Anderson Professional Centre: A Fresh Perspective in Medical Office Development
[ By Jon Hemmer ]
Physicians gain financial strength in large numbers, which supports the increasingly high cost of infrastructure and technology and creates opportunities for better financial performance. These changes create demand for medical office buildings that have comprehensive capabilities.
Health services real estate development is a demanding specialty. It requires a thorough understanding of the technical needs of medical groups as well as a clear vision of the trends in today’s healthcare marketplace. It is a complex field, and one key to success is gaining the respect and trust of physicians. It takes a long time to build that trust.
Paul Hemmer Companies began developing medical office buildings 16 years ago and has developed 13 such properties totaling 450,000 square feet. Most of these were built in the Northern Kentucky suburbs of Cincinnati. This is in addition to the nearly l5 million square feet of industrial, commercial and retail property that the company has design/built developed. In 2006, Hemmer earned over $176 million in revenue among its more than 60 construction and development entities. With that experience came an understanding of the specific needs of medical offices, some of which include:
Oversized elevators to accommodate gurneys.
High ceilings to fit tall equipment.
First-floor offices with easy access to parking, that require a bigger footprint and less building height.
Fewer rest rooms in common areas.
Accommodation for new medical technology.
Architecture that creates healing spaces.
Demographics and Redevelopment
The trust that Hemmer has built among healthcare providers, and the reputation it has developed, led to Hemmer’s involvement in the Anderson Professional Centre project. Hemmer hadn’t previously worked in the suburb of Anderson Township, which was experiencing a retail redevelopment. As part of that redevelopment, four real estate investors had purchased a five-acre site with a 60,000-square-foot empty Thriftway supermarket. Those four investors intended to redevelop the site but soon realized they didn’t have the resources alone and approached Hemmer.
Hemmer executives considered the potential for the location. Anderson Township is about 15 minutes from downtown Cincinnati, home to 43,000 residents. The area’s demographics include many business owners and professionals, including those in the medical field. Anderson Township is growing; a new school was recently built, and a major hospital is nearby. Retail redevelopment was in the works to replace outdated shopping centers. Nearby offices were aging, making new professional office space attractive. Staging had been done on the site and a parking lot was in place. In addition, the concept plan had been approved.
Experience sharpens a developer’s ability to assess risk and the potential for success. The gut feeling of Hemmer’s executives – honed by experience and armed with demographic research – told them the Anderson site had good potential for success.
The Anderson Professional Centre is an example of suburban medical office projects that are a growing market in commercial real estate development. To understand the future of that market and the potential viability of a medical office project, it is important to recognize a number of key trends, such as these recently outlined by Colliers Turley Martin Tucker and GBBN Architects:
Demographic Shifts. Population migration away from the urban core is expected to continue. This will create more demand for healthcare providers and facilities in suburban locations. The population in suburbs and exurbs tends to be more affluent, in good health, privately insured with broad healthcare coverage, and with the resources and expectations to use more services. Healthcare providers will seek practice locations where they can conveniently serve this population. They are treating their practices more like retail businesses, desiring to locate near thriving residential areas.
Convenience Factor. The 21st century consumer brings new demands to the way he or she uses healthcare services. Today’s consumer wants:
A healthcare environment that is not unlike retail shopping environments.
The family physician to be located five to 10 minutes from home.
A service-oriented environment – that means accessible parking, minimal and pleasant wait times, convenient hours and comprehensive service capabilities.
The primary care doctor’s office to be near other neighborhood retail shops and offices the consumer might frequent.
A physical setting that is psychologically supportive, allows confidentiality and eliminates environmental stressors.
New Technology. New technology becomes available and affordable more quickly in today’s medical marketplace. Technology can improve clinical outcomes, office productivity and practice capacity. Consumers expect it, and physicians seek to make it available in their offices. Physicians’ offices must be able to accommodate not only today’s technology but technological advances that are on the horizon. As technology is more available and affordable for medical offices, practitioners’ dependent ties to hospitals will lessen.
