Jones Lang LaSalle


Inside Real Estate
Investors Seek Healthy Returns In Medical Office Building Niche
BY JOE GOSE
FOR INVESTOR'S BUSINESS DAILY
Posted 5/18/2006

Soured by falling returns in other real estate assets, property investors have found a prescription to treat their ills: medical office buildings.

Several trends are igniting demand for physician buildings, surgical centers and other medical facilities: Graying baby boomers are getting more medical procedures. Changing Medicare rules are pushing outpatient care. Cash-strapped health systems are selling property to raise money.
Investors have been combing the real estate landscape for better yields. So the swell of interest in health care offices parallels a wave of investment in other niches, such as self-storage and senior housing.

Some 226 medical office building sales above $5 million were sealed last year. That count was up 7.6% from 2004, says real estate research firm Real Capital Analytics.
Demand has boosted prices: Buyers are shelling out an average of $216 a square foot — 16% over last year and 26% more than in 2004.

As prices have gone up amid the clamor for medical properties, rates of return have dropped. They're still better, though, than what other properties generate.

Real Capital's data show a capitalization rate of 6.8% this year for big medical building deals. That measure, which is net operating income divided by purchase price, is down 150 basis points from 2004. By contrast the average cap rate for apartments was 5.9% in the first quarter of this year.

Pension funds, insurance firms and other institutional investors are among the biggest buyers of medical office buildings.

"In the past, a lot of institutional buyers were hesitant to invest in medical office buildings because they didn't understand how to work with the medical community," said Glen Perkins, executive vice president of Houston-based PM Realty Group. The real estate brokerage, operator and developer launched a health care unit more than three years ago.

Partnering For Profit

Institutional investors have partnered with medical building developers and operators lately. It's partly for expertise with the niche's complexities, such as a maze of Medicare rules to follow.
"Now investors are more comfortable with the assets," Perkins said, "and are just now finding out that they're an attractive investment."

PM Realty partnered with New York-based AIG Global Real Estate Investment to build a $12.5 million doctors' building in northwest Houston. Earlier this year, San Francisco-based RREEF teamed with Denver's NexCore Group. That duo plans to recapitalize, develop and acquire $500 million worth of medical properties over the next two to three years. Chicago-based LaSalle Investment Management, one of the earliest medical office institutional investors, is raising money for its second such fund.

So what's the attraction of medical office buildings? Tenants are steady. They sign on to pay rent for at least eight years. And they renew leases about 90% of the time, per research by investment bank Cain Brothers. By contrast, conventional office tenants typically sign only five-year leases. They renew just 60% of the time.

Staying put is good for business in health care. Physicians depend on referrals that develop in buildings. They also tend to spend a lot on office improvements and equipment. That makes it costly to move. The bottom line is that medical office buildings typically generate annual cash-on-cash returns of 7% to 10% — that is, cash income as a percent of cash invested.
Rising interest rates may squeeze those returns, suggests NexCore CEO Greg Venn. And costlier capital may already be curbing demand.

"There's still upside for buyers of medical office buildings," he said. "But I don't know if we'll see the huge downward pressure on capitalization rates that (comes with) big jumps in prices anymore."

REITs Tap Market

Despite the changing scene, real estate investment trusts [REIT] focused on health care buildings are still growing through acquisitions and consolidation. In early May, Long Beach, Calif.-based Health Care Property Investors (HCP) agreed to acquire Orlando, Fla.-based CNL Retirement Properties in a deal valued at $5.2 billion. The firms list 270 medical buildings among their nursing home and other assisted-living holdings.

Nationwide Health Properties (NHP) in Newport Beach, Calif., is adding medical office buildings to its senior housing stable. In January, the REIT paid $56 million for 21 medical offices in the Southeast and Texas. That's in a joint venture with Denver-based Broe Cos., which provides medical office management among its business lines. Eventually, Nationwide wants to make medical office investment part of its core business, says Donald Bradley, the firm's chief investment officer.

© Investor's Business Daily, Inc. 2000-2006. All Rights Reserved. Reproduction or redistribution is prohibited without prior authorized permission from Investor's Business Daily. For information on reprints, webprints, permissions or back issue orders, go to www.investors.com/terms/reprints.asp.