Nimble navigation of today’s ever-changing healthcare real estate obstacle course requires familiarity with the deep recesses of local markets and staying the course through shifting industry trends
Winning a race requires not just speed, but vision, preparation, endurance, agility and coordination. In the space race, consider the recent SpaceX/NASA collaboration that sent astronauts Robert Behnken and Douglas Hurley (Bob and Doug) to meet up with the International Space Station, which many of us witnessed in May. It was the first time since the retirement of the space shuttle in 2011 that humans were launched from U.S. soil. Viewers were awed, buoyed and inspired by this lofty goal and achievement, a temporary antidote to the sorrow brought on by COVID-19.
What led to the mission’s initial success? Many years of trials, testing and teambuilding that spanned age groups, genders and nationalities. A deep study of the tasks at hand, down to the most minute detail. Collaboration amongst a wide variety of human beings and disparate entities. The collective wisdom and courage to hang back and wait for exactly the right conditions, because jumping the gun could ruin the whole opportunity.
The same can be said for more earthbound pursuits, including healthcare real estate (HRE). Assembling the team, commitment to practice, studying the course and getting out of the blocks is one thing. But getting past the unexpected twists and turns encountered along the way, staying in the race and making it to the finish line requires those same tenacious traits we witnessed that Saturday in May.
Aaron Phillips is First Vice President at Colliers International’s Irvine, CA office, specializing in healthcare properties and tenant representation, with a focus dedicated to healthcare and medical office building (MOB) real estate. He has experienced and overcome many obstacles in the race throughout his career working with tenants and landlords. Mr. Phillips recently shared his expertise when he participated in a panel discussion, “Leasing & Operations Update: Rents are Up, Vacancy Rates are Down – What does this Portend for Transaction Velocity and Absorption in 2020?” during InterFace Healthcare Real Estate West, held February 19 in Los Angeles, CA.
Although the session was held just before the pandemic took hold, Mr. Phillips and the other panelists shared valuable insights about the HRE and MOB space – insights that are just as relevant now and will continue to be after the crisis is over.
During the conversation, Mr. Phillips illustrated how today’s most challenging threats to traditional MOBs – such as retailization, the “aging out” of retiring physicians and changing market dynamics – can be met and conquered by adhering to a few time-tested best practices.
Remaining flexible in the face of perceived threats
These days in healthcare, everyone talks about retailization, the shift to outpatient and off-campus and the opportunities in repurposing other product types for medical use. But there isn’t much discussion about the traditional MOBs that all these services are moving out of. What happens to the buildings that are “left behind?”
Mr. Phillips acknowledged that “everybody has been toting the retailization flag” in recent years.” But he said most of the deals were smaller, in the 7,000- to 8,000-square-foot range, “so it wasn’t that unnerving” for owners of more mainstream MOBs. However, he said, the retailization projects have been getting larger and are involving more space.
“Just two weeks ago,” he told the audience, “I was out in Foothill Ranch in our marketplace. Hoag (Health Network) took over a former JoAnn (fabric store), about 45,000 square feet. The renderings and what they have done there is a complete transformation of the space.
“So, when you see a space like that that is literally the size of a medical office building, it is threatening” to the landlords of existing MOBs.
However, when we revert back to our space race analogy, the fact that someone builds a SpacePort doesn’t mean they’re going to land on Mars.
“I think there are two factors at play,” Mr. Phillips said. “One is the administrative or nonclinical occupancies in the MOBs that are being relocated off-site to save money. They’re doing that to save money.”
“But I think also are these newer retail-based locations, are they to drive market share, or are they actually providing care there? And I think the money is at the campus. The money is at the hospital, And the money is at the MOBs. The ancillary retail locations, I think for the most part right now, they’re strategic. They’re looking for market share.” But he said most acute care and higher-acuity outpatient care still happens in hospitals and in MOBs.
Staying on top of trends that affect leases
Along with physician group acquisitions and consolidations by health systems, another trend affecting MOB leases these days is retiring physicians, Mr. Phillips said. Tenants may try to get out of a lease under certain circumstances, such as a retirement or a sale of a practice. Being aware of these possibilities and eventualities, and prepared to respond to them, is very important.
“I’ve had a few retirements,” he noted, sometimes with clauses enabling the physician-tenants to terminate their leases early under certain circumstances. “So, lucky for the tenants, they were able to walk out the back door with minimal obligation,” he said.
“I think the national average for the retiring doctor is about 65 when you’re talking about five- or 10-year leases, it’s kind of concerning or a little grim as far as what might happen with our vacancy rates,” considering that a sizable number of physicians will be retiring in the next few years.
Although this trend can be a threat to landlords, there are both solutions and potential benefits, Mr. Phillips emphasized. Leases can be written to provide the landlord with some level of protection in light of how many doctors are reaching retirement age and how many physician practices are being sold. And on the bright side, if a hospital or health system buys a physician practice, it can be a good thing for the landlord because suddenly you most likely have a higher credit-rated tenant.
Know your market
That brings us to our next best practice: know your market.
As healthcare delivery changes and private practices are acquired by larger health systems, the space dedicated to those services is used and apportioned differently. Effectively managing and marketing that space requires knowing your market well.
“I’m in Orange County so it’s very consolidated in the market,” Mr. Phillips explained. “I think you need to have a finger on the pulse as far as the local health system and what their initiatives are. What programs they’re pursuing as far as recruitment physician. Is it urology? Is it nephrology? Is it cardiology? Orthopedics?”
Colliers | Irvine’s recent 26,000-square-foot lease to Orange County ophthalmology leader Harvard Eye Associates is one such example where the need to expand was immediate and critical. Colliers was able to assemble a large block of space in an existing building that had recently undergone a major renovation, providing an attractive solution for the client.
“We’ve had recent success in a sleeper market,” Mr. Phillips adds. “Laguna Hills had an 18-20% vacancy where we did a high 5 (capitalization rate) deal with Harvard Eye for 26,000 square feet.”
In addition to knowing your market, knowing a health system or physician group strategy is a key component. Keeping a bead on how and where physician recruitment is taking place and corresponding space requirements – and being ready to respond – is a big part of that.
“Identifying the actual physician recruitment and actually getting them delivered in a space, it’s a very lengthy process,” Mr. Phillips explains. “It could take a year, potentially two years as far as a runway to actually get that space delivered. It’s important to know the strategy or have access to relocations in order to actually deliver a large block of space, which in a consolidated market is probably 12,000 square feet and up.
“We’re seeing requirements as high as 60,000 square feet. So, you just better be geared up and ready to deliver that space.”
Similar to galactic pursuits, adventure and exploration in today’s healthcare space requires more than just a lot of luck. It requires innovation, preparation, creativity and teamwork. It means meeting the ever-changing needs of clients and their customers quickly, creatively and smartly. Developers, owners and tenants nationwide who experience the marketwise and strategic Colliers difference are positioned well to win the race.