The old beer adage flavors trends in healthcare commercial real estate entering the Age of Affordable Care Act (ACA). There are tasty opportunities for new types of healthcare real estate and a glut of less-filled medical office buildings (MOB) that may result from consolidations.
Healthcare providers are looking for patient-luring, high technology facilities and they want to pay less for the capital development. Facilities will be smaller, more flexible and expandable. Look for an airline-style hub-and-spoke system.
The new law and changes in healthcare delivery are also going to affect real estate — building sales and leasing, and the value of physician practices and clinics. Many existing medical office buildings will have to re-adapt. Some older facilities may be destined for scraping and redevelopment into other uses.
Deadline on evolving trends
Healthcare has been evolving over the past decade and ACA merely deploys previously evolving trends. All healthcare providers are now implementing change. To understand the future trends in healthcare, the ACA backend effect has to be understood.
Cars and people both run better with 5,000 mile oil changes and 25,000 mile tune-ups — for people, it’s periodic blood tests and annual physicals. It costs significantly less to deal with preventive healthcare for people than treating preventable illnesses.
“The top five illnesses in terms of cost and numbers are lifestyle-related and preventable,” says Mark Stapp, professor of real estate practice and the director of the Master of Real Estate Development programs at the W.P. Carey School of Business at Arizona State University. Stapp says ACA’s focus on wellness is going to have “profound effects on medical real estate and economic development.”
While most political and public discourse focus on the consumer side of the law, healthcare providers are gearing up for what the law means in terms of delivering healthcare and the facilities required for delivery. ACA deploys three fundamental healthcare delivery changes:
1. Creation of Accountable Care Organizations (ACO)
2. Emphasis on keeping people healthy
3. Using hospitals for only the most acutely ill
Meeting the standards of care financially rewards healthcare providers; failing to meet the new standards results in financial penalties. The solution is a model deployed by Banner Health in the Valley — deliver healthcare into neighborhoods using a hub-and-spoke system. This is one reason Banner has built six health centers across the Valley.
Private sector healthcare organizations are not the only ones affected by the law. The Maricopa Integrated Health Service is considering a bond issue to fund its strategic plan. If passed, resulting construction and renovations will enhance its already-existing hub-and-spoke healthcare delivery system.
With thousands of Arizonans obtaining health insurance for the first time, there is an increased demand for healthcare providers. That component of ACA alone would seem to make MOBs an ideal real estate investment. The reality is, to obtain efficiencies, older buildings may not work.
“There are a lot of medical office buildings and clinics that are going to be functionally obsolete; and not just old ones,” reports Tom Weinhold, managing director of Cassidy Turley’s healthcare practices group. “Owners are going to have adapt to general office use or possibly tear offices down and replace them with other uses. Medical infrastructure has requirements today that some buildings cannot accommodate.”
Stapp says it could be a double-whammy in an already over-built office market.
“General demand for office space is decreasing,” he says. “Real estate has value from supporting an activity. If that activity goes, so does the value. The changes in medical care are driving changes in building design.”
Stapp says there are prospects because of ACA, too.
“Much of the public discourse is focused on the healthcare delivery, but there are rippling opportunities,” he says. “The emphasis on wellness is going to more broadly open that field. Community design, how and where people live, transportation options will all change development patterns. The population wants a healthy environment and business will find opportunities in that demand.”
“The days of the ‘build it and they will come’ hospital towers are over,” suggests Layton Construction’s Steve Brecker, executive vice president-healthcare. “Owners large and small are looking at their dollars much more carefully than before. There is a bigger analytical process in the decision to build or renovate a facility.”
Brecker’s comment, which comes from the firm’s nationwide perspective, is that no healthcare organization is overbuilding. Everything is right-sized for staff efficiency. “Interiors are the focus today. Unlike the ‘70s and ‘80s, a lot of forethought goes into everything from the lobby design to the comfort of the waiting areas,” he says.
At McCarthy Building Companies, Vice President of Business Development Chris Jacobson has a similar observation. “It’s a lot less expensive to build a clinic in an outlying area and bring healthcare to the patients as opposed to forcing patients to drive a long distance to a medical center,” he says. “The outlying clinics capture market share for a provider, and feed more acutely ill patients into the central medical center.”
This is the gist of the hub-and-spoke system deployed by Banner.
“Banner is the trendsetter,” Jacobson says. “They are using an accountable care model (as an ACO) and emphasizing wellness to save money.”
