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What Drives Value in Medical Office Buildings?

By Travis Ives, Cushman & Wakefield Healthcare Practice Group, San Diego

Medical Office Building reframe, what new looks like

With increased attention given to healthcare and related medical investment properties in the U.S., we have discovered many investors, property owners and industry trackers across the country are wondering the same question: What is currently driving value in medical office buildings? Through our work as market experts with Cushman & Wakefield’s Healthcare Capital Markets team, we have conducted in-depth analysis of these highly complex transactions and have identified five core areas that may be adding or subtracting to an MOB property’s value.

Credit.  Properties with strong anchor tenants that are either owned by, or closely affiliated with, a larger integrated health system represent the least amount of risk to the investment community and produce higher value compared to buildings with smaller independent physicians. Other key factors include the size, market share, and financial strength of the health system and the tenant’s ability to attract and retain patients.

Term.  Understandably, long-term leases (10+ years) providing stable cash flow typically result in a higher valued property, while those shorter than five years represent undesirable near-term tenant rollover. Single-tenant net-leased (STNL) medical properties with seven to 10 years of term remaining are now attracting new buyers, increasing competition and driving values higher. Unfortunately, many healthcare providers are reluctant to sign leases longer than five years due to uncertainty surrounding reimbursements and potential changes to their care delivery models.

Improvements. Medical office improvement costs can easily be double or triple those of traditional office, but not all improvements are viewed equally. Given the high cost to secure new tenants, investors generally favor buildings with generic medical improvements that will retain value in the event the space needs to be re-leased. Highly specialized improvements, despite their high costs, attract a smaller buyer pool and result in lower values. Freestanding imaging centers — expensive to build and highly specialized — are an excellent example.  But surgery centers, also expensive, buck this trend by functioning as anchors and attracting other users that want to be proximate to the center. Investors favor multi-tenant medical office buildings with ground floor surgery centers, especially when the medical office tenants are tied to the surgery center in some way.

There are other physical and structural issues within the “improvements category” to consider. The floor plates have to be large enough to support current and future diagnostic technologies.  Many investors now prefer tenant spaces of 5,000 sq. ft and greater to smaller ones.  Additionally, as electronic healthcare records are now in place for most physician groups and diagnostic capabilities are exploding, technology and bandwidth requirements have become more stringent. Buildings lacking these characteristics are at a competitive disadvantage and smart investors underwrite accordingly.

Location. With regard to location, medical office buildings can generally be classified as either on- or off-campus. Historically, on-campus buildings have commanded a premium over off-campus buildings in part because they are often occupied by the sponsoring health system and its affiliated physicians.  However, the passage of the Affordable Care Act and the incentive to deliver care in more convenient and easily accessible locations has caused that value gap to shrink somewhat. Strategically located off-campus buildings that allow providers to capture favorable patient demographics in affluent neighborhoods are also highly desired by investors.

Use. A building with a large primary care presence where synergistic referral patterns can be established between its tenants is attractive to investors. The most valued properties function as a one-stop-shop for patients.  Physician tenants and ancillary service providers and their businesses benefit greatly from this structure. In contrast, buildings with no synergistic referral patterns and no anchor tenant would be less desirable.

The healthcare sector continues to experience significant growth as an industry and medical office properties are becoming an increasingly popular institutional and private investment vehicle.  The long-term demand for patient services and favorable demographics suggest that demand will continue for some time. Yet, the complex nature of healthcare service delivery, the heavily-regulated nature of healthcare as a business, and the evolving landscape of health insurance markets will all affect the financial wellbeing of health systems and physician practices. Both buyers and sellers will need substantial expertise to navigate successful real estate investment outcomes.

Travis Ives, based in San Diego, CA, is a Director in the Healthcare Practice Group. Mr. Ives provides transaction and advisory services for healthcare clients across the spectrum of facilities including medical office buildings, ambulatory surgery centers, and acute care facilities. Mr. Ives is a top producing broker on the West Coast focusing exclusively in healthcare real estate.

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