Monday, March 06, 2006

Jones Lang LaSalle


A Doctor in the House? Yes, and He Owns It, Too
March 5, 2006
Ventures
By VIVIAN MARINO


ABOUT four years ago, Dr. Robert Vogt-Lowell started putting money into what he now considers to be his best investment yet: medical offices for his pediatric cardiology practice.
He and his wife, Arlene, first bought a 2,200-square-foot office condominium in the Miami suburb of Kendall. Two years later, they bought a 1,500-square-foot unit nearby, in Miami Lakes. And they would like to buy space eventually in Pembroke Pines, where he also sees patients.


"If I decided to sell my practice, I could include the offices or sell them separately, or I could rent them out for income," said Dr. Vogt-Lowell, 47, who has watched the prices of similar properties rise steadily (unlike the value of his stock portfolio). "I needed a place to practice, and I got a great investment. It's been the best of both worlds."

More and more health care professionals are making such investments, snapping up everything from office condos to shares in medical buildings and complexes. But they are hardly the only ones buying. In the last 18 months or so, large investors like pension funds, real estate investment trusts and private companies have been expanding their holdings in medical office buildings.

"Three years ago, it was probably not as hot a niche as it is today," said Dale Sperling, chief executive of Unico Properties of Seattle, which owns and operates six million square feet of office space on the West Coast. The company started investing in medical office buildings in earnest more than a year ago by buying part of a Tacoma, Wash., medical campus for $10.8 million.
But as Mr. Sperling and other investors have found, the medical market is not necessarily an easy niche to break into. For one thing, it is not cheap. The average price per square foot is $248, up from $142 in 2002, according to Real Capital Analytics, a research firm, and as a result the initial yields — also known as capitalization rates — have dropped to around 7 percent from more than 9 percent just three years ago.


Finding the right properties — those on or close to hospital campuses are generally the most desirable — can be difficult. Purchases often require extensive research, because medical offices need special plumbing, electrical wiring and ventilation for their expensive equipment. And regulatory changes — like those related to Medicare and Medicaid reimbursements — could add layers of complexity that affect how buildings operate financially.

Still, the big players remain confident that the medical office building sector will continue to grow. Graying baby boomers are requiring more health care, and demand has climbed for outpatient facilities, especially as both insurers and government agencies push doctors to perform lower-risk procedures outside hospital settings.

Hospitals looking for revenue to invest in new technology, meanwhile, have been selling more of their real estate or forming ventures to operate surgery centers and outpatient services within existing facilities or at satellite sites.

Laws intended to prevent doctors from referring Medicare and Medicaid patients to health providers in which they have a financial interest have provided another reason for hospitals to remove themselves from the real estate business. (Under the so-called Stark laws, hospitals must lease space at fair market rates.)

For investors, one of the biggest draws of medical buildings is a stable tenant base. Doctors tend to have longer leases than occupants of traditional office buildings — eight years on average, versus three to five — and have renewal rates of 90 percent or higher, according to building owners. Many sign "triple net" leases, in which they agree to pay operating expenses like property taxes and insurance premiums.

"When doctors move into one of our buildings, they just stay there for their whole practice lives," said Robert A. Rosenthal, president of Pacific Medical Buildings in San Diego, noting that they typically spend more money on finishes like high-end carpeting and wood cabinets. "Although doctors are demanding, they're pretty good tenants. They pay rent on time, have good credit ratings and a low rate of business failures."

Doctors generally prefer to stay put in order to retain patients, and many building owners will offer them equity interests as an added incentive to stick around. "Physicians want to become partners," said Murray Wolf, publisher of the newsletter Healthcare Real Estate Insights, who, like many others, has held seminars about health care real estate. "Like the rest of us, they've watched the stock market plodding along and decided to invest in real estate."

Mr. Rosenthal, who has been involved in medical real estate for 35 years, says his tenants are choosing larger equity stakes these days. In the last 8 to 10 years, he said, "the amount of participation has been very low, usually, on average, one to two tenants in each building, and they would come in for $50,000 to $100,000, but lately we've gotten much more interest and much larger investments."

"Now they're in the $500,000 range," he added.

Outside investors can also acquire stakes in medical office buildings; the minimum investments generally range from $50,000 to $250,000. "In a typical project, one-third of the equity is provided by principals of the company and two-thirds from our private investors," Mr. Rosenthal said.

He says the biggest problem is accommodating all his investors. "We have a lot more money chasing fewer projects," he said.

Mr. Sperling says his strategy is to approach the hospitals and health care systems and persuade them to sell property or take in a partner. Unico closed five such deals last year. "Our success rate is high," he said. "About a third who we sit down with agree to transact a deal."
Investors in medical office buildings share in the cash flow generated from rents, but they also stand to profit handsomely when the building, which often appreciates in value over the years, is eventually sold or its mortgage refinanced and built-up equity returned to those holding stakes.
Either way, though, investors should not expect quick profits. "Our properties are long term," said Jeffrey J. Kanne, a managing director of the National Electrical Benefit Fund, a pension fund based in Rockville, Md. "We are going to be in the medical building business because of the demographics."


Some individual investors with deep pockets are opting to buy their own buildings or form small partnerships, while others are buying, and often renting out, office condos. Those with less to spend, or perhaps less desire to be landlords, can invest in real estate investment trusts — companies with portfolios of commercial property that disburse most of their profits as dividends.

Fourteen publicly traded REIT's specialize in health care real estate. Among them are Health Care Property Investors, Ventas and Cogdell Spencer, which just two weeks ago paid nearly $40 million for a 171,500-square-foot building and parking deck on the campus of Methodist Hospital in Indianapolis. The overall sector is up 6 percent so far this year, according to the National Association of Real Estate Investment Trusts. There are also unlisted health care REIT's like CNL Retirement Properties.

Stephen M. Coyle, the chief investment strategist for Citigroup Property Investors, is generally bullish on the sector. "Medical spending is a huge part of our national economy," he said, though he cautions that location is a key to success. "More than anything else they need to be near a good hospital."

Kenneth A. Weston, a real estate consultant and developer whose firm, Kenneth Weston & Associates, specializes in medical office condos in South Florida, says the high prices in many large metropolitan areas have pushed investors to look in secondary or tertiary markets. ("People there get sick, too," he said.)

The Miami market, he said, "is so hot that some people are buying buildings with capitalization rates as low as 1 or 2 percent, which is financial suicide," he said. "They're buying with the idea of being able to create a condo complex out of it."

Right now, around $375,000 to $675,000 buys a 1,500-square-foot office condo in the Miami area, he said, which is almost double the average price of just three years ago.

There is no shortage of takers, though, at least for his condo buildings. "When I do my medical projects, 50 percent are presold to users before we do the projects," he said.

DR. VOGT-LOWELL, the pediatric cardiologist from Miami, says he and his wife were lucky to be able to buy their two properties, both near hospitals, before prices really escalated. He said they paid $525,000 in 2002 for the Kendall office, which is in a three-building complex and includes four examination rooms and a large reception area. The Miami Lakes condo, which is in a three-story building and has four smaller examination rooms, cost $295,000 in 2004.
"I was told that today we could get $800,000," he said of the Kendall unit.


The rising value is nice, but the best part, says Dr. Vogt-Lowell, who had leased for 12 years, is not having to rent anymore. At least not from a stranger. Both properties are actually held in a limited liability corporation in his wife's name, he says. "If I don't have the rent paid up," he said, "I'll be sleeping in the living room."

Copyright 2006The New York Times