Medical Practice Structure. The days of the sole practitioner are gone. Medical practices will continue to grow through mergers, either with other physician groups or through mergers and acquisitions by medical institutions such as hospitals. Physicians gain financial strength in large numbers, which supports the increasingly high cost of infrastructure and technology and creates opportunities for better financial performance.
As practices become large, financially strong entities, they have less dependence on hospitals for facilities, technology and other support structures.
Growth in Healthcare. Healthcare spending comprised 7.2 percent of the nation’s economy a generation ago. Today, healthcare spending represents 16 percent of the nation’s Gross Domestic Product (GDP) and is expected to reach 20 percent by 2015. Healthcare real estate is a $750 billion market, larger now than industrial and nearly as large as retail. Fueled by a boom in outpatient facilities and medical offices, more than $100 billion was spent on new healthcare facilities in the past five years. Medical office buildings now comprise more than one-third of the healthcare real estate value. Developers expect to add 13 million square feet this year. Vacancy rates are typically low, at five to 10 percent. Leases are generally long; renewal rates are in the 90 percent range.
Physicians’ offices must be able to accommodate not only today’s technology but advances that are on the horizon. This requires higher ceilings, adaptable space and systems upgrades.
A Collaborative Endeavor
Hemmer formed a partnership to launch the development. The partnership included one of the entities that comprise Paul Hemmer Companies and some of the original investors who had bought the site. The partnership also included other outside investors who had invested in Hemmer projects in the past and some of the tenants – including physicians – who would eventually move into the buildings.
Hemmer created a plan for Anderson Professional Centre to develop two office buildings of 40,000 square feet each. The company invested more than usual in the architectural design to create a fresh perspective, with open space and more glass, and with exteriors reflecting the community’s new development. Hemmer had to gain approval for the project not only from the city, but also from the major retailers who were involved in the retail redevelopment adjacent to this site – Macy’s, Kmart and Kroger’s – as well as the developer of the shopping complex.
After plans were approved, a broker representing one of the region’s largest multi-specialty medical groups, Group Health Associates (GHA), approached Hemmer. GHA was looking for a new building in Anderson Township. They wanted a building of their own, but they didn’t need 40,000 square feet, and they wanted more parking than was in the original design for Anderson Professional Centre. To meet the clients’ needs, a project redesign began. Square footage was trimmed from the first building to create a 28,000-square-foot structure customized to meet Group Health Associates’ requirements. Then Hemmer went through the approval process a second time – again seeking approval from Macy’s, Kmart, Kroger’s and the developer – to request to add 5,000 square feet to the second building.
The result was Anderson Professional Centre, a professional and medical office development with a total of 73,000 square feet. The finished project was 7,000 square feet less than was originally planned, so the financial numbers changed. But GHA was in a hurry to move, and that brought a timely and secure return on the investment. GHA’s commitment to fully occupy one building gave Hemmer the confidence to construct both buildings at once. Hemmer first became involved with the project in 2003 and GHA moved into its new offices in 2005.
The presence of Group Health Associates primary-care physicians in the 28,000-square-foot building serves as an anchor to attract other healthcare providers to the development – just as an anchor store secures a retail development. The adjacent 45,000-square-foot, Class A office structure opened in 2006. Both buildings are two stories. The tenant mix in the larger building includes The Urology Group Inc.; Cincinnati Psychology & Psychiatric Associates; Anderson Cosmetic and Vein Institute; Ecolab Inc.; United Pet Group; and ReMax/Results Plus realty agency.
The finished development totals 73,000 square feet with 45,000 square feet of Class A professional office space in the building at the far right.
The $10.5 million, 73,000-square-foot Anderson Professional Centre development has a net rental rate of $15.00 per square foot, plus a property management fee of $6.75 per square foot. The net rental rate includes a finish allowance of $35 per square foot. If the tenant’s needs require a higher finish allowance – as medical offices do – then the rate increases depend on the finish costs.
