by CJ Follini

“By trying we can easily learn to endure adversity. Another man’s, I mean.” – Mark Twain

As the somnolent days of summer take hold, it’s the perfect time to attend yet another real estate industry conference, this time for healthcare real estate at last week’s BOMA International Medical Office Buildings & Healthcare Facilities Conference in Philadelphia, PA . Even though healthcare real estate is proving to be one of the more recession-resilient (not proof ) asset classes, do we need to jinx ourselves with high-fives or, create anxiety by gathering in one spot where the economic bogeyman (or government for that matter) can easily target us? Kidding aside, the medical office conferences run by RealShare Conference Series, Interface Conference Group, and most recently the aforementioned BOMA conference are all professional, well-run and informative; so over the next two weeks I will recap the most important themes and comments from the June 24th -26th BOMA conference in Philadelphia.

1. Healthcare real estate professionals have always been an optimistic bunch but now it was joined by the conference buzzword – caution – as everyone seemed to express “cautious optimism.”
2. Equity capital is definitely out there and debt is supposedly available (more on this later) and deals are being offered, but each are passing each other unable to connect like ships in the night. Why? Where are the distressed sellers?
3. Hospital systems and large healthcare providers have new found focus on outpatient facilities, de-leveraging and honing their finances.
4. The rapid de-centralization of hospitals and the rapid rise of the ambulatory clinic and its real estate needs.
5. Seamless care through healthcare system/physician integration.
7. Dr. Peter Linneman’s (BOMA Keynote Speaker) take: “Get ready for a bumpy ride.”

During the 2 days at Philadelphia’s Downtown Marriott I heard the phrase ‘cautiously optimistic’  so often that I thought of substituting it as the poster child for oxymoron supplanting ‘jumbo shrimp.’  These were the same healthcare real estate pros that were very recently waving the medical office banner and receiving the amorous attentions of lenders seeking safety and cash flow. Why the sudden change? First, the scrappy, niche label of this asset class has come off and we have now become – oh god! – a “core holding” for institutional investors. And they expect performance. This means tougher underwriting standards and forget those aggressive exit caps; it’s all about yields now. Second, today’s deals are equity driven and when folks are playing with their own money, guess where the caution comes from?!

During the Deal Diagnosis: Equity Perspective conference session moderated by Cushman & Wakefield’s Jeff Piehl, private equity leaders like Seavest Inc. and Harrison Street Capital said they have capital (they cant all be fibbing), and the lenders sat there and said they are all ready to lend to “quality deals” (they ARE all fibbing), and brokers indicated they have sellers, so why is transaction volume so slow?  What’s going on?  From my interviews (coming on BLACKSWAN video soon) with several healthcare brokers and financial intermediaries, they feel it’s a group of factors. First, there is more focus on cash flow and current yields while exit caps are being steeply discounted. Second, if the equity in question is asset agnostic meaning it goes wherever risk-adjusted yields are most attractive, and today’s deals require at least 30% equity participation in order to receive financing, then the cap rates have to be high enough (think 8% and up) to attract this fluid equity.

But Jim Schrim, Chief Operating Officer of Klingbeil Medical Partners LLC and the straightest shooter in the biz, told BLACKSWAN: ” Deals are not getting done because the sellers of quality assets are still out to lunch with their unrealistic expectations, and the rest of sellers have stuff nobody wants or can finance.”  As for those I spoke with re: new development, my favorite response was from a national developer who spoke off the record and told me – “New build is deader than Dillinger.”  So where’s the optimism?  Uniformly the conference participants and my interviewees said their existing operations are stable, leasing steadily if not heatedly, and they have seen no contraction in their existing clientele.  Hey Kudlow, green shoots?

One of the best conference sessions I’ve attended in recent memory (including my own speaking engagements) was the Gauging The Health of Healthcare Systems: A CFO Roundtable. The extremely informative participants, James Foley from Shore Memorial Hospital in NJ and Robert Lux from Temple University Health System detailed their current environment:

• every health system is taking a scalpel to their cap-ex budgets due to the deep freeze in the debt markets which are only now “beginning to thaw.”
• Many systems have had their liquidity negatively impacted by investment losses which in turn affects their credit ratings and thus their access to capital – vicious cycle.
• When evaluating a health system’s operational health either as a lender or a real estate provider, analyze the system’s total margins first and foremost i.e. their DSCR and reliance on non-operating income.
• One reason there are fewer deals around (see above) is due to non-profits’ ardent attempts to re-finance before monetizing assets. No panic selling…yet.
• Finally and most important, it is critical to and inevitable that all health systems increase their outpatient services and the portion of revenue derived from them. For example, Mr. Foley of Shore Memorial that his hospital currently derives 40% of total revenue from outpatient services and that he was committed to increasing that to 60% by 2013. He also said that this was demand driven and not supply side. Mr. Lux said, “Technology improvements and striving for greater efficiencies have dictated the need for more outpatient services. It’s absolutely more consumer friendly.”

This means that new healthcare infrastructure will continue to be needed for off-campus buildings like ambulatory surgery centers and diagnostic facilities but every project is now closely scrutinized on a strict cost-benefit analysis rather than the recent, ‘ we got the money, build it and they will come.’

Part 2 of CAUTION RUNS RAMPANT AT BOMA MEDICAL OFFICE CONFERENCE will appear one week from today on July 6th.

Stay tuned for BLACKSWAN video interviews debut within 2 weeks!

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