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MEDICAL PRACTICES GOING CONDO
MEDICAL OFFICES: THE NEXT EMERGING COMMERCIAL REAL ESTATE
Many Medical Practices Going Condo
As the popularity of office condominiums grew, physicians started to see the potential. Now, office condos are being built specifically with physician tenants in mind.
By Pamela Lewis Dolan, AMNews staff. Dec. 4, 2006.
By the time Stephen Kundell, MD, learned of a real estate option geared toward doctors in private practice, he already had paid out more than $250,000 in rent and spent thousands more in upgrades to his office space that netted nothing in return.
But Dr. Kundell didn't want to buy a building. So the pediatrician from Thousand Oaks, Calif., did what physicians around the country in a similar situation are doing -- he invested in a medical condominium.
In general, office condominiums aren't a new concept. But a few years ago, when rent prices saw a dramatic increase and property costs soared out of reach for many physicians, more of them started to see the investment potential of office condos. It was an opportunity to earn equity, manage your own space, share construction costs with others and possibly qualify for small business loans. And buying a condo was a lot less expensive than buying a building.
Now medical office condos are being constructed in most major markets around the country. Even though the residential real estate market in most of the country has flatlined or declined in recent months, construction of medical office condos hasn't slowed, real estate experts say.
The medical condo market is so new that no one has researched it specifically. But according to Bob Bach, a researcher with the national real estate firm of Grub and Ellis, the office condo market in general is booming. Plus, he said, the success of new, larger medical facilities, such as hospitals, is partly reliant on neighboring medical condos. While many of those nearby condos were needed initially to house specialized technologies, Bach said, doctors found that they also could benefit by setting up their practices close to a hospital.
Lubbock Avalanche Journal
DFW developer to test local real estate waters with new office condo concept
Sunday, June 29, 2008A Dallas developer is preparing to test A DFW developer will test the local real estate waters with new speculative construction of an 18,000-square-foot-plus office condominium - the first to be built in Lubbock in more than 20 years.
Construction on the $3.1 million Chicago Professional Center, which will be built at the northeast corner of 19th Street and Chicago Avenue, is being directed by CMD Professional Centers.
"We haven't built an office condo (in Lubbock) in years, probably since the mid-1980s," said Scott Womack, a commercial broker with Coldwell Banker/Rick Canup Realtors Inc., which is marketing the property.
CMD believes there's a demand for the concept among physician practices, attorneys, CPAs and other professionals who would rather own than pay rent - and do it less expensively than building their own office.
"Over the past four or five years, we've done 1 million square feet of these in Texas, California, and Nevada, said Dee Young, company consultant and former Hobbs, N.M., businessman.
"This is the first one we've done in Lubbock, but it's hardly a new concept. It's no different than owning a home, except it's another piece of property," he said.
SCB Commercial Construction, which was contracted to build the one-story structure, said it plans to start work within the next two weeks and complete the complex sometime during the first quarter of 2009.
Trey Strong, a principal with SCB, said the project has already spurred interest among a few professional groups.
Strong said the complex, which has already been approved by the city, stirred some concern among Brentwood neighborhood residents until they were reassured about the type of building that was going in.
"This is going to have a very residential look to it," he said.
Strong associate Mike Black agreed.
"They're excited to see it. We're going to clean up the fence and alleyway and build something that will blend into the neighborhood that will only operate during the day," he said.
Black said the building, which will feature five separate entrances, will be subdivided into units as small as 3,000 square feet.
Young said owners will determine their own finish-outs and will share in the expense of keeping up common areas, including landscaping, which
will be controlled by an owners association.
Womack said the building's proximity to the medical district and downtown Lubbock should attract some buyers who can either purchase outright or lease space.
"We're definitely testing the market, but trying to find a 12,000-square-foot piece of land to construct a 3,000-square-foot building (in that area) is virtually impossible," he said
Medical properties continue to hold value, attract buyers
Friday, July 4, 2008Orlando Business Journal - by Richard Bilbao Contributing Writer
Photo by Jim CarchidiDr. Mark Trolice of the Fertility C.A.R.E. office in Winter Park owns two medical office buildings.The nation's growing -- and aging -- population is the driving force behind a thriving commercial investment potential: health care real estate.
In fact, medical property remains the No. 1 choice for real estate investors, in the opinion of Miguel de Arcos, managing director for Sperry Van Ness in Lake Mary, a commercial real estate adviser.
That's because there will always be demand for health care, no matter what condition the local real estate market is in.
Currently, "Investors are having a hard time finding properties that are worthwhile," says de Arcos. But health care-related properties offer income security because doctors' offices typically stay in one place for their patients' convenience.
