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Feverish Pace of MOB Development Fueled By Strong Demand, New Occupancy Trends

Convergence of Industry Trends, Market Forces Should Keep Healthcare Developers Busy In 2013 and Beyond
January 23, 2013
The hot medical office building (MOB) market is likely to remain in at least a semi-feverish state as the transition of common medical procedures to outpatient clinics accelerates with full implementation of the Patient Protection & Affordable Care Act, fundamentally changing the nation's health-care delivery system.

Health care was the largest job-creation sector in 2012, with most of the jobs added in ambulatory care facilities, a trend that will continue this year according to Jeffrey Cooper, executive managing director of Savills US.

Continued health-care employment growth, combined with the expected increase in demand for medical crae services from the aging population is expected to continue to drive development of medical ambulatory care facilities, including MOBs, surgery centers, urgent care clinics and diagnostic lab facilities.

"That's where all the growth is going, with the Affordable Care Act kicking in over the next 12 months, including requirements for mandatory coverage," Cooper said. "Health-care systems are really gearing up to handle those patients, and much of it will be through development of non-acute care facilities. In many ways, the ACA will be very positive for health care real estate, helping create demand for outpatient facilities."

While diminished Medicare/Medicaid reimbursements are a risk given the looming threat of federal sequestration spending cuts, most experts continue to view the market's growth prospects favorably.

"We believe strong demographics will win out, and our expectations are for continued strong prospects in the health care sector," said real estate economist Carlos Ortea, who analyzes the medical office property market for Property and Portfolio Research (PPR), a CoStar company.

Despite the number of new projects breaking ground in recent months, CoStar data suggests that MOB development slowed in fourth-quarter 2012 -- though it’s likely more of a pause, Ortea noted.

MOBs accounted for 7% of total office construction in the top 54 markets tracked by PPR, down from 11.5% in fourth-quarter 2011 and below its 10-year historical average of 11.3%. Also, fourth-quarter construction of medical office rentable building area (RBA) under way as a percentage of total medical office inventory was 0.6%, down from 1% in the last three months of 2011 and lower than the 10-year average of 2.3%.

"I would expect that this is a short-term trend," Ortea said. "The delivery of medical office space as a share of total office space has generally climbed in recent years, accounting for 17.7% of total office deliveries from 2007-12, up from its historical trend of 14.6%."

"In the near term, I don’t think oversupply is a problem. But could very well be an issue in the medium to long term since supply has historically doubled that of national office," he said.

Most of the increase is linked to long-term demographic trends, including population growth and the retirement of the baby boom generation. That said, Ortea believes more developers will likely move forward on projects to capture the potential increase in demand springing from the ACA health-care legislation.

The Patient Protection & Affordable Care Act (ACA) requires hospitals to invest in and implement many costly new systems and procedures at a time when they also face lower Medicare and private insurance payments, all of which is forcing them to look for possible ways to cut costs.

Duke Realty (NYSE: DRE), a major developer and operator of MOBs, said in its 2013 predictions this week that implementation of the ACA should continue to drive changes already under way that will affect demand for health-care real estate demand in coming years, despite the recession's lingering aftermath, lower hospital reimbursements and other issues.

Increasingly, MOB developers are expected to design more sophisticated facilities as hospitals move higher-acuity care such as post-surgical recovery and other complex procedures off the hospital grounds, the Indianapolis-based REIT predicts.

Also according to Duke Realty, hospitals are expected to make wider use of "freestanding emergency departments" and urgent care clinics, with operators such as Baylor Health System partnering with specialized for-profit emergency department operators to build new facilities. For-profit companies are also building standalone emergency rooms as an end unto themselves at high-traffic, retail-oriented sites.

MOBs offering higher-acuity and/or non-acute care, for example North Fulton Hospital’s new North Fulton Medical Plaza in suburban Atlanta, cost less to build, operate and maintain than hospitals and inpatient facilities. These outpatient facilities will need to be designed to a higher, more sophisticated standard than typical MOBs, while hospital may also have an opportunity to repurpose vacated space as services move to medical office buildings.

To date, freestanding emergency departments have been mostly owned and operated by hospitals. But mainstream providers such as Baylor Health System have recently announced they are partnering with private interests like Emerus to build dedicated emergency centers. In addition, for-profit companies are building stand-alone FEDs as an end unto themselves, at targeted high-traffic, retail-oriented sites.

"More and more, we’re seeing for-profit [emergency department] companies competing for the typical 7/11, Walgreen’s and McDonald’s sites," noted Don Dunbar, executive vice president of Duke Realty.

Hospitals, health systems and physician groups are increasingly willing to partner with both for third-party companies specializing in a wide range of other health care facilities, including MD Anderson, which is extending its brand across the nation by partnering with local providers on cancer treatment centers; and Community Health Network, partnering with Centerre Healthcare to build rehab hospitals. The real estate implication is that new, expanded or renovated "branded" facilities might be needed to accommodate these partnerships.

Lastly, adaptive reuse of other types of buildings such as offices, retail, industrial space and even movie theaters for medical use will become a more prevalent health care and real estate strategy, according to Duke.

"While there might be a dwindling number of vacant Circuit City, Borders and Linens ‘n’ Things stores in the suburbs, there will continue to be other suburban opportunities as chains like Best Buy and even Macy’s downsize," Duke said. In addition, health care reform will force providers to enter into other markets, especially central cities. Kaiser Permanente, Dignity Health and Scripps Health are three examples of health systems that repurpose space for medical use.

"Many are jumping on old grocery stores," giving potential new life to former retail and office buildings, according to Duke Realty's Dunbar.

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