Banner’s Vice President of Development and Construction Kip Edwards says, “We’re going to deliver care at the most convenient and accessible level to our patients. This means not only clinics, but online, telemedicine and other support and educational services.
“What we’re doing is putting physicians, PAs and nurses into a neighborhood setting, so that a patient does not have to wait to see a doctor. In the current system, you’re sick today. You call the doctor and can be seen in three days or next week. You’re not sick next week, you’re sick today. Banner is developing the facilities so a patient can get into the doctor today at the place where all his records are located. Then, if he needs x-rays, prescriptions and a lab test, it’s all in one place; no more running all over town.”
“What all this means for designers and builders is that owners are cautious and we’re not seeing new mega projects,” says Steve Whitworth, healthcare division manager for Kitchell Development. “Most projects these days are in the $5M to $10M range. We’re seeing outpatient space expansion, practices combining and technical upgrades.”
Clinics are being absorbed
Banner, along with Vanguard, Cigna and other major providers, are buying up medical practices to be those family clinics.
“Some of the practices are going to stay in their office condo or leased space,” reports Weinhold. “We’re seeing the big providers saying to doctors, ‘We’ll take your debt and administration, give you some up-front money, and you can work for us.’ Sometimes, there will be an agreement to keep current space for three to five years.”
The consolidations and acquisitions have completely chilled the market for medical practice sales. Although not CRE, many physicians and groups used to plan on a practice buy-out — with or without real estate — that would fund retirement.
“That’s just not the case anymore. No one wants to buy a medical practice except the accountable care organizations,” Dave Peterson says. The owner and designated broker of Arizona Business Intermediaries, LLC, has seen the market grind to a near halt, “It used to be I could take on a practice listing, send it out to a direct marketing list of other physicians and close a deal. Small physician practices used to value at two- to three-times earnings. Now, it’s sometimes less than one times earnings.”
Peterson says that the big healthcare organizations are buying practices on set formulas and with some upfront money. In the end, he says, the now-employee doctors will move into a neighborhood or community clinic.
“There are two impacts on the value of practices and the interest of physicians being their own boss,” he adds. “The first is [ACA]. It’s putting practices in the position of only one interested buyer — large healthcare organizations. The second, which a lot of people don’t consider, is the cost of medical school and its related debt. All of this makes working for a healthcare organization on salary appealing.”
It also causes medical practice values to plummet — dental clinics, cosmetic surgeons and other discretionary practices are not affected by ACA.
“With the emphasis on efficiency and limited dollars, today’s builder is a construction manager and trusted advisor,” observes Layton Construction’s Brecker. “We’re not waiting for plans and giving estimates, we’re involved in the design to use our experience to help the owner and architect design a project that delivers what’s needed for the dollars available. It’s different than just a few years ago.”
Hamilton Espinosa at DPR talks about ROI and efficiency, “As providers are pushing healthcare into the neighborhoods, they are going to spending less to build or remodel. At the hospitals and medical centers, major renovations are not going to be funded unless there is a return on investment.”
Espinosa says full-time equivalent employees and energy are the biggest operating costs for a healthcare system.
“If we can show that a renovation is going to increase staff efficiency and cut energy cost, the owner is going to be willing to put more capital into the project,” he adds.
This is another example of the builder becoming part of the overall design team early in the process. Builders may have an opportunity for more development money if offsetting operational savings are part of the construction project.
Following the Banner model opens other opportunities.
“John C. Lincoln is developing a freestanding emergency department (off Carefree Highway and I-17, Phoenix). Scottsdale Healthcare is building neighborhood clinics and urgent care centers,” points out Kitchell’s Whitworth. “The freestanding (emergency department) is the seed of a future hospital. Dignity (Health) is doing the same thing in Glendale.”
Kitchell is also using new construction techniques to build medical facilities. “It started with the Chandler Regional (Medical Center),” Whitworth explains. “We’re building modules in a warehouse and then bringing them to the site for installation. There’s a safety factor by cutting the number of people interacting onsite. Because healthcare organizations are almost using the same template for interior work, there is a cost savings building offsite.”
Kitchell does not have its own facility, but uses partner warehouse space or on occasion, leases space, for the offsite panel construction.
“We’re constantly looking for new ways to do things to reduce costs and increase quality,” he says.