Investors see these properties as a bottomless investment, thanks to the never-ending need for medical attention, he says.
And the potential for investing in the medical field is immeasurable, says Dr. Leonard "L.J." Levine, a former plastic surgeon and owner of Levine Enterprises LLC, a medical office space development company. He retired from his practice in March and now reaps the fiscal rewards of owning, and leasing out, 16,000 square feet of medical office space in Orlando.
A doctor who wants to make some cash by selling his building -- but who wants to continue to practice medicine -- has the option of a sale-leaseback. That involves selling his property to an investor who then leases it back to the doctor for a five- to 10-year term until retirement.
This type of deal gives doctors a chance to capitalize on the market when property values are high, as well as sell their practice to a partner after their lease has ended -- effectively doubling their profits, de Arcos says. "Sale-leasebacks are an effective strategy to free up cash locked up in the real estate."
Sale-leasebacks also can be a perfect chance for investors to get hold of land with good potential, says Mary Hurley, a real estate and leasing manager for Orlando-based Pineloch Management Corp., an investment and development company.
"Sometimes you have to look at the future [of the investment]," she says. For instance, if the property is in a growing area, investors may be more likely to buy the property due to the value of it increasing over time.
Dr. Mark Trolice of Fertility C.A.R.E., a Winter Park fertility clinic, agrees. He owns the building his practice is in at 5931 Brick Court along with the one next door and considers them a good investment.
Either way, de Arcos says the potential that health care-related properties have as an investment should not be overlooked, because of the ever-growing need for more doctors and more medical attention.
"The population is growing and aging, and that is job security for doctors," he says. "Medicine is recession-proof."
Commercial Condos in a Nutshell
The use of the condominium form of ownership for commercial properties has become prevalent in Texas and across the United States as business owners have discovered the benefits of owning, rather than leasing, their place of business. The structure of the commercial condominium includes units (the individually owned office or retail space) and common elements (the portions of the project common to all owners). Condominium-Basic Components. A condominium is a form of ownership with individual units owned in fee simple with shared ownership of the common elements.
The individual unit is defined and depicted in the condominium declaration. In most circumstances, a commercial unit will include the interior spaces located within the “walls, floors and ceilings” of the unit as depicted and described in the declaration. A unit will most likely also include other elements or improvements associated exclusively with the particular unit’s use. For example, paneling, tile, wallpaper, paint, finished flooring, and any other materials constituting part of the finished surfaces within the interior office space is usually included within the definition of the unit.
The common elements include both general common elements and limited common elements. Limited common elements are owned in undivided interests by all unit owners but assigned for the exclusive use of at least one but not less than all units. For example, a balcony or awning serving just one unit may be designated as a limited common element allocated solely to that unit. If the balcony is allocated as a limited common element exclusively serving a particluar unit then taht unit will have the sole and exclusive right to use the assigned balcony. General common elements are all other portions of the condominium regime other than the units and the limited common elements. Examples of teh general common elements include the land, exterior manonry, common hallways and parking facilities. Condominium projects and the regimes are structured differently based on architecture, site characteristics, and marketing concerns. A prospectiv e purhcaser should always consult the condominium documents for a description and configuration of the units and common elements within a particular project.
Condominium Declaration-The Creation DEocuments. All Texas Condominiums are governed by Chapter 82 of the Texas Property Code (known as the Texas Uniform Condominium Act, or "TUCA"). TUCA sets forth various requirements for establishing a condominium regime. The principal formation document is the declaration of condominium regime.
All Texas condominiums are governed by Chapter 82 of the Texas Property Code. The declaration is filed by the developer/owner with the official public records of the county where the condominium regime is located and must be filed prior to the conveyance of any condominium unit within the project. The declaration actually creates the units and common elements and is the primary document for determining how the regime will be governed. A typical declaration defines the units and common elements and includes: (i) use and occupancy restrictions; (ii) information pertaining to the creation and operation of the condominium association; (iii) unit maintenance cost allocations and assessments for maintenance expenses incurred by the association (iv) provisions associated with the enforcement of rules and the collection of maintenance assessements; and (v) certain development rights reserved by the developer/owner. The declaration is also often used to communicate certain features and charactristics associated with the project.
The Condominium Association. A condominium owner's association, which is usually a non-profit corporation, is formed to govern the affairs of the condominium regime. The members of the association are the unit owners and the association is managed by a board of directors. In many cases a private property manager is hired to assist the board in the day to day operations of the project. As a member of the association, a unit owner has the right to particopate in certain decisions affecting the project. The declaration allocates a cerain number of votes to each unit. Usually the allocation is based on the square footage of the unit relative to all other units in the regime. It is customary, and legally permissible for the developer to appoint and remove board members until a certain percentage of units have been sold to third parties.
