While opinions widely differ among the ranks of healthcare providers, most would agree that the financial ramifications of long term commitments for medical real estate space will continue to weigh heavily on growth in people or technology. Some see real estate as a cost of doing business, yet, we attempt to dispute this notion and advise that it can be a tremendous avenue for personal wealth if performed with diligence and comprehension. The leasing vs. ownership model for a medical building still significantly benefits the providers seeking to purchase or development. That said, is the advantage of real estate ownership appropriate for you and your organization?
Providers, especially small to mid-size physician practices, need to answer several questions in order to determine if ownership is the right strategy going forward.
- Will the provider own the building alone or should a joint venture with other practices be considered?
- Will partnering with a hospital be considered?
- Will a third-party developer or investment partner be considered to help guide the practice through the development process?
- What are the front-end cash requirements?
- What is the tolerance for debt guarantees?
- How does ownership align with long-term practice strategies or goals?
- What is a viable exit strategy?
The answers to these questions will help guide the physician group (and broker/developer/investor) to the right decision regarding equity participation in a medical office project. In today’s tight lending environment, the more cash invested, the better the borrowing terms available. Although borrowing for commercial real estate today has become increasing more challenging, especially compared to residential, we routinely take calls from lenders who will fund medical single and multi-tenant buildings by qualified buyers that will use the space.
How will the provider’s occupancy help to determine the cost of the building? Follow me here, as this is difficult for medical tenants to grasp. Rents are based on the cost of the entire project and cost of borrowed funds along with the return on cash investment desired, rather than the availability of space. In today’s medical real estate investment climate, the typical cash on annual return ranges from 9% to 15% per year based on a fully occupied building. As time lapses and rents improve, two favorable investment events happen: The cash return increases on an annual basis, and the market value of the property increases. Both of these events create increased value and wealth for their owners.
The inherent risk is the inability to maintain building occupancy with a practice group or medical rent-paying tenants. Empty buildings are extremely volatile and difficult to price. Prices parallel the availability of space coupled with the absorption of space in the regional and local marketplace. Rarely do vacant buildings increase in value unless the land underneath appreciates in value.
If you have a question regarding leasing, ownership, or simple investment into a medical building, please contact MREA at 713.701.7900.