cap rate edged up just slightly in the second quarter, to 9.36%.
In addition, more capital is chasing medical office buildings since other areas of the economy-including commercial real estate-are struggling.
Both publicly announced offerings of medical office buildings and sales increased in the second quarter, according to Real Capital. Offerings were up nearly 30%, to $210.1 million, and sales were up nearly 58%, to $265.9 million (See chart). Offerings hit their highest level since the firm began tracking medical office building data in the second quarter of 2001.
Robert White, president of Real Capital Analytics, says greater volumes of closed transactions than of publicly announced offerings in recent quarters indicate a strong market; some sellers do not have to hire a broker or list a property online to attract buyers.
"One caveat to this is we're only tracking deals that are $5 million and greater. ... I think we're just seeing the tip of the iceberg (of sales)," White says.
For years, real estate companies and financial advisers have urged hospitals to sell their medical office buildings, and the chorus is growing. Modern Healthcare first reported this trend last fall (Oct. 28, 2002, p. 42).
In July, investment banking firm Cain Bros. released a report telling hospitals, "It may be time to consider selling your medical office building(s)." The report cited the favorable interest-rate climate, new buyers and changed attitudes among buyers regarding ground leases containing restrictions on how the building can be operated. Other reasons cited by Cain Bros. for offloading real estate include increased liquidity on the balance sheet and eliminating risks associated with federal fraud-and-abuse and antikickback laws.
Timothy Schier, a senior vice president at Cain Bros.' Houston office, says a well-located medical office building that sold for $10 million two years ago might go for $12 million today. "Investors look at what the alternatives are and real estate is much more stable than the NASDAQ or the S&P," he says.
Recently, medical properties have been viewed as rock-solid investments, partly because physicians don't move around a lot. Lillibridge Health Trust, Chicago, a healthcare real estate firm that sticks to on-campus projects with stable not-for-profit hospitals, enjoys a nearly 97% occupancy rate on its established properties and a tenant retention rate of 99%. "What that means to the investment world is that it's a very predictable asset class. People don't move out," Chairman and CEO Todd Lillibridge says.
In an example of new capital entering the arena, General Electric Co., a longtime healthcare lender, joined the equity side by forming a $600 million joint venture with HCPI, Newport Beach, Calif., to acquire medical office buildings. The joint venture, HCP Medical Office Portfolio, announced in June, already has provided $38 million in financing to developer Rendina Cos., Palm Beach Gardens, Fla. In addition, GE Healthcare Financial Services in July announced that it had acquired an $84 million portfolio of healthcare real estate mortgages from Finova Capital Corp., a subsidiary of Finova Group, Scottsdale, Ariz.
Seeing an opportunity, some new players have entered the field. Great Lakes REIT, Oak Brook, Ill., an owner of suburban office buildings, last fall bought eight totaling 459,000 square feet from Advocate Health Care, also in Oak Brook, for about $59.6 million. It was the largest single sale of medical office building assets by a provider in the last two years, according to Real Analytics.
That sale may have been eclipsed in June, when St. Vincent Health, Indianapolis, a division of Ascension Health, the nation's largest not-for-profit system, sold 11 medical office buildings to Lillibridge Health. Estimates of the sale have ranged from $50 million to $80 million.
Great Lakes spokesman Brett Brown says medical office buildings are recession-proof. "These buildings are 99.4% leased right now. It adds stability to the portfolio," he says. Brown says Great Lakes is looking at other medical office properties, but its involvement could be short-lived. In July, the REIT announced it had hired Cushman & Wakefield, a real estate adviser, to explore selling all or part of its assets.
Another new entrant is Windrose Medical Properties Trust, Indianapolis, which went public in August 2002, five months after being formed as an outgrowth of developer and manager Hospital Affiliates Development Corp., which is now a Windrose subsidiary. Windrose has 19 properties worth $132 million. Of those, 12 were acquired in a May buyout of Medical Properties of America, a private Nashville company with holdings in Florida, Georgia, Tennessee and Texas.
LaSalle Investment Management, a division of Jones Lang LaSalle, a Chicago-based real estate investment firm, created its $250 million LaSalle Medical Office Fund in 2001. So far it's invested nearly $149 million in seven properties, including a purchase from a suburban Los Angeles hospital that it expected to complete this fall. Two of its properties are new developments, on the campuses of Presbyterian Hospital of Dallas and Sharp Memorial Hospital, San Diego, both launched through a joint venture with developer Cambridge Holdings, Dallas. The fund's president, Steve Bolen, said the fund plans to raise additional capital from its institutional investors next year, perhaps even more than its first round.
In what could be another positive turn, some institutional investors such as pension funds and at least one international real estate firm are considering sinking long-term capital into the medical office building sector, sources say. If that happens, hospitals could get better deals in the long term and a wider array of developers to choose from when they sell existing properties or develop new ones.
"It will continue to keep pricing aggressive because you'll have a lot of capital looking for a home and it will give you new players in the business because not all capital (sources) will team with existing players," says John Winer, a partner in the real estate services advisory group of Enrst & Young, based in New York.
Still, those major capital investments could be months or years away. Yet it doesn't appear that the robust market is a determining factor for hospitals when they decide to sell their assets. In fact, the vast majority have not put medical office buildings on the block.
Provena Health, a six-hospital system based in Frankfort, Ill., signed a deal to sell six medical office buildings totaling about 250,000 square feet to Dasco Cos., Palm Beach Gardens, Fla.; the deal is expected to close in September. Thomas Hansen, the system's vice president of strategic planning and business development, says the system was pleased with the purchase price, which he says exceeds $20 million. But he says the decision to sell was not influenced by a robust market.
"We want to be out of the business of managing properties," Hansen says. "The good news is, we're doing it at a time when we're going to do very well in the real estate market."