MEDICAL OFFICE OUTBREAK
The fast-spreading healthcare industry makes medical office buildings a lucrative investment.
By J. Michael Davis, CCIM
A new trend in the growing healthcare sector offers physicians the opportunity for equity participation in new medical office building developments. Hospitals planning to build new MOBs on their campuses increasingly are turning to third-party developers and sponsors rather than constructing and owning the facilities themselves. As the business of healthcare changes, many physicians have become more-sophisticated business participants in joint medical ventures. MOB developers encourage this arrangement because physician-tenants who are offered MOB ownership are more likely to sign on early for projects and agree to longer lease terms.
As the prevalence of ambulatory surgery centers, or ASCs, specialty ancillary centers, specialty hospitals, and other evolving opportunities for physician-hospital joint venture participation has grown, physicians in certain U.S. markets have become accustomed to these additional earnings opportunities. Physicians familiar with investment options are more likely to push for equity participation in real estate. In particular, specialists such as those practicing cardiology, surgery, neurology, urology, and orthopedics, as well as larger physician groups, may find it easier to afford higher equity levels and can better tailor projects to their particular investment and diversification objectives.
Photo caption: Once-local hospitals now focus their resources on creating national healthcare facilities, such as Texas Children's Hospital in Houston, which has begun a $1.5 billion capital expansion.
Photo credit: Texas Children's Hospital
Developing MOBs
MOBs anchored by ASCs are becoming increasingly common because of the continued shift in the healthcare industry from inpatient to outpatient surgery. Also, physicians often find operating in an ASC environment more efficient, leading to a better experience for the patient and more income for the physician. A growing number of hospitals are happy to let developers and physicians divide MOB ownership so the hospital is free to concentrate their capital on core acute-care services.
But hospital executives often are concerned about losing the income stream if current surgical volume leaves the hospital and is transferred to an ASC. As a result, more hospitals are partnering with their physicians and a third party in operating two-party or three-party ASC joint ventures. Some hospitals favor physician investment in ASC ventures due to the belief that an ownership interest will encourage the physicians to make the ASC as successful as possible. Hospitals often want to have an ownership interest in these facilities, but they also want to outsource the non-core real estate development and ownership of the ASC. An attractive option is to offer physicians the ability to invest in both the ASC operations and the real estate.
In addition to ASCs, diagnostic imaging centers and other ancillary service operations also can be anchor tenants of MOB components. Again, hospitals often are more interested in owning and operating these building components than in being landlords for physician practice space. Joint venture structures and equity models have been developed to support the equity investment by physicians in these operations.
Equity Participation Models
Several models of physician ownership have developed to allow physicians to participate in MOB ownership as equity co-investors with the owner or developer of the project. In these models, physicians make passive financial investments and generally are not responsible for property operations. The ownership entity typically will be a limited liability company or a limited partnership, which allows the tenants to lease space and own an interest in the sponsor's ownership entity.
As the market has come to understand physician participation in MOB ownership, three different equity models have evolved to address those market needs.
Direct Cash Equity Contribution.In the most basic of the three equity participation models, physician investors make cash contributions to the project that typically are tied to the physician's proportion of building occupancy. The cash contributions can be made either in the planning stages or after construction is completed. In either case, participation usually will be structured so that physicians' risk is limited to the amount of their equity investments.
Physicians may obtain equity ownership pari passu with developers, meaning that a physician's ownership interest will have the same rights and privileges as the developer. When this is done prior to groundbreaking, physicians share all the risks and stand to gain all the rewards of the project's development on the same basis as the developer.
Oftentimes physicians do not want to bear the full risk inherent in the construction stage of a new project so the developer may assume the role of project guarantor based on the strength of the project's leasing profile. Developers assuming risk during the construction phase may structure their interest to achieve a higher return on the project. Any returns more than the amount of the developer's preferential return would be proportionately distributed to all equity participants based on their capital contributions and risk responsibility. Alternatively, a physician can obtain a post-construction ownership interest, which offers more-limited participation in the project with less risk.
Selling equity participation to physicians involves the developer issuing a private placement memorandum that outlines the terms of participation between the physician equity investor and the developer or sponsor offering the equity investment. The equity participation is offered pursuant to certain exemptions from registration under the Securities Act of 1933 and state securities laws. The memorandum spells out the investment criteria that have been developed for the particular project including a description of the securities offered, the eligible investor requirements, restrictions on transfer, the proposed purchase price, distribution provisions for participation in annual net cash flow, and proceeds upon sale or refinancing. Physicians considering an equity investment will want to get legal counsel and accounting advice as they consider the terms of any proposed offering.
