The growth of medical office buildings, spurred by the desire of physicians to be convenient to their clients, has resulted in many physicians and medical groups having an ownership stake in real estate. Yet without a fundamentally sound approach to maximizing the value of the asset, physician ownership can encounter several unforeseen challenges which, over time, confound the best efforts of the ownership group while diverting attention and resources that could be better spent on practicing medicine.
In many cases, practice ownership will turn to an asset management team to navigate the intricacies of the commercial healthcare real estate market, such as working with both brokers and tenants. Physician owners should develop a strategic approach founded on a series of proactive steps to stay ahead of common issues in medical real estate investments.
Select the team
The most important decision is made right at the start. Selecting the right team and identifying the right direction and motivation can overcome the complexities inherent in the ownership of a medical office building. An asset management team should model their actions as if they were the owner, addressing each issue that arises as though the asset were their own. For this reason, having the backing of ownership is crucial and fundamental to the outcome.
Every asset and market is different with its own distinct characteristics and challenges. That is why it’s important to develop a comprehensive marketing plan to lease up any unoccupied space with deliberate speed. Vacant space may seem like a neutral factor, but it is a hidden cost involving real estate taxes, utility expenses, upkeep and other hidden costs. Physician owners, in partnership with an asset management team, should seek to maximize their ability to build and preserve a revenue stream while controlling expenses.
Separately, that asset management team working on ownership’s behalf should seek out and manage the right broker. The broker selected should be deeply engaged in the local medical community with a multitude of contacts among local medical professionals, which expedites finding tenants.
Partner with the right owner
You’ve heard the saying, “Sometimes it takes money to make money.” Driving value through periods of market volatility entails a mindset of acting in the long-term best interest of ownership. It is important that asset managers develop relationships with owners based on a commitment to understanding the necessity of leasing concessions, including improvement allowances and rent abatement, in order to create and preserve value through new leasing and tenant retention incentives.
When the cost of a medical office fit-up can run as high as $120 to $140 per square foot in the Carolinas, for example, it is the responsibility of the landlord to be creative in making deals to retain occupancy. This can be a challenge for physician groups if they are under-capitalized and unable to make improvements.
Both healthcare professionals and asset managers should have strong understanding of the costs involved in fitting-up spaces and know when to make deals to accommodate tenant improvements, as well as when to offer creative solutions such as rent abatement programs.
Asset managers must provide honest feedback when rates and allowances are under market, as well as when building finishes have reached the end of their life cycle and hamper leasing efforts. This is where having a long-range capital plan is essential. Staggered lease expirations can minimize the negative impact to cash flow that often occurs with vacancy and releasing costs. In such a situation, tenants often realize their superior leverage position before ownership does. Effective capital planning is required to address significant capital repairs (e.g., roof, HVAC, parking lot), which typically require replacement concurrently.
Know the competition
Just as a physician is an expert in a specialized area of medicine, an asset management team with experience in healthcare real estate market has the expertise to successfully execute an asset maximization strategy over time.
Making cash flow projections requires deep knowledge of your competition in real-time, even as rates and other economic factors constantly change. Practice ownership working with an asset management team should look for a team that can track data on all medical office building spaces, including rental rates, average occupancy, average tenant improvement allowances and other details that create an exact profile of competitors.
The team should know what the competition is offering by analyzing lease comps, which are verified, as well as looking at rent comps, which are determined by detailed analysis of asking rates.
Asset managers understand that just as every building is different, so is every owner. It takes a team with integrity and transparency to provide honest feedback when they know that ownership has limited options. Knowing when to say “no” can be the deciding factor in determining whether ownership’s projections are realized. Importantly, this awareness of when a deal should be declined depends on the degree of trust developed between physician ownership and the asset management team.
Proactive capital planning is essential to developing and maintaining a long-term budget for your property. An effective budget must consider both property enhancements and capital improvement recommendations over the life of the structure. Budgeting oversight must involve knowing when distributions need to be made as well as meeting financial reserve recommendations.
To deliver long-term value, proper owner representation means accurate and timely administration of lease transactions. This translates into collecting and entering the critical information into a database while also managing all leases and contractual commitments.
Finally, successful ownership in the market rests on knowledge of the balanced relationship between equity and debt and how capital assets are acquired. Effective oversight requires extensive experience in the acquisition and disposition of medical office buildings on a market-by-market basis, as well as the intricacies of sale and leaseback solutions. Each office building requires multiple touchpoints.
Given the relatively short maturities of commercial real estate loans, owners need periodic access to capital markets. This requires experience and resources on the financing side, where markets change daily. Asset managers maintain a large and established lender network for exactly these types of eventualities. Their capabilities include analyzing financing and refinancing alternatives to ensure the ideal financing structure is in place.
In sum, successful asset management requires a determined focus on both the near-term and the long-term to meet both cash flow and asset appreciation goals. Those objectives can be harmonized through a strong, long-term relationship between medical practices and their asset management team.