Time may be right to expand or build medical / business offices

Dr. Nason is one of many physicians either expanding or renovating their current building or constructing a new one, contributing to a boom in medical office building construction while other sectors continue to wane.

They are taking advantage of today's low costs spurred by a flagging economy while looking to the future, when health system reform will be fully implemented, bringing in millions more patients who are currently uninsured and baby boomers who will need more care.

Experts caution, however, that not every physician should jump on the expansion bandwagon. They say factors that contribute to successful growth include having a practice that is already successful and would benefit from health reform and senior care. They also say physicians need a sound business plan, solid insurer contracts, business savvy (or someone on board who is business-minded), and plenty of capital to make the practice attractive to loan-wary banks.

"Should everyone expand just because they think, 'This will be big, and I'll get a lot more patients [when health reform kicks in]?' " asked Arthur Wilmes, principal and consulting actuary with Milliman, an international actuarial and consulting firm. "It will be a good time only if your practice has a clean strategy of how you will align with certain insurance payers."

Fueling expansion

For some physicians, the timing is right for expansion. In addition to low interest rates and construction costs to build new, a large selection of buildings that once housed failed businesses are for sale or lease at bargain prices. For example, in Oak Lawn, Ill., a practice that is renovating a shuttered Suzuki dealership is a few blocks away from another practice that is moving into a former funeral home the city bought with the intention of using as a restaurant site.

Others are seeing renovation or expansion as a long-term investment.

"Business-smart physicians are looking to the future," said Thomas Adams, president and CEO of Florida Medical Space, which specializes in health care real estate. "They may only be in practice for another 10 to 15 years, but the real estate they own will set them up financially much longer."

Experts predict a need for additional or renovated medical office space, both to facilitate the use of electronic medical records and to accommodate huge increases in the number of patients spurred by boomers and the uninsured who would gain coverage in 2014. There also is increased pressure from insurers to change more procedures to outpatient status, increasing demand for private practices.

In a 2010 Medical Office Report prepared for Marcus & Millichap, a national real estate brokerage firm, senior analyst Thomas Hershey estimated that nearly 45 million more square feet of medical office building space will be needed if 50% of the 46 million uninsured individuals attain coverage through health system reform. The report also stated that an additional 25 million square feet of medical office space would be needed by the end of 2013 to accommodate the population growth in the 55-plus age group.

A June 2011 report from the U.S. Census Bureau shows that medical office construction has been increasing every month in 2011. May saw $5.06 billion in construction, seasonally adjusted, compared with $5.02 billion in May 2010, a 0.7% hike.

Meanwhile, medical office sales experienced a 122% increase in one year, going from $1.8 billion in 2009 to $3.9 billion in 2010, said Jessica Ruderman, director of research services for market research firm Real Capital Analytics.

"Medical office buildings are a safe haven," she said. "People who buy them will be looking at it as a good investment."

"More physicians are now looking to be employed by the hospital, and a lot of the hospitals are moving these doctors into the community to expand their market share," said Chris Bodnar, first vice president and head of the national health care capital markets group in CB Richard Ellis' Denver office. "These retail centers that are being converted are more in the community and are places where people frequent."

This means that physicians who own medical office buildings may discover more interest if they want to sell, especially if the space will be leased back to the practice, analysts said. Buildings with tenants tend to be more valuable than those without. Physicians are usually seen as attractive tenants because medical practices tend to move less frequently than other small businesses.

"There's ... an immediate opportunity for hospitals and medical groups to monetize their real estate investments," said Bryan Lewitt, senior vice president of CB Richard Ellis' Southern California health care services practice in Los Angeles.

The real estate services firm projects that significant new space will be needed. It estimated on March 16 that the state would need 7.2 million square feet of medical space to handle 3.1 million newly insured Californians.

"These newly insured patients will need a place to receive medical attention, and currently the space does not exist," Lewitt said. "In this recovery, no industry is better positioned than health care to take advantage of the reduced pricing and lower lease rates available in the current market."

A May 24, 2010, report by Marcus & Millichap, a national real estate services firm based in Encino, Calif., predicted that an extra 60 million square feet of medical office space would be needed nationally by 2019 because of health reform expansions.

How to succeed with expansion

Before getting into the building frenzy, physicians should determine if a practice is financially sound and if it would benefit from expansion.

Wilmes said primary care physicians will need to expand their space to get more people through the office and to accommodate what he sees as the primary care physician's new role as a delegator who decides which patients need to be seen and which can be delegated to someone else.

Renovation or a move also could be warranted if the office can't accommodate its future needs. The office may not be equipped to handle EMRs or other technology, and its space configuration could be inefficient.

Once the time is right to build, renovate or expand, experts recommend following these tips to make it easier, successful and less expensive.

Location is important. A cheap vacant building won't be worth the money if it isn't in the right spot. Moving close to a hospital and a visible, easily accessible area is important.
Have ample capital. Dr. Nason said 75% of his clinics were built before he went to the banks for financing. "I have three to four banks lined up to compete. I tell them to come back with a good term or they won't get a callback from me," he said.
Present a good business plan. Dr. Nason said he presented his vision to the bank, but his partner, who has a business background, showed the pie charts and data, including the expected number of patient visits at each clinic.
Seek out incentives. Some communities will offer tax incentives for developments, especially if they are in areas targeted for growth or with a lot of vacancies. Dr. Nason said he received some financial incentives from the communities where he built his clinics.
Ask for better deals. "Lenders find that doctors are an attractive credit risk," Adams said. "They will be creative with doctors in lending." Landlords are getting more aggressive in their efforts to retain physicians in medical office buildings, so physicians could have leverage for better lease terms, or to get them to renovate the space.

Change of fortune

Like a lot of real estate during the recession, sales of medical office buildings slowed significantly. But unlike other types of properties, these sales have come back, and it's expected that office construction will pick up as well. Sales figures are in millions of dollars.

Quarter

Cumulative
12-month sales

Quarterly
volume of sales

Annual quarter-to-quarter change:

Q1 2008
$6,242.9
$1,236.2
0%

Q2 2008
$5,551.1
$1,580.0
-30%

Q3 2008
$5,066.4
$949.4
-34%

Q4 2008
$4,768.8
$1,003.2
-23%

Q1 2009
$3,958.5
$425.9
-66%

Q2 2009
$2,798.8
$420.3
-73%

Q3 2009
$2,512.7
$663.3
-30%

Q4 2009
$2,051.1
$541.7
-46%

Q1 2010
$2,214.8
$589.6
38%

Q2 2010
$2,406.4
$611.9
46%

Q3 2010
$3,055.3
$1,312.2
98%

Q4 2010
$4,210.7
$1,697.0
213%

Source: Real Capital Analytics