Affordable Care Act takes some risk out of healthcare property investment

Post Date: June 2013

Written: May 2013

Medical Office Momentum

The re-election of President Barack Obama and last year’s favorable Supreme Court ruling on the Patient Protection and Affordable Care Act have removed some uncertainty as to whether or not the healthcare law will take effect. While some provisions have already been implemented, the majority of them are scheduled to begin Jan. 1, 2014.

This outcome has created greater clarity for healthcare providers, who continue to adjust not only to new rules but also to changing preferences among consumers. Additionally, this situation creates considerable opportunities for real estate investment in the healthcare sector, and transaction volume is likely to remain lively in the near term.

The private sector spent almost $30 billion on all types of healthcare construction in 2012 according to the U.S. Census Bureau, up 4.1 percent from 2011. Although construction slowed late in 2012 as healthcare providers waited to see the outcome of the election and the Supreme Court’s decision, the sector in general and medical office buildings in particular are poised for growth as these same healthcare providers push forward on needed expansions. Several factors are driving this growth.

Development Model Shifts

During the last several years, there has been a fundamental shift in the way many medical providers deliver care. Instead of housing all healthcare functions under the roof of an acute care hospital or on its campus, many services — such as outpatient visits, blood tests, imaging, rehabilitation, and some surgeries — are now performed in medical office buildings, often away from the main hospital campus.

These facilities are more cost-efficient for providing outpatient services. They also allow hospitals to have greater reach when it comes to referring patients to the more expensive and ever more specialized acute care hospital. MOBs are typically found in suburban communities where the population of privately insured individuals is growing. Often insurance plans for these patients provide higher-margin revenue sources when compared to Medicare and Medicaid programs. For some health systems and providers, having a high number of private-pay patients can make a meaningful difference on the bottom line.

As such, MOBs become the “spokes” that surround a hospital campus “hub,” and help health systems to both capture higher patient volume and also provide a greater continuity of care.

Under the hub-and-spoke model, healthcare systems often work with third-party developers or construction groups to build medical office facilities because standard office space is typically not designed with appropriate structural support systems to handle clinical services. The majority of space in these buildings is used by physicians’ practices and healthcare service providers connected to the system building the facility. However, space may also be leased out to other complementary healthcare providers such as pharmacies, imaging centers, and physical therapy groups.

To help fund non-real estate initiatives or make other capital investments, healthcare systems are often willing to construct and then sell medical facilities to real estate investment trusts or private equity groups while continuing to use the facility. When third-party development groups build these facilities, they will often look to sell the asset so they can redeploy the capital into new projects. Hospitals will often give themselves some level of control over future ownership decisions through the use of ground leases or buy-back provisions.

Accelerating the Pace

While this change in the hospital business model began long before the Affordable Care Act was signed, this law changes the medical landscape significantly and accelerates the pace of pushing outpatient services away from acute care hospitals. With the expansion of access to healthcare, more patients will be seeking outpatient medical care in the coming years, increasing demand for many of the services typically located in MOBs. This means the demand for these types of facilities will continue to grow for the next several years.

Changes in how care is administered and paid for as a result of the law could also create more MOB demand. For example, under the new law, hospital systems could receive higher government reimbursements if patient-readmission rates decline. Many hospitals are aligning themselves with other healthcare providers to focus specifically on the care patients receive when discharged. Post-acute care providers and physicians will have incentives to improve and maintain quality outcomes as well.

That means healthcare systems are under pressure to ensure that patients follow their doctors’ instructions after in-hospital procedures, for example, making sure a patient undergoes rehabilitation following an inpatient surgical procedure. To make rehabilitation more convenient for patients (and hence lower the risk of an unreimbursed readmission), a hospital may offer rehabilitation facilities at several sites, each close to hospital-owned physician practices.

Investment Opportunity

MOBs make attractive investment opportunities for many reasons.

The Affordable Care Act is not the only factor driving growth in the healthcare sector. The aging U.S. population, with an average of 10,000 baby boomers turning 65 each day, is also increasing demand for medical services. According to the Centers for Medicare and Medicaid Services, $2.7 trillion was spent on healthcare in the United States in 2011; this is expected to reach nearly $4.8 trillion by 2021.

Investments in healthcare facilities are not geographically restricted. Healthcare continues to be a business most influenced by local market needs. As long as the medical practices located in the building are affiliated with a healthcare system or well-capitalized healthcare practice that has a strong area market share and a good mix of private-pay patients, the size of the market is less important.

MOBs also tend to have low tenant turnover. Because most physicians’ practices need specialized space, depend on being conveniently located to patients and other related practices, and value continuity of location for marketing purposes, there is a higher renewal percentage than is typically seen in commercial office buildings.

Of course, this is not to say that MOB investments are without risk. If a community’s demographics shift or if expected residential growth fails to materialize, tenants in an MOB may not see the demand for services they had expected. As a result they may relocate to a more desirable site closer to their target population.

Historically there has been lower investment pricing volatility in the medical facilities real estate market. Regardless of the economic conditions, people will always need healthcare services.

Asset prices in the MOB sector are reflective of the high levels of tenant retention and demand for space, as well as credit enhancement from hospital systems, as investors compete for the properties that will provide the strongest returns with the lowest volatility. Acquisition cap rates for traditional MOBs are typically between 6.5 percent and 8.0 percent for facilities with material hospital tenancy and longer-term leases, though higher yields can be found in higher acuity and special-purpose buildings.

With the U.S. population aging, the Affordable Care Act remaining in place for the near future, and healthcare providers highly motivated to reduce the cost of healthcare delivery while improving quality and customer experience, it seems likely that medical office facilities will continue to be attractive investments. 

Source: Stephen H. Mauldin and Kevin Maddron, CCIM 

DISCLAIMER: This blog has been curated from an alternate source and is designed for informational purposes to highlight the commercial real estate market. It solely represents the opinion of the specific blogger and does not necessarily represent the opinion of Pacific Coast Commercial. www.PacificCoastCommercial.com