New moves for service delivery
Other healthcare providers are getting ready to implement ACA strategies. Rather than acquiring practices and building all its own clinics, the Mayo Clinic seeks to affiliate and partner. This move is not at the exclusion of building its own clinics, but in addition to greenfield facilities. Mayo has affiliations with the new cancer center at Yuma Regional Medical Center and the Sierra Vista Regional Health Center is developing a Mayo telemedicine connection.
“We’re putting less focus in inpatient services,” reports Cheryl Lisiewski, director of facilities project management for Mayo Clinic. “Our remodeling and expansion are creating a better environment for outpatient services and increased examination space.”
Mayo is undergoing a nearly $350 million expansion on the Phoenix campus with a proton beam therapy facility and new cancer center.
“We’re looking to develop new clinical offices, but primarily, the expansion allows us to renovate and backfill offices for departments that are now in compressed spaces,” she says. The expansion does generate some new inpatient beds, but it’s almost exclusively designed to meet outpatient needs.
The investment on campus is not preventing Mayo from reaching into the community. “We may develop stand-alone and primary care facilities,” explains Lisiewski. “We’re also interested in strategic partnerships for the Mayo Care Network. It’s similar to what we’ve done in Minnesota and Wisconsin.”
Mayo Clinic expects to announce its first primary care clinic in an outlying community in the near future. Negotiations were not completed at press time. Mayo’s model is good news for MOB leasing, but on a small scale compared to the number of facilities. Its partnerships mean working with existing practices or newly consolidated groups.
“There isn’t a relationship between MOB office space that will be delivered and population growth,” cautions Weinhold. “Well-located space is being snapped up by REITs at premium prices. Outlying MOBs are seeing values decline. It’s not just a simple conversion to switch an MOB to a general office.”
“There are a lot of different vehicles being used,” he adds. “Walgreens, CVS and Walmart are developing in-store mini-clinics. The urgent care centers, FastMed and NextCare, are going into retail center end caps. NextCare has started building on retail pads.”
These options are not good news for owners of Class-B and -C office space.
“I had physicians who were buying medical office buildings before and during the recession,” recollects Arizona Business Intermediaries’ Peterson. “Now they want to get out, but they’ll be lucky to recoup the purchase price on some of those properties. It’s not just recession-pricing, it’s that the buildings are going to be empty under [ACA].”
“The big problem, too,” explains Cassidy Turley’s Weinhold, “is that a medical office is not
adaptable to a general office. Owners are going to need to come into these office condos and gut the place. It’s unlikely once vacated there are enough small practices to take up the space that’s going to be available.”
New buildings, new opportunities
“New businesses are going to model around the new ideas that come out of [ACA],” projects Stapp at the W.P. Carey School of Business. “There’s a huge impact from wellness, because healthy people reduce healthcare costs. This is going to create opportunities for wellness business — and these businesses are going to need facilities. For example, there is a shortage of primary care physicians. This increases opportunities for complementary integrative medicine. That opens the door to small niche practices not impacted by ACA.”
“Our marketing is going to change for healthcare,” McCarthy’s Jacobson advises. “Without the big projects, we need to adapt to smaller projects and facility upgrades. Cost is going to be a big driver in the process.”
Jacobson say smaller facilities provide opportunities for builders to take on multiple projects using big medical center experience: “The materials and systems are the same for the health centers. Redundancies are not required, but the electrical and HVAC still function the same way as a hospital.”
Jacobson sees opportunities with delivering healthcare into rural areas, “Telemedicine, robotics and web services may not means anything more than a room in a rural clinic, but the backbone is going to require central facilities like call centers and data centers.”
Whitworth echoes that comment, “We have a benefit at Kitchell that we can call a medical professional any time, 24/7, and they’ll tell us whether to take two aspirin, get to an emergency department or make an appointment for a doctor. That medical professional has to be located in a facility somewhere.”
“Banner is going to spend $15B over the next 10 years renovating its medical centers and building clinics,” concludes Banner’s Edwards. “Sometimes, we might find a facility we can renovate or repurpose. Other times, we might have a greenfield building. Occasionally, we might lease space.”
Multiply that by the number of healthcare organizations in Arizona, and the future of healthcare CRE has some potential.
“I just don’t see it happening next year,” says Espinosa.
Eric Jay Toll is a freelance writer based in Scottsdale. He covers CRE, development and construction, business, medical and travel news for a variety of publications. His work appears in AZRE, Az Business, USA Today, CardioSource World News, and Toll is the senior correspondent for Arizona Builder’s Exchange. Toll spent three decades as a land planner, including 17 years in public agency development and economic development department management. He lives in Phoenix.