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Pain Relief for Hospitals

When Tuality Healthcare needed an additional office building on one of its two hospital campuses west of Portland, Ore., administrators faced a potential construction expense between $15 million and $25 million. Instead, the not-for-profit healthcare group opted to lease a portion of its land to developer Pacific Medical Holdings LP of San Diego, Calif.

Pacific Medical built a 115,000 sq. ft., multi-tenant office building on the site and leased the space directly to doctors. Tuality's new 7th Avenue Medical Plaza opened to doctors last year. Cost to the hospital: nothing.

Hospital systems like Tuality are anxious to get out of the landlord business as increasing liability insurance costs and reduced Medicare and Medicaid payments put the squeeze on capital budgets. In response, hospitals are turning over their on-campus office buildings to niche real estate providers like Pacific Medical.

Pacific Medical, which has developed medical office buildings for more than 30 years, owns or manages 1.8 million sq. ft. of medical office space and is developing another 16 buildings totaling 1.5 million sq. ft. The multi-tenant buildings average 75,000 sq. ft.

Manny Berman, COO of Hillsboro, Ore.-based Tuality Healthcare, says hospitals already are burdened by capital expenses related to equipment purchases and building renovations. In short, they don't want to deal with the hassles of real estate development and ownership. “You've got to be selective about what you use capital for, and not having to use that capital for a medical office building frees it up for other uses,” Berman says.

The medical community's business-savvy approach to its real estate needs is gaining momentum, says Greg Scrine, vice president of market strategy in the Chicago office of GE Healthcare Financial Services, a lender. “There are a number of specialty players out there that are buying these facilities.” GE Healthcare Financial closed $250 million in loans on medical properties in 2003, and expects to close $350 million this year.

Investors are eager to tap into the burgeoning health care industry. Health care spending in the United States will reach $3.4 trillion and account for 18.4% of the gross domestic product (GDP) by 2013, according to the Centers for Medicare & Medicaid Services. That growth promises to increase the demand for office space on hospital campuses, where occupancies may average 90% and lease terms average seven to eight years, or as much as 15 years for highly specialized space.

Medical office buildings require more intensive management than conventional offices and may not fit some investment portfolios. Building maintenance standards are more stringent than for a conventional office building, with restrooms cleaned several times daily and medical waste kept under lock and key until it is removed by a certified contractor. And building managers must be prepared to respond swiftly to a doctor's demands, says Bob Rosenthal, president of Pacific Medical Buildings. “They're accustomed to getting things when they want.”

A third-party landlord eliminates the typical landlord-tenant conflicts between hospitals and doctors, but hospitals can retain control over the mix of tenants in an on-campus office building through terms of a ground lease. Those terms can preclude services that compete with the hospital's business.

On the other hand, GE Healthcare's Scrine says that medical offices owned by hospitals frequently charge below-market rents. “So there's an opportunity for a buyer to bring lease rates up to market and improve the economics of the building.”

The lack of capital driving many hospitals to sell ancillary buildings will likely continue for at least a decade, according to Arnold Schaffer, chief executive for the San Fernando Valley at Providence Health System. “I don't see the federal government really being able to fund health care adequately as the baby boomers age. “It's hard to imagine that we would have adequate access to capital for the trend to reverse.”

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