December 2, 2011

Strong vital signs for health-care real estate

Hanley

Three years after the start of the Great Recession, the U.S. real estate markets remain sluggish at best. Businesses have not resumed hiring, resulting in stubbornly high unemployment and dismal rates of absorption of vacant office space. (The Seattle CBD is faring much better than most, however.)

Consumer debt loads, job worries and general anxiety have curbed consumer demand, hurting shopping centers and industrial space. The housing markets continue to fall; only in the multifamily sector are there signs of life.

Instead of a normal rebound from the 2008 crash in real estate values, the market cycle has flattened into an ongoing malaise, without any prospect of meaningful improvement in the near future. Businesses are surviving with less commercial space, homes are being given up for apartments, and the remaining homeowners cannot afford to move up. A leading real estate trade association, The Urban Land Institute, has pronounced this as “the era of less.”

However, one real estate market sector is showing vigor: health care. Indeed, in the last 18 months we have seen an extraordinary number of medical campus expansions in the Puget Sound area:

• Commencement of a huge expansion of Seattle Children’s main hospital campus (from 22 to 28 acres), which will double both the hospital’s square footage and number of beds and expand its emergency department.

• The opening of Virginia Mason’s Jones Pavilion, containing a new emergency department and other patient care spaces.

• Swedish Medical Center’s Issaquah Hospital, which opened in July as the first new full-scale hospital complex built in the Puget Sound area in 25 years.

• A nine-story, 275,000-square-foot hospital tower at MultiCare’s Good Samaritan Hospital in Puyallup.

• A $500 million, 12-story medical tower at Providence Regional Medical Center in Everett.

In addition, health-care systems have been aggressively purchasing or building off-campus clinics, ambulatory surgery centers, and other kinds of facilities to expand their geographic footprint, grab market share, or roll out new technologies. Notable recent examples:

• Completion of a Bellevue clinic and surgery center in 2010 by Seattle Children’s Hospital.

• Group Health’s announced plans to build “clinics of the future” in Burien (43,000 square feet) and Puyallup (58,000 square feet).

• Evergreen Health’s joint-venture development of a three-story multi-specialty clinic and urgent care center in Redmond (46,000 square feet).

• Swedish Medical Center’s redevelopment of the former Ballard Hospital campus to contain a five-story medical office building, emergency department and radiation treatment cancer center.

• Seattle Cancer Care Alliance’s current construction of a 60,000-square-foot proton-beam radiation therapy cancer treatment center on the campus of Northwest Hospital.

What is going on? How can there be this level of capital investment in new medical real estate in light of current economic conditions?

To be sure, most of the major campus capital projects were planned and funded before the Great Recession, and those projects reflect dated forecasts and a confidence not currently seen in other sectors of the economy.

But that is only a small part of the story. Strong economic, societal and regulatory forces are bearing down on the health-care industry. These pressures will transform the industry and, with it, the real estate that serves it.

What are these forces? There are several:

• The baby boom generation is aging, and entering the years when its demand for medical services will triple, so providers will see a surge in demand for medical services from this bulge in the U.S. population.

• Recent federal health-care reform will add about 32 million more Americans to the insured population rolls, a new source of demand for medical services.

• Technology advances have created many new medical procedures, and made existing procedures more effective and affordable, stimulating further demand for state-of-the-art care.

• Government policymakers struggle to contain costs, but the political will to curb use of health-care services will, in the short term, be tempered because this is one sector of the economy that creates jobs. (Health care, high-tech and energy industries accounted for 35 percent of the 1.8 million new jobs added since February, 2010.)

These and other forces will lead to substantially greater demand for health-care services. Meanwhile, new cost-containment initiatives (from both private insurers and governments) will focus on curbing expensive inpatient procedures and emphasizing outpatient services and wellness programs. Technology gains will facilitate this shift, by permitting more and more sophisticated services in outpatient settings. MRI, CT and PET scans, colonoscopies, knee and hip replacements, laser eye surgery, and soon spine surgery will all be routinely available at off-campus clinics.

These pressures will cause health-care providers not just to expand their facilities but to reconfigure and relocate them to meet demand, achieve cost efficiencies and maximize revenues.

Future health-care real estate strategies will emphasize:

• Consolidation of physician groups (formerly independent practitioners, now employees) deployed in strategically placed campus medical office buildings and off-campus clinics and specialty care centers (eliminating doctor-owned real estate, and jeopardizing small, investor-owned medical office buildings).

• New kinds of off-campus medical facilities, designed to have low costs of construction but high use efficiencies (such as patient flow and energy usage), flexibility to permit easy reconfiguration, and customer-friendly features that will support a new emphasis on wellness programs.

• Facilities that allow a higher acuity care (while still qualifying as “outpatient care” for reimbursement), which will permit transfer of certain procedures from a central hospital to an off-campus setting.

Looking forward, we should expect to see continued expansion of health-care infrastructure, and the development of new kinds of health-care real estate stock, in new locations, and with new functions and appearances. As is certainly true for the rest of the health-care industry, big changes are coming to health-care real estate.

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