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Medical office buildings buffered from real estate slide

Values are declining, but not as much as for other property. And credit terms for physicians looking to buy are getting more strict.

By — Posted June 22, 2009

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Medical office buildings are turning out to be a bright spot in an otherwise dismal real estate market.

"There are a lot of great investment opportunities out there," said Steven Brezny, MD, a family physician in Powell, Ohio, who put in an offer this month on a 4,500-square-foot office building he intends to use as a new home for his practice.

The medical office building market has long been characterized by stability rather than extreme highs or lows. In a world where flat is the new up, that is attracting a lot of attention from physicians as well as more traditional real estate investors.

For instance, a pair of papers published in the May 4 and May 25 Industry Insights, issued by the investment banking firm Cain Brothers, said now is a good time for health systems to sell real estate assets if they need cash. For buyers, these types of investments were less risky than they had been in the past.

"We do think the timing is still good," said Tim Schier, author of one of these articles and a senior vice president with Cain Brothers in Houston.

Prices have softened, but because medical office buildings tend not to be "flipped," or bought and sold with the intention of a quick profit, those who have invested in this type of property are less likely to be burned by extreme swings in the market, according to Cain Brothers.

Physician-owners said they were investing for the long haul, and many don't expect to cash out until they retire.

"We're seeing values go down, but nowhere near what is going on with traditional office buildings," said Tom Dalcolma, a partner in Street Sotheby's Medical Realty Advisors in Columbus, Ohio.

According to Real Capital Analytics, in May 3% of commercial office buildings were identified as being in bankruptcy, foreclosure or some other form of financial distress. This was true for only 1% of medical office buildings. Sales volume of medical buildings dipped 20% over the past year but plummeted 51% for other types of offices. A report issued by the New York-based firm in May concluded, "Medical office properties have proven to be a safe haven, and this niche has little trouble."

Interest in this usually staid sector is growing because there is a sense among investors that health spending is not being hit quite as hard as the rest of the economy in this downturn and many believe this sector will recover more quickly. Also, more medical procedures are moving to offices from hospitals, and demographic trends, such as the aging of the population, mean demand for health care will increase. Recovery is expected to be slower for retail and general office properties because investors expect it will take a while for consumers to start spending again.

"People still view [medical office buildings] as one of the most secure investments you can make, and the demographics all point to an increased need for health care services," said Paul Heiserman, a partner in Street Sotheby's.

There are also inherent characteristics of medical office buildings that can make them appealing to investors. Doctors are more likely to sign 10- to 15-year leases, longer than leases for other types of office tenants. And because of the significant investments needed to set up medical office space, are more likely to renew.

"Doctors' offices tend to stay put for a lot longer, and they don't grow or shrink with the same sort of volatility of other companies," said Robert Burr, president of the health care real estate development firm College Street Partners in Beverly, Mass.

That is not to say, however, that buying or selling at this time is without challenges. Those who work in this part of the real estate world say deals are happening more slowly.

"The financing is tough for a buyer to get, and it is more expensive if you get it," said Gordon Soderlund, senior vice president for strategic relationships with the medical building developer and manager of DASCO Companies in Palm Beach Gardens, Fla.

This has left some physicians with properties they want to sell but cannot or struggling to get capital to move ahead with purchases.

"The banks are really running scared," said Wallace M. McLeod Jr., MD, an ophthalmologist in Augusta, Ga. His real estate investments include part-ownership of the medical office building in which he practices. He also owns a 5-acre plot of vacant land in a neighboring town that has been for sale for the past three years, although he said he is financially able to carry the property until the overall market recovers.

Dr. Brezny nearly gave up on buying an office for his practice because he had such a hard time arranging a loan. Banks wanted far more of a down payment than they had in the past and were willing to lend for far shorter lengths of time.

"It's a good time to buy. It's just a tough time to get loans," he said.

Many physicians have reasons other than money to invest in their buildings. For Julio Cruz, MD, a dermatologist and pathologist in Dublin, Ohio, owning his own 11,000-square-foot facility allowed him to establish a laboratory to his specifications. He has also found that owning the facility makes it more attractive to physicians he is trying to recruit.

"It's very convenient for me," he said. "It's been a good idea and a good investment."

If selling is necessary, experts advise doing so before retirement with a deal to allow lease-back of the space for a period. Empty buildings are less valuable and harder to sell than those fully rented.

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