Medical providers today are firmly in expansion mode, looking for new outposts to set up freestanding medical clinics, ambulatory surgery centers and specialty practices far from their main hospital campuses.
At the same time, they are struggling to rebuild their cash flows after the challenges of the COVID-19 pandemic. Many face a labor shortage as the country deals with a shortage of nurses and doctors. And the competition for patient dollars is only increasing.
It all adds up to interesting, and challenging, times for the real estate companies that help these providers find and sell their medical space.
We recently spoke to two top healthcare real estate professionals serving the Twin Cities market about the demand for medical office and healthcare space, the challenges that providers are facing and the outlook for the rest of the year.
Here is what they had to say.
Jon Lewin
Chief Financial Officer
MedCraft Healthcare Real Estate
Minneapolis
How strong is the demand for healthcare real estate, even with the uncertainty in the economy today?
Jon Lewin: We continue to be active on the leasing side of things. But that doesn’t mean there aren’t challenges. Health systems are struggling with cash flows. They are still recovering from the pandemic. The pandemic really did impact their cash flows.
I do think that healthcare systems are starting to get a little healthier again, though. Some have announced mergers to help improve their financial health. We’ve seen that Sanford Health and Fairview Health Services have agreed to a merger, though the closing date of that merger has been pushed back. That merger will have a long-lasting effect on the local healthcare real estate market. We are watching that merger closely and trying to understand what their overall strategy is.
Do you expect the financial challenges that some healthcare systems are seeing today to result in a higher vacancy rate in this sector?
Lewin: Physicians, once they establish their practices, don’t like a lot of disturbances. I don’t think that that a bunch of vacancies will pop up in medical office building space. I think we’ll see more disruption in the administrative end of the sector than we will see in the physician practice space. That will be something that we will watch closely.
Can you talk a bit about how the trend to outpatient services is impacting healthcare real estate?
Lewin: The movement to outpatient care, which has been a rend for 15 to 20 years, continues to pick up steam. More procedures are able to be done with outpatient surgeries. It’s not just GI and emergency medical services. Cardiology is looking into outpatient surgery on certain procedures. The ambulatory surgery center market that has been so hot will continue to be very, very active.
Those ambulatory surgery centers provide good incentives for health systems and physicians to come together. They are lucrative deals. And they provide the communities that they are in with great access to healthcare.
Hospitals don’t want patients taking beds for any longer than they have to. Once you have a patient that has gone through a surgery, a procedure that hospitals can bill at a higher rate, hospitals want them out and back home fast. If those patients remain in the hospital for two, three or four days, or longer than that, the hospital views them as taking up a bed. The hospital is not getting the reimbursement rates that cover the expenses of maintaining that patient in that bed.
You’ve mentioned rehab hospitals. How does this play into today’s model of healthcare?
Lewin: The rest of the country has rehab hospitals. These are hospitals where people recovering from injuries or illnesses go to receive specialized treatment. They are sometimes called inpatient rehabilitation facilities. This gets patients out of the large hospitals while still providing them with the type of nursing care and other medical treatments that they can’t get at home. Minnesota has never had these. Here, if you were a patient who needed additional monitoring or care, you might move into, say, a senior living facility, a high-acuity senior facility. But the rehab hospitals are coming. And they can change the way patients receive care.
How busy is your business today?
Lewin: We continue to see a lot of activity. We still have a lot of physician practices and specialty groups looking for healthcare real estate throughout the Twin Cities market, whether they are growing or looking for new space. We have done a lot of leasing at the Fairview Southdale facility in Edina. We’ve seen a lot of leasing activity at WestHealth, an Allina Health facility in Plymouth.
There are a lot of complementary practices that want to co-locate next to each other. That way, patients can go in and get an MRI and see their physicians. Once they have surgery, they can do their physical therapy in the same building or the same area.
We are not Chicago. We don’t have the elaborate El and subway system. People are used to getting in their cars. If you are elderly or you have elderly loved ones whom you are taking care of, drive-time is a big deal. If you live in South Minneapolis, you don’t want to drive to Eden Prairie for a follow-up. So medical providers want to open more locations throughout the area to better serve their patients.
What about rents? Are rents rising throughout this sector?
Lewin: The costs of developing new facilities have gone up since 2018 thanks to the pandemic and supply chain shortages. Say we build a new facility in town. To get the returns we need to get on those buildings, you are probably looking at $28 to $32 a square foot in rent. The market in the Twin Cities was more like $22 to $24 a square foot pre-pandemic. The days of getting $16 tripe-net rents for a B-plus or A building are probably over. There is continued pressure on the rent side of this sector.
We work with our clients to make sure their facilities and spaces are programmed appropriately. The rents are what they are. If they are used to paying $20 a square foot on 5,000-square-foot space, maybe there is an opportunity to take less space by being more effective and efficient. They can create centralized workstations and remove physician offices. The operating rooms can be more efficient if you use the latest technology. In every space we work on now, we take into consideration what the tele-health situation might be.
Are investors still interested in healthcare real estate?
Lewin: There is still an extreme amount of interest in this space. But investment activity has almost come to a screeching halt. That is 100% driven by the Fed and the rise in interest rates. It has really caused a pause in the market.
