Medical Real Estate: Outlook 2015 – The Impact of the Affordable Care Act
October 28, 2014
By Aaron Kuhl
At the time of the historic passage of the Affordable Care Act (“ACA” or Obamacare) in 2010, there was a great amount of discussion among healthcare stakeholders regarding its impact on the delivery of healthcare for the nation. Another area of focus was the consequential effects the ACA may have on medical real estate markets as historically, medical office buildings (MOBs) were viewed by investors as a stable investment with growing demand proportional to the aging U.S. population.
Since the ACA, there has been a duality of existence in medical real estate. Expansion and contraction, often in the same submarkets, has been occurring nationwide. The medical group’s size, specialty and most importantly their strategic plan (or lack thereof) has been determining their future role in the ACA.
Smaller medical practices that consist of one to four physicians are typically in the contraction category. These practices have become increasingly isolated from their peers and view ACA market forces as threatening. Correspondingly, they are downsizing facility space and signing short-term leases without making upgrades or improvements to the patient environment. Without long-term leases by credit tenants, the value of the building decreases for potential purchasers and further reduces the existing landlord’s ability to finance improvements. Additionally, without long-term anchor tenants or upgrades to lure new tenants, medical buildings fall into disrepair, empty their tenant rolls and find themselves (or their creditors) working through the repositioning process.
Alternatively, large groups of private physicians, entrepreneurs, health systems and hospitals are moving to larger, specialty facilities that cater to their niche in the healthcare arena. These groups include surgery centers, comprehensive health centers, specialty hospitals, imaging centers, dialysis centers and an expanded network of primary care offices that often carry a 10 to 15 year NNN lease. The common thread between these expansive entities is visionary leaders who understand the need for collaboration, including development and investment partners.
With a desire for stable tenancy and pole position on future developments produced from larger medical groups, medical real estate investors are now looking beyond the yield of a single deal. They are working toward forming strategic alliances with these groups to help deliver not only strong, consistent returns, but to be a part of the overall delivery of healthcare into the future.
The other coveted investment in this niche is MOBs located on or adjacent to a thriving hospital campus. For various reasons, including the complexities of the federal anti-kickback statutes related to the medical industry (STARK regulations,) the vast majority of hospital systems have divested their ownership of “on campus” MOBs to publicaly traded REITs (HCP, HTA HR, HCN.)
Along with the consistent divesting of real estate, most major health systems across the country have adopted a growth strategy around their hospitals as a central “hub” and the expansion of primary care clinics as “spokes” to connect the surrounding communities to the specialty or expanded services of a hospital campus. This has impacted medical real estate development by increasing demand for larger tenant facilities in areas with a dense population base.
At a local level, metro Phoenix with its dense and consistent increase in population has been a prime candidate for growth strategies from major health systems since the ACA. Examples include: Adelante Healthcare converted a defunct retail center into a ±39,000 square foot comprehensive health center in Surprise in 2011 and built a purposeful ±41,000 square foot comprehensive health center in Mesa in 2012. Cigna also built a $15 million, ±90,000 square foot health center in 2013 on the former Bell telephone building site in central Phoenix.
Plans for expansion from major health groups continue in metro Phoenix as we move into 2015. Some include: Banner Estrella in the Southwest Valley, Dignity Health in Glendale and West Valley Hospital/Abrazo Health Care in Avondale.
The consistent trends of declining lease agreements, downsizing of facility space as well as short-term leases will occur in 2015 and beyond from the thousands of smaller medical groups that exist in the Valley. These groups will continue to find themselves reacting to the ongoing changes from the ACA. Some will focus on their entrepreneur qualities and develop strong strategic plans that adhere to the current medical real estate climate, while others may leave their practices to join larger medical groups or wait to be absorbed.
The ACA has assuredly changed the future of medical real estate throughout metro Phoenix and the nation. However, opportunities continue to evolve for stakeholders who recognize that it is essential to collaborate and align themselves with entities that place a high priority on the creation of mutual value.