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Medical Office Investors Mobilize as Health Reform Becomes Law

With health care reform now law, developers and commercial real estate investors are responding to the new demand for medical office space, which could reach 60 million sq. ft., by some estimates. At the same time, many private equity real estate funds are flush with cash and under pressure to invest as deadlines approach.

The funds, which include some of the nation’s biggest investors, such as insurance companies and pensions, typically have a four- or five-year window to spend stockpiled capital, according to their bylaws, and time is running out.

“They are under quite a lot of pressure to invest that money,” says Tim Friedman, head of communications at London-based data provider Preqin. The current “dry powder” — or committed but still unspent capital available to real estate fund managers — totals $195 billion worldwide, according to Preqin.

Vintage 2006 and earlier funds possess $23 billion, or 12% of the industry total, says Friedman. “They have four-year investment periods and they’re getting toward that four-year period right now and they still haven’t called up all the capital.”

In general, fund managers held off buying as they waited for asset prices to drop to the lowest possible levels. But because they also rely heavily on financing, fund managers were hindered by a lack of liquidity in the marketplace. “These guys need to be buying at the bottom on the way up,” says Friedman.

Some funds are committed to specific property types, such as retail, but opportunistic funds can target assets across sectors, including medical office.

Medical office spree

The 32 million additional Americans who will be covered by health insurance as the Patient Protection and Affordable Care Act takes effect over the next few years, will create a demand for a substantial amount of new medical office space, analysts agree.

An Atlanta-based investor, National Standard Finance, a public-private investment company, plans to spend $3 billion in 2010. About $750,000 of that is earmarked for health care-related real estate projects, says John McCulloch, senior vice president for the health properties group.

“We’re out very aggressively looking for assets,” he says. Health care reform is definitely one of the drivers for the search, adds McCulloch. “We’re looking at the development of hospitals and medical office buildings all over the country.”

Next year, National Standard hopes to ramp up its spending for health care assets from $750,000 to about $1 billion. “When you have this amount of people — a tenth of the population being thrown into the medical system of our country — that’s a lot of people. And today [the industry is] not prepared to handle that influx,” says McCulloch.

National Standard is homing in on potential construction and acquisitions in Southern California, specifically Orange County, as well as assets in Palm Springs and San Diego.

Over the next five years, the company plans to continue its aggressive pace, examining opportunities in Arizona, Texas and Florida, as well as potential deals in the Midwest, including Iowa and Oklahoma.

Other investors and developers across the country are conducting similar searches after hanging back to await the fate of the health reform bill over the long months of Congressional debate.

“You’re going to see a lot of construction permits being issued in the next six to 12 months,” says McCulloch. Despite the intense public debate and some backlash, including a political effort to have it repealed, McCulloch is unfazed. “I don’t see it being reversed,” he says.

Primary care offices will be needed for physicians who will act as gatekeepers to specialized care such as referring patients to cancer or heart specialists, says McCulloch. He foresees a need for more centers to house patients released from hospitals under pressure to keep patient stays short. “I really think the big growth is going to be in skilled nursing,” he says.

In any case, the nation’s nearly 80 million aging baby boomers also will require more health care over the next decade, bolstering the need for new facilities.

Concerns over cost

Reaction among commercial real estate companies and trade groups has been mixed, as they fret over the cost of the measure. The National Retail Federation (NRF) expressed “extreme disappointment” at the passage of the legislation. Many retail workers will lose their jobs because of it, the federation said.

"We are particularly concerned about mid-sized companies that are large enough for the mandates to apply but too small to have the ability to absorb these added costs," said Steve Pfister, NRF senior vice president for government relations, in a statement. "They could be among the hardest hit.”

But others welcomed the law. “Uncertainty about the health care plan — whether it would pass, when it might pass, what it might contain and what it would cost — was the primary obstacle to deals in the medical office space,” says attorney Neil Shapiro, head of the health care practice at New York-based Herrick, Feinstein.

“It was the removal of that uncertainty, far more than anything that the legislation contains, that will spur investment sales and leasing activity in medical offices.”

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