So You Want to Build Medical Office Buildings

[ By Robert A. Rosenthal, AIA ]

Although the development of medical office buildings may not seem to differ much from general office buildings, there are many significant developmental and operational differences. In short, a lot of things change when the word "medical" is added to "office building."

Starting with design:
The bay depths of medical office buildings are typically shallower than general office buildings, which are usually planned as a ring of perimeter private offices and an inner core of cubicles. In contrast, the medical office plan is built up from the dimensions of an examining room that is 10 or 12 feet deep. These rooms are served by a five-foot internal corridor that also serves an inner row of exam rooms or some support rooms which can be up to 16 feet deep. Therefore, typical bay depths are 31 (10-foot room, five-foot corridor, 16-foot room) or 33 feet (12-foot room, five-foot corridor, 16-foot room).

However, these dimensions only work for small suites suitable for one to three physicians. As the suite gets larger than about 3,000 square feet, it gets too long to be efficient in a 31- or 33-foot deep bay. In that case, a double room bay is required that adds up to a 50-foot deep bay (12-foot exam, five-foot corridor, 12-foot exam, five-foot corridor, 16-foot room).

This geometry is important: designing a building with bays that are too deep can cause leasing problems. Although the rental rate may be acceptable in the market, a tenant may be forced to take more space than needed because the rooms are too deep, making the total rent unacceptable to the prospective tenant.

Structural and HVAC Considerations

In addition to having to accommodate heavy file systems, many tenants will have equipment that is sensitive to vibration, so it is important to provide very stiff floors. Calculated deflections of less than 1/360th of the span is the norm.

Medical suites consist of many small rooms. In some of these rooms, patients are unclothed, while in others, the staff is working at a fast pace. Some diagnostic equipment generates heat while other equipment needs a constant ambient temperature, even on nights and weekends.

These requirements put unusual demands on the building's HVAC system. Each suite must be divided into many control zones. Odors must be controlled with frequent air exchanges and each room must have a supply and a return air grill.

Parking, Elevators, Common Areas

Terrace at South Meadows in Reno, Nevada, is a 66,000-square-foot medical office building, completed last year.

Because of the high patient traffic, more and larger elevators are required. At least one elevator must be large enough to hold a stretcher or gurney.

Because of the large number of toilet rooms located in the tenant spaces, it is not necessary to provide large, multi-person toilets. Typically, two single-occupancy toilet rooms per floor are usually adequate. However, a circulating hot water loop should be provided on every floor to supply instant hot water at all sinks and lavatories.

Laboratory specimen box closets must be located on every floor. In the past, a physician sent specimens to only one lab. However, with the advent of managed care, insurers and HMOs have contracts requiring physicians to use multiple labs. In order to accommodate these multiple lab boxes, a secure closet should be provided or else the boxes will be strewn about the corridors. Mailboxes and mail rooms must be larger than those in general office buildings, in order to accommodate the large amount of mail received by the typical physician, including oversize x-ray films and drug samples.

Tenant Improvements

All too often, tenant improvements are constructed to residential or light-duty commercial standards. For example, the suite entry door of a moderately busy primary care physician who sees 30 patients per day will open 60 to 70 times per day. By contrast, the front door in your home might open six to seven times a day, one tenth of the medical office. Therefore, if a residential door will last for 20 years, the medical office door built to residential specifications will be serviceable for only one-tenth of that time - or, two years. Accordingly, the hardware, the hinges, the closer, the frame and the door itself must be able to withstand the abuse that it will take in a medical office.

Other materials and finishes in the medical office must also be selected to maintain their original appearance despite the high traffic. High density commercial carpet, plastic laminate cabinets, vinyl wall covering, steel or aluminum door frames are routinely provided.

Patient privacy must be maintained throughout the suite. This requires that special care be given to the design and construction of partitions, doors and ceilings of rooms that may be occupied by patients, or rooms in which patients' financial and medical records are discussed. Plumbing and electrical fixtures should not be located back-to-back, even though it is cost effective to do so. Partitions should be set on a bead of caulking or sealant and should extend above the ceiling plane.

Many suites require special construction, including radiation protection, electromagnetic frequency shielding, 24/7 constant temperature, conditioned power supply and other requirements.

The Evolution of Medical Buildings It was not until the beginning of the 20th century that physicians began to locate their offices above a bank or retail store or, in larger cities, in multi-use office buildings. By the beginning of World War II, a number of specialized buildings had been erected exclusively for use by physicians, including some on hospital campuses. The end of the war, however, brought rapid change. The thousands of physicians discharged from military service tended to locate their practices near their patients, in the newly booming suburbs. But soon, changing neighborhoods, increasing traffic congestion, and the centralization of healthcare delivery around hospitals caused a growing increase in the construction of hospital-based medical office buildings. Most of these buildings were owned by the hospital and financed with low-cost, tax-exempt bond issues. In the 1970s, however, federal tax policy that favored real estate investments, high inflation that devalued many other investments and growing physicians' incomes caused the medical staffs of many hospitals to lobby hospitals for ownership of these buildings. Many buildings were owned by partnerships of physicians or physician-hospital joint ventures. In the 1980s, a new set of economic forces caused hospitals to begin turning to third parties to develop and own their medical office buildings. Regulations restricting the use of tax-exempt financing, prospective payment regulations and Medicare fraud and abuse guidelines made it expensive and risky for hospitals to own or joint venture the ownership of medical office buildings with physicians.