Transactions are still taking place, but at a far slower pace. At some point, sellers will have to sell. Health systems are still looking for ways to generate cash. Health systems are still recovering from the pandemic and labor shortages. They are still struggling with how to get physicians and nurses happy again. One of the fastest ways to generate cash is to sell some of their assets. I think that in the second half of this year, we will see more transactions happen because these health systems do need cash.
Jill Rasmussen
Principal
Davis
Minneapolis
Can we start by talking about some of the changes that COVID brought to the way healthcare providers serve their patients?
Jill Rasmussen: There have certainly been a lot of changes that came into play with COVID. But these changes were already taking place. The pandemic mostly accelerated them. Healthcare systems and clinics are all trying to deliver more convenient and cost-effective care. That typically means care that takes place away from a hospital campus.
It’s just more convenient to offer care in outpatient facilities. It’s more convenient for patients to access these facilities. Outpatient facilities typically have strong visibility from major roads. They are cheaper to build. It makes sense for providers to shift more care to the outpatient setting.
Are there any interesting trends that you are seeing with these outpatient facilities?
Rasmussen: They are often a little larger than they had been in the past. That has been the trend for a while. With the growth of ambulatory surgery centers, healthcare providers don’t have to perform as many procedures in the hospitals themselves. They are finding that outpatient facilities offer a better patient experience and outcomes. It is more convenient and cost-effective. Because the model works so well, the buildings themselves are getting a bit bigger. You might have a surgery center, some primary care, specialty care, imaging and a pharmacy all in the same freestanding center.
Healthcare providers are also expanding into growing markets, into second-tier market areas. They are opening in places like Blaine, Lakeville or Woodbury, communities where you are seeing a lot of growth. People want convenience and care closer to home. That was a trend that certainly started before COVID. People are not excited to go to a hospital or a big medical campus just for well-care. Hospitals have become a place for acute care. Everything else is being pushed off campus.
This approach also allows for better design and more efficient layouts. You can design around the care-delivery model. Healthcare providers can set up their system or independent clinics according to how they want to deliver that care.
What about telehealth and virtual doctor visits? Those were popular during COVID. Will they have any impact on the amount of space healthcare providers need?
Rasmussen: Everyone thought that everything would go virtual. But the reality is, virtual visits don’t work with every type of care. They might work with behavioral health. But for most everything else, people want to see a doctor in person. Telehealth and virtual medical visits, then, didn’t make as big of an impact as people thought they might. Is there going to be a need for less healthcare space because more care will be done virtually? We haven’t seen that play out yet.
How busy is the healthcare real estate market in Minnesota?
Rasmussen: The demand for space is still high. We are seeing a lot of leasing activity in existing buildings. A lot of leases and expansions are happening. The bigger independent clinics are taking a close look at their own expansion strategies. They are finishing their market coverage plans.
We just finished two projects for MNGI Digestive Health. The provider opened a new facility in Maple Grove and expanded in Woodbury. The principals of MNGI knew that they needed to get into those markets with newly designed and efficient facilities if they wanted to provide full market coverage. This is what a lot of medical groups are looking at today.
From the new development standpoint, everyone is still dealing with supply problems. Our hope is that things work their way through sooner rather than later. We are building a 100,000-square-foot building in Lakeville for Allina Health, a specialty care surgery center. MNGI is coming in, too, and taking a floor in the building. Lakeville is a huge growth market. A lot of groups are looking to get into or expand their presence in Lakeville.
Are you seeing any signs of relief when it comes to supply chain issues?
Rasmussen: The supply chain is getting better. We had been seeing delays with steel for a while. That has gotten better. Now it is switchgear and elevators. There are some delays with doors and frames. When the lead time for some of these materials is longer than the time it would take you to develop a building, that is challenging. Our hope is that it gets back to a reasonable timeframe soon. There is not a lot of other office development demand right now, so hopefully that frees up some of the materials. Even industrial development, which had been so busy the last several years, is slowing a bit. So maybe it will get easier to get some of these materials delivered in a shorter time.
Can you talk about the aging of the country, too, and how that is impacting healthcare real estate?
Rasmussen: Healthcare providers do have to consider how old the country is getting. Maybe there will be a better coupling of memory care, assisted living, seniors housing, medical office buildings, surgery facilities, pharmacy and imaging all coming together as one project. That might be a better approach than having all these different practices with different owners and developers spread out across a market. You are starting to see this coupling happen in other markets. They create a little healthcare community. You have seniors housing and healthcare facilities in the same development or nearby.
How about the retailization of healthcare? Will we continue to see medical providers moving into locations in retail strip centers?
Rasmussen: Those retail sites are often in great locations. They have good visibility and good parking. It can be challenging, too. Retail sites have a different lease structure. They usually have shorter-term leases. It can be a little challenging for clinics to move into that retail environment. We just put a medical group in Savage in a retail center. The group went through some issues, but at the end of the day it ended up in a space with great big signage and in a location where their patient base is traveling regularly. Their patients go to the grocery store and Target and then to their appointment.
We put a provider in a former Old Country Buffet a few years ago. Some providers have gone into old Blockbuster stores. It can be a good fit. You get that big parking lot and good signage.