Rent-Amortized Ownership. In this ownership model, the basic structure of the physician participation is similar to a direct equity ownership model; however, no initial equity investment is required by the physician. The equity required to establish the physician's equity position in the project will instead be contributed over the term of the physician's lease by paying an additional amount of rent sufficient to fund the equity contribution plus an amount to compensate for the sponsor's cost of equity contributed over time.
For example, assume that for every 2,000 square feet leased, a physician with a 10-year lease could contribute $10,000 toward an ownership unit under the direct cash equity contribution model. The developer could offer a comparable rent-amortized ownership structure to the physician as an alternative. Assuming that the sponsor's cost of money is 8 percent and the $10,000 was amortized over 10 years, then the tenant's rent would be increased by about $1,490 per year to reflect the sponsor providing the capital. The physician would participate in net cash flow and any proceeds for a sale or refinancing similar to the direct cash equity contribution model.
This ownership model requires careful analysis and consideration as the rents could be above market and lead to excessive leverage or result in a future buyer not factoring the higher rents into its underwriting upon a future sale.
No Equity Ownership. Colloquially known as the free equity model, in this alternative model physicians obtain participation in a portion of the project's annual cash flow and share of refinancing or distribution proceeds upon sale without making any equity contribution.
In one variation of the no equity ownership model, some developers may offer a fixed percentage of the building equity without any equity contributions to physicians who sign long-term leases by a particular cutoff date. In this variation, the developer is getting value from the early commitment of physician-tenants to long-term leases and returning some of that value to those physicians as equity participation. Longer-term leases - 10 years versus five years - for example, might enable the developer to give up 5 percent to 10 percent of the equity without impacting the developer's returns. The quicker lease-up period also improves the developer's returns and makes an equity position to physicians without contribution feasible.
Rendering caption: Cabrillo Medical Center, now being constructed adjacent to Children's Hospital San Diego, is a 31,711-square-foot, three-story class A office building that will be available for sale or lease to single or multitenant medical office users.
Rendering credit: Ware Macomb
Comparing Models
With the three ownership models, the ownership percentage offered by the sponsor will depend upon the amount of interest from prospective tenants. The direct cash equity contribution and rent-amortized ownership models may require a minimum contribution and the no equity ownership model may require a minimum level of subscription interest. The implementation of a free equity model is simpler than the rent-amortized or direct cash equity contribution approach because it does not require a private placement memorandum if the offering is not deemed to be a security.
All three options also require physicians potentially to be responsible for ongoing capital investments to improve the property during its operation, but the direct cash equity contribution model can be structured to limit that exposure.
The three models are illiquid investments, which may make it difficult for the physician to get equity returned in case of retirement, death, or ending a practice. Depending on circumstances, the direct cash equity contribution model may provide more liquidity than the other options through buy/sell provisions with the sponsor. The models also require close attention to legal and tax issues. The agreements required in the direct cash equity contribution model can be especially complex, although most sponsors are experienced at educating potential investors and already have established forms of offering memorandums and ownership documents.
One clear advantage that physicians get from a direct purchase/own building or condominium model is the ability to control the timing of the investment sale to meet their needs. The direct cash equity contribution model shares the characteristic of the direct purchase model in that physicians can participate in ongoing cash flow from the building operation, a feature that is not available with the condominium model. Additional benefits of the direct cash equity contribution model over the direct purchase/own model include operational efficiencies from a professional building manager, better ability to lock in operating costs, ability to structure the agreement to limit physician liability for post-occupancy costs if required, and potential greater flexibility to acquire additional space in the building if a practice requires expansion space.
Generally, physicians also appreciate that the direct cash equity contribution model is a purely financial investment. They do not have to worry about being a landlord or about building operational issues as is necessary in the other two models.
Physicians with excess funds may favor the direct cash equity contribution model, but for those with more modest means, the rent-amortized and no equity models are preferred. These models essentially are variations of the direct cash equity contribution model, so they have similar pros and cons. The rent-amortized ownership model can have an advantage of stronger property cash flows, which allow more aggressive debt financing terms. However, this introduces rent discrepancies between owners and non-owners, and it increases the risk of above-market rents due to amortized equity. Physicians can appreciate the benefit of a risk-free share of property cash flows and sale proceeds from the no equity ownership model.
Physician MOB ownership models will remain attractive as long as real estate returns are more lucrative than other alternatives such as stocks and bonds. Also, more sophisticated physicians and groups will realize that they can invest at the wholesale value level in new development projects to the extent that they sign long-term leases. By aligning the interests of physicians who can assure long-term stable tenancy with those of hospitals and developers who benefit from the stable cash flows that result from that structure, physician equity participation has become an increasing force in MOB development and ownership.
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