By Matt Hudgins
PEARLAND, Texas--The medical-office sector is undergoing a broad
transformation with the rise of master leases.
In those deals, a large company or organization leases several
floors or an entire building, then typically sublets the space to
smaller users. Until recently, the sector had relied on myriad
small leases backed only by the guarantees of individual physicians
and small practices.
Just this summer, construction kicked off on a proposed medical
office building south of Houston after hospital operator Memorial
Hermann Health System agreed to lease more than one-third of the
building. HCP Inc., a developer, is building the project on
Memorial Hermann's campus here, where the hospital system already
has a master lease for an existing 80,000-square-foot office
building.
Marshall Heins, Memorial Hermann's head of facilities, declined
to disclose the terms of the lease or the rent it will pay for the
new space. In general, he says, rents are climbing rapidly and
property values are eclipsing those of conventional office
spaces.
"Medical-office lease rates continue to rise across the
country," he said. "This is probably the hottest sector right
now."
The deal is an example of a side effect of health-care reform
some might not have expected. Across the nation, the value of
medical office space is skyrocketing as the size and credit quality
of tenants increase.
In the past, many medical offices were leased by individual
doctors and small practices rather than by large, well-funded
institutions. In an exodus that began in 2009 and accelerated under
the Affordable Care Act, many physicians are abandoning the
independent-practice model to join large systems that are better
able to create efficiencies and control costs.
For example, the Affordable Care Act requires health-care
providers to maintain digital medical records by 2015 or lose
progressively larger percentages of Medicare reimbursements each
year. At Memorial Hermann, doctors to whom the company leases space
will have access to Memorial Hermann's digital-medical-records
infrastructure, as well as optional services in areas such as
reception, billing and office management. Those doctors, in turn,
are expected to steer patients to the system's hospitals.
Master leases such as the one signed by Memorial Hermann are
becoming the norm at medical office buildings, boosting property
values and investor demand for the asset type, according to Eric
Johnson. Mr. Johnson runs a group that advises health-care
companies at Transwestern. The Houston-based commercial-real-estate
firm markets HCP's building for lease and brokered the recent deal
with Memorial Hermann.
"The beauty of these master leases is that now we're not doing
2,000-square-foot deals. We're doing 30,000- to 50,000-square-foot
deals, " Mr. Johnson said. "For a developer, with one lease, you
can hit your minimum pre-leasing requirements required by the
lender for construction."
Memorial Hermann previously owned its office buildings and
leased directly to tenants. About five years ago, it sold those
properties and leased them back in order to free up cash for other
purposes. "With health-care reform, we spend our dollars where we
get a better bang for the buck," Mr. Heins said.
The new economics of the industry have also led to strong demand
from investors who want to own medical office buildings. Some 822
properties with a collective sales volume exceeding $8.2 billion
changed hands during the 12 months that ended June 30, a six-year
high, according to New York researcher Real Capital Analytics.
Median prices on a 12-month rolling average reached $229.67 per
square foot in the past 12 months, the highest since early 2008,
Real Capital found.
Asking rents for medical offices average $23.36 per square foot
currently in Houston, according to CoStar Group, a researcher. That
is up 4.9% from the $22.27 recorded in the fourth quarter of 2010
and exceeds the previous high of $23.08 set in the first quarter of
2009. Yet rent growth alone may not account for the steeper uptick
in acquisition prices.
Some observers attribute the increase to the relatively low risk
associated with health-care systems as tenants. "The institutional
capital has seen this transfer of credit from individual
practitioners to, now, bonded hospitals that have institutional
credit," Mr. Johnson said.
Properties leased to pharmaceutical companies, which also are
generally seen as having a relatively low risk of defaulting on a
lease, increased values for landlords during the 1990s, points out
David Rodgers, a research analyst at Robert W. Baird & Co. "You
went from these lower-value buildings to an asset class that became
somewhat sought-after, and credit has a lot to do with that," Mr.
Rodgers said. "We are seeing that very same trend, the move to
credit, occur within the medical-office field."
Wunderlich Securities Inc. research analyst Craig Kucera argues
that, more than credit, rising values reflect low interest rates
and potential rent growth as large health systems take up more of
the market's rentable space. "These large physician groups are
thriving," Mr. Kucera said.
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