(Reprinted from Healthcare Real Estate Insights,
March 2003)

Outpatient Centers Are In Fashion

By Murray W. Wolf

Industry sources agree that outpatient centers are one of the hottest healthcare real estate markets going.

The precise size of the market is difficult to determine due to varying definitions of "outpatient care." However, an estimate of $100 billion per year is not unreasonable, based on the most recent U.S. Census bureau data.

In light of that and other documented trends, the need for renovated, expanded and new outpatient facilities seems clear. But, experienced developers say the current pace of construction is exceeding even their expectations.

San Diego-based Pacific Medical Buildings and its predecessor company have specialized in developing and operating medical office buildings (MOBs), parking structures and outpatient facilities for more than 30 years. Yet, president Bob Rosenthal says the market has never been more active.

"This is the busiest that we've ever been by a factor of 10," he says.

Developers throughout the U.S. report similar increases in outpatient facilities construction. What's behind the trend? Where are the opportunities for real estate professionals? Healthcare Real Estate Insights™ talked with several national and regional players in an effort to find out.

The Census Bureau's definition of "outpatient care centers" excludes healthcare services delivered in the offices of physicians, dentists and other healthcare practitioners.

So, although some outpatient services are housed in MOBs, basic medical office space is not generally considered to be part of the outpatient facilities market.

Outpatient facilities can also include kidney dialysis centers, rehabilitation centers, sports medicine facilities, fitness centers and centers for complementary alternative medicine (CAM).

CAM includes acupuncture, homeopathy, chiropractic or osteopathic manipulation, therapeutic touch, and other practices that are not considered to be part of conventional medicine. There's also increased demand for "medical retail" like pharmacies, durable medical goods and health foods.

The total market for outpatient care centers and medical and diagnostic laboratories was about $90.1 billion in 2001 (the most recent year for which statistics are available), the Census Bureau estimates.

That excludes medical office space, home healthcare, ambulance services and other unspecified services.

The outpatient care market grew more than 28 percent during the three years from 1998 through 2001, the Census Bureau estimates.

Assuming at least comparable growth in 2002 and 2003, spending on outpatient care will exceed $100 billion this year.

Given the market size and growth rate, it's little surprise that outpatient facilities were a significant contributor to last year's 12 percent rise in healthcare construction, and are likely to help fuel additional growth in 2003.

Third-party payors have pushed to decrease healthcare costs, especially since the Balanced Budget Act of 1997 reduced Medicare and Medicaid reimbursements rates.

That's helped to spur the growth of outpatient centers because they tend to have lower capital and operating costs than inpatient facilities.

It can cost $275 per square foot to build a fully licensed inpatient acute-care hospital, whereas some outpatient facilities can be built for half of that.

Overhead can also be minimized thanks to highly specialized, productive staff, as well as facilities specifically designed to maximize operational efficiency for a particular outpatient specialty.

Outpatient facilities can also avoid costly hospital services like emergency departments, intensive care units, food services and laundries.

"It's a general trend of the hospital becoming a place for very sick people and everybody else is going to outpatient centers," Mr. Rosenthal says.

Clients often prefer on-campus sites, says Steve Wiser, a senior healthcare architect for Louisville, Ky.-based META Associates, which plans, develops and maintains healthcare facilities.

"Sometimes surgeries don't go as planned," he says. Being on campus allows more immediate access to emergency care and other healthcare services for patients, as well as greater convenience for physicians and staff.

On-campus outpatient centers are also better real estate investments, Mr. Rosenthal contends. They are the healthcare equivalent of "beachfront property" - no one can ever beat their location.

Some older hospitals are so landlocked or antiquated, however, that the administrators choose to rebuild at other sites. These replacement hospitals offer a clean slate for all facilities - including outpatient centers.

Even so, off-campus outpatient centers can be a cost-effective way to establish a presence in fast-growing suburban markets, according to Lee Roy Ash, a senior vice president of planning with META Associates.

That's especially true if the satellite facilities have good freeway access and visibility. Sites adjacent to Interstate highways "are the hottest thing going for everything right now," he says.

As with MOBs, hospitals and health systems are increasingly turning to third-party financing and ownership of outpatient facilities. Third-party developers enable healthcare organizations to build new outpatient centers without tapping limited capital or borrowing power. That frees the capital for other investments, such as costly new medical equipment.

Administrators maintain control by retaining ownership of the land and providing long-term ground leases - 50 years is common - and by writing conditions into lease agreements that regulate the tenant mix and lease rates.

It's still more common for hospitals and health systems to explore third-party financing and ownership of MOBs than outpatient facilities. But, sources agree that administrators appear to be warming to the idea.

Sources say health systems are also increasingly open to third-party acquisition of existing facilities.

Banks and other financial institutions financed most outpatient facilities during the 1980s and 1990s.

But, some lenders became skittish when reduced reimbursements affected borrowers. So, credit tightened during the late 1990s. Recently, however, financing options for outpatient properties have broadened, sources say.

J. Todd Tidmore III of Plano, Texas-based MedCapital Group says large institutional lenders consider most individual outpatient center projects too small to be worthwhile. But, developers are seeing increased interest from smaller life insurance companies.

The smaller life companies "don't have as many (investment) options," Mr. Tidmore explains. Loans made to high net worth physicians to finance outpatient facilities can be attractive relative to other current alternatives.

Several publicly traded companies like HEALTHSOUTH Corp., United Surgical Partners International, Inc. and AmSurg Corp. specialize in forming joint ventures with physician groups to develop outpatient facilities.

But, it's also becoming more common for hospitals to get involved in joint ventures.

Rather than settling for only the rent from a ground lease, a hospital can take an equity position in the building and receive rental income - often providing returns in the "mid-teens," Mr. Rosenthal says.

Hospitals reap a share of the cash flow while the developer insulates them from potential real estate risks like construction cost overruns and operating losses. Under these joint venture arrangements, the hospital usually contributes the land while the developer provides the capital.

New on-campus outpatient centers usually have two impacts on parking - both negative. First, they create new parking demand. Second, they reduce supply because they often occupy the site of existing surface lots.

Adding the cost of a new parking structure to the project can drive rents to uncompetitive levels, Mr. Rosenthal says. One solution is to charge for parking.

Initially, administrators often balk at the idea of paid parking, he says.

But, the added revenue can be the key to financially feasible project, and Pacific has developed strategies to help hospitals and health systems to ease the transition to paid parking.

Parking can also become a profit center that makes a proportionately larger contribution over time because parking fees can be increased at a faster rate than rents.

Most parking facilities are partnerships with the hospital, although some are master leases with the developer as the owner. Either way, administrators usually insist on retaining control over parking rates.

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