Healthy investment: as the aging population spurs development of medical office buildings, real estate managers seize opportunities to diversity portfolios

Journal of Property Management, Jan-Feb, 2007 by Darnell Little

America is getting older. The first wave of Baby Boomers--numerically the largest generation in U.S. history--has reached the age of 60.

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Many business sectors are gearing up to capitalize on the graying of the population--especially the healthcare industry. For real estate managers, that creates new opportunities in the rapidly growing area of medical office buildings.

"There's a focus on healthcare in general as a growing industry," said Jeff Cooper, senior managing director for real estate at Granite Partners, an investment banking firm. "You've got more people living to an older age. There's more demand for doctors. Those doctors will need office buildings and that creates opportunity for us."

GOLDEN YEARS, GOLDEN INVESTMENT

Around 35 million people age 65 and over were living in the year 2000, according to U.S. Census Bureau information. That number will more than double by 2030, the bureau estimates. Such statistics are driving heavy investment in all types of medical office buildings.

Some medical office buildings simply provide office space for physicians to meet and consult with patients, while a few units may have some heavy medical and diagnostic equipment like X-ray or other imaging machines. Other medical office buildings are like mini hospitals, housing operating rooms where doctors perform surgical procedures.

Complicated buildings or not, the attractive financial return on all medical office buildings is raising interest in the market. Medical office sales have grown from $857 million in 2002 to $2.1 billion in 2005, according to information from Real Capital Analytics, a real estate research firm.

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In the second quarter of 2006, Real Capital Analytics tracked $3.5 billion in medical office building sales during the prior 12 months. Medical office space now averages $211 per square foot, compared with $203 for all other office buildings. In 2002, medical office rents averaged $142 per square foot.

"The returns on medical office are much better than in office, retail and residential," Cooper said. "It provides you with an attractive margin on your property."

LONGER LIVES, LONGER LEASES

As with all real estate, getting a decent return on a medical office building greatly depends on its location. A medical office building located near a major hospital carries a high premium. Even better is a medical office building located directly on a hospital's campus.

Physicians like to be housed as close to a major medical facility as possible. They do not want to spend a lot of time commuting back and forth between their offices and their primary hospital--nor do their patients.

"The closer you get to that hospital campus, the higher your rates can be," said Keith Kaiser, co-chair of GVA Worldwide's management services practice group. The company manages more than 800,000 square feet of medical office space. "That generally translates into stronger fees for the management service provider."

Prime locations often translate into longer leases as well. Leases for medical office buildings tend to be several years longer than leases for traditional office spaces. While the standard office lease is three to five years, medical office leases are routinely in the eight- to 10-year range because doctors form strong bonds with the nearby hospital and are reluctant to move. Changing locations can also be difficult for physicians with expensive, heavy medical equipment in their units.

Because of the longer-term leases, Wall Street tends to look at medical office buildings as secure investments, said Mike Heritage of the London Real Estate Group. The group is building a $15 million, 80,000-square-foot medical office building called Northcare in Colorado Springs, Colo. Scheduled to be completed in 2008, Northcare will be adjacent to the St. Francis Medical Center. Heritage estimates the building is 65 percent presold.

"The safety and security of the investment is higher than your typical office building where you have tenants that can move to a different location in the city if they get a better deal," Heritage said. "Physicians can't really go anywhere else, so you really have a captive audience."

CRITICAL CONDITIONS

Although managing medical office buildings is proving to be lucrative, it brings its share of challenges.

Medical office buildings routinely have greater cleaning and power demands. More insurance issues might arise if some tenants house expensive medical equipment. An understanding of government regulations and ordinances--like Occupational Safety and Health Administration (OSHA) requirements--is necessary if a building has actual patients walking in the door, said James Lennox, CPM, a director at real estate firm Trammell Crow Co.

"You really need to understand the legal requirements for the generation and proper disposal for hazardous wastes," Lennox said. "It adds another layer of complexity to how you resolve issues and operate your building."

The technical aspects of managing a medical office can provide an intense challenge for the property manager. Some tenants may have complex medical equipment requiring extra power to operate; if the doctors treat patients in the building, the operation of this equipment is critical.