Management Issues

• These buildings have more traffic. The typical physician will see 30 patients per day, with surgical specialists seeing fewer patients and primary care physicians seeing more. Furthermore, each physician employs an average of 3.5 full-time equivalent staff members. This translates to a daily population of one person for each 58 square feet of usable area. A 100,000-square-foot building containing 85,000 square feet of usable area will have 45 tenants and almost 1,500 people visiting and working in the building. Medical offices are typically open longer hours than the typical office. This means greater power usage. The heavy traffic causes more water usage.
• We all know that physicians tend to be demanding and expect good service, delivered promptly. Unlike the tenants in a general office building, the tenants in a medical building see and speak to each other almost daily, making it easy for them to compare notes about the way that they are treated by the landlord. Furthermore, they speak frequently to hospital administration and sometimes are very vocal in making their needs or unfortunately their complaints known.
• A high level of cleanliness is expected in the common areas and in the suites. Combined with the high traffic, this requires more day porters and better cleaning crews.
• Virtually every office generates bio-waste that must be collected and disposed of separately from normal trash. Usually a special contractor is required to provide this service.
• Emergency power may be required if the building contains certain services. A communication link with the hospital is required, typically a fiber optic cable to the hospital's data center. Sometimes a pneumatic tube system to the hospital's lab is provided.
• Lighting levels in the common areas are generally higher in medical buildings since they are frequented by elderly patients who may have diminished vision. For the same reason, directories and signs must be large and easy to read.

Economic Issues

Ground rent can be a percentage of land value and/or a percentage of operating income. In all cases, the lease term should be at least 50 years. The most favorable leases are subordinated to the primary debt and cover only the land area under the building's footprint.

During the past several years, construction costs have increased at a greater rate than physicians' incomes. This trend accelerated last year when cement increased 20 percent and steel prices spiked more than 40 percent. These increasing construction costs resulted in higher medical office rents and created a widening gap between rents and the ability of physicians to pay them.

Some developers have met this challenge by offering physician-tenants a share of the cash flow generated by the building, in return for the execution of a long-term lease prior to the start of construction. Pacific Medical Buildings (PMB) has taken this approach a step further by also giving the hospital participation in cash flow, in addition to a base ground rent.

In a typical PMB project, cash flow is distributed among four parties: physician-tenants, the hospital, cash investors and PMB. Cash flow is the cash remaining after deducting operating expenses, reserves and debt service.

The Challenges of Development

A compromise involved the hospital's signing a fall-away master lease for one floor. As new tenants were signed, the master lease would be reduced by one-half of the newly leased area. This plan allowed PMB to obtain construction financing, since the company had 66 percent leased (33 percent from physicians plus 33 percent by the hospital). However, the 50/50 feature prevented PMB from remaining at 66 percent for a long time.

The challenge presented by the 140,000 square foot, five-story Mission Medical Plaza in Mission Viejo, California, was to capture a large primary care medical group that had been located across a busy street from the hospital. Not only would this group occupy 60,000 square feet (almost 50 percent of the rentable area) but also, its presence would attract many medical specialists who received their referrals. The problem was that this group insisted on owning and operating its own diagnostic imaging department and the ground lease prohibited any tenant from offering services that competed with the hospital.

PMB spent many months attempting to resolve this issue, which ultimately resulted in a joint venture between the two to own and operate the imaging service. Each party benefited. The hospital got half of the outpatient imaging revenues that it was not currently getting. Although the group lost half of the imaging revenues that it currently receives, it is likely that the imaging volume will increase from other physicians in the building. Furthermore, by locating on the hospital campus, the physicians in the group can walk to the hospital, thereby saving time and money.

In Hillsboro, Oregon, the hospital's outpatient services were growing rapidly, but expansion was constrained both by its site, which was surrounded by busy streets on all sides, and by a shortage of capital that was needed for inpatient modernization. Hospital management turned to PMB, who helped to acquire most of the block across the street and developed Tuality 7th Avenue Medical Plaza, a 115,000-square-foot outpatient services building.

The building contains 70,000 square feet of outpatient services, including six ambulatory surgery operating rooms, two cardiac catheterization rooms, two endoscopy rooms and a large diagnostic imaging facility. The remainder of the building contains doctors' offices. An FAA-approved heliport is located on the roof. The project is connected to the hospital by an enclosed, heated and cooled pedestrian bridge.

Opportunities in Medical Office Buildings

The marketing is much easier, since most prospective tenants come from the hospital. A physician will decide at which hospital he/she wishes to work and will then look for conveniently located office space near that hospital. Developers need to work closely with the hospital's medical staff office to learn their recruitment plans and to be introduced to new doctors.

The tenants will typically sign long-term leases. The average lease term in our portfolio is almost eight years. In new projects, PMB does not sign leases for fewer than five years.

The tenants will typically renew their leases when they expire. PMB has a portfolio occupancy of 96 percent and a 98 percent renewal rate. The tenants have good credit, a low rate of business failure and generally pay their rent on time.

Robert A. Rosenthal is president of Pacific Medical Buildings, a developer, owner and manager of hospital-based medical office buildings. Located in San Diego, Pacific operates in six western states and owns/manages two million square feet of buildings.

For more information

Pacific Medical Buildings
www.pacificmedicalbuildings.com