Given the predicted growth in health services real estate, Hemmer will continue to develop medical offices. Paul Hemmer Companies expanded its operations and opened an office in the Chicago market three years ago and now is developing Sterling Creek Professional Center, a medical and professional office project in Portage, Indiana. That $20 million development will include multiple buildings on 21 acres just south of Route 6, across from the Portage Memorial Hospital. Hemmer also broke ground in March 2007 on a state-of-the-art surgery center in Crestview Hills, Kentucky, a suburb of Cincinnati, Ohio. The project is a collaborative endeavor involving plastic surgeons, orthopedic surgeons, OB/GYN specialists, podiatrists, neuroscience specialists and rehabilitation therapists. The two-story 34,000-square-foot ambulatory surgery center with outpatient services and medical offices is expected to be completed in 2007 and will serve several thousand patients a year.
By Jon Hemmer, vice president, real estate development services, Paul Hemmer Companies.
The demand for medical office buildings is stronger than ever, as the population of individuals 60 years of age or more is rapidly expanding. The future of medical real estate development is bright, as physicians and hospitals seek modern facilities to treat the next generation of patients. Many services that are traditionally handled on an inpatient basis at the hospital are being shifted to outpatient facilities located in new medical office buildings.
While the medical business is booming, healthcare providers are continually being squeezed by narrowing margins and declining reimbursement rates. Physicians feel they are working harder than ever, only to make take home less income. Because of this trend, physicians are seeking alternative methods to improve their financial status. The shared equity model in new medical office buildings is a prescription for success for the physician, developer and sponsoring hospital.
As the need for new medical facilities has grown, so too has the competition in the medical real estate development field. The market once dominated by a handful of national firms now has over 25 nationally recognized medical real estate development companies. This increased competition has been healthy for the end user — the healthcare provider — as each firm strives to distinguish themselves with their shared ownership models.
There are several shared ownership models available in the market today, and each provides the ability of the healthcare system to bring a building online without any cash investment or debt on their balance sheets.
Model #1 Equity Participation Program
The Equity Participation Program is a development program designed to help healthcare providers develop new medical facilities on an off balance sheet basis to better position themselves to effectively address the onslaught of changes that are sweeping the healthcare industry. Tenants are typically provided with 50-70 percent of the equity ownership in the facility with no cash investment. Tenants receive this equity on a pro-rata basis, based upon the proportionate share of space leased in the building.
This program is designed specifically with the healthcare provider and physicians in mind. Healthcare providers that need new facilities but are concerned about the cash investment and associated debt can utilize the Equity Participation Program to develop new facilities without taking on the financial risk. The funding for the project is structured so that the tenants in the project have no liability for the mortgage debt.
A healthcare development company partners with the healthcare provider to develop the new medical facility, providing 100 percent of the capital. The healthcare provider is not required to assume any mortgage liability or make any cash contribution for ownership in the project. This allows healthcare providers to direct their capital toward investment in their core business of providing high quality cost-effective healthcare to their patients.
Model #2 Tenant/Developer Investment Program
Under the Tenant/Developer Investment Program developers offer the tenants an opportunity to share in the equity ownership through an investment program. Tenants will receive a significant ownership interest in the project (up to 70 percent) in return for their equity investment, should they elect to invest. Should the tenants not wish to invest, the investment will be contributed by principals of the development company.
This additional equity investment reduces the loan amount, which in turn reduces the base rental expense. The reduced base rental expense, combined with the net cash return and equity appreciation, provides a very substantial financial return for the tenant investors. The size of the equity contribution for each of the tenant investors will be allocated based on their pro-rata share of the rentable square footage in the project.
This program is structured similar to the Equity Participation Program, in that the hospital and tenants are not required to assume any liability for the mortgage debt. Use and occupancy restrictions will also be incorporated into the tenant leases to prevent them from providing services that are in competition with the hospital.
Model #3 Asset Conversion Program
The Asset Conversion Program is designed to monetize existing assets for healthcare systems, thereby affording them the opportunity to reinvest the proceeds into their core hospital business. By converting a traditional hospital-owned medical building to a shared ownership program, the hospital enhances physician recruitment and strengthens existing relationships, as the physicians get the option to become owners in the facility without any of the typical development risks.
No matter which development model is best suited to their healthcare client, developers need to be mindful of the scrutiny hospitals face with regulatory compliance issues relative to facility ownership and operations. When selecting a medical real estate development firm, healthcare clients should be selective in their review and partner with a company who has an extensive track record in healthcare development.
