The last four years? They’ve been challenging ones for healthcare providers and the brokers and developers working in the healthcare real estate sector.
First there was COVID, which, as it did with all industries, injected chaos into the delivery of healthcare services. Since then, medical providers have faced nursing and doctor shortages, declining reimbursements and higher costs both for building new facilities and delivering care.
The higher interest rates that came in late 2022? Those didn’t help, either.
Still, despite these challenges, the healthcare real estate sector in the Twin Cities market remains a busy one, with tenants still actively looking for space and investors once again considering sinking their dollars into healthcare facilities.
Ann Duginske Cibulka, vice president of real estate development for healthcare at Minneapolis-based Ryan Companies, said that demand for healthcare space remains strong throughout the Twin Cities market.
Much of this demand stems from the ways in which patients receive medical care today. Instead of traveling to a central hospital, more patients are seeking care, even for more intensive procedures, at freestanding clinics or ambulatory surgery centers.
Because of this, both physician groups and healthcare systems are searching for healthcare space in both the cities of Minneapolis and St. Paul and their suburban communities. Cibulka said.
“The constant shift of patient care to outpatient services is a big reason for the steady demand for healthcare space,” Cibulka said. “As care comes out of the hospital and into more convenient outpatient centers in the community, we are seeing more demand for space throughout the market.”
At the same time, physician groups and healthcare providers are embracing new technology to assist them in treating their patients. Many occupiers, then, are searching for new, modern space that they can more easily equip with this tech, Cibulka said.
Then there’s the population growth in the Twin Cities suburbs. As more households form in these communities, medical providers are scrambling to fill the spaces that get them closer to these potential patients.
This doesn’t mean, though, that medical providers don’t face challenges that might make them cautious when searching for new locations, Cibulka said.
“Though demand is strong, there are a number of feasibility challenges facing physician groups and healthcare providers,” Cibulka said. “There is caution when it comes to growing because of these challenges. The reality of real estate today is that construction costs and inflation have occurred. There has been some relief in the last six months. But construction costs are still significantly higher than they were two years ago.”
Interest rates, of course, remain a key challenge for health systems looking to expand by either purchasing or building new real estate. The hope was that the Federal Reserve Board might cut its benchmark interest rate this year, maybe more than once. That hasn’t happened yet.
Until rates actually fall, healthcare providers will remain cautious when expanding their real estate holdings.
“We are still at a new normal with interest rates that is driving up costs,” Cibulka said.
While costs have risen, the revenues of healthcare providers have been reduced, too. COVID, of course, played havoc with the revenue streams of providers. Medical providers also face rising nursing and staffing costs. The cost of supplies has risen, too.
The combination of falling revenues and increasing costs is making it more challenging for healthcare systems and physician groups to build stronger bottom lines.
A lot going on
Jon Lewin, principal and chief financial officer with Minneapolis’ MedCraft Healthcare Real Estate, said that the demand among tenants for healthcare space is still outpacing the supply available, both in the Twin Cities market and across the Midwest.
Lewin said that most of MedCraft’s healthcare real estate portfolio is leased up, with the exception being some space in older facilities built in the early 2000s.
This doesn’t mean, though, that leasing activity is brisk. Lewin said that while demand for healthcare space is high, medical providers and physician groups are actually moving slowly when making leasing decisions today.
That’s partly because the healthcare industry continues to see big changes in how patients want to access healthcare services. Medical groups are also struggling with lower profits today and higher costs, all of which means that they are carefully weighing their options before making a move today.
“The last four years, starting with the pandemic, have been a whirlwind,” Lewin said. “Some healthcare groups are expanding by buying independent practices. Some independent practices have spun back out of larger groups. Other medical groups are partnering with smaller physician groups. We have seen a flurry of new ambulatory surgery centers. There have just been a lot of factors in play.”
The good news for commercial real estate professionals working in the healthcare real estate sector? Medical providers understand that they can’t grow their profits or market share by cutting locations, Cibulka said.
“That is such an important message,” she said. “It’s important for providers to have strategies to improve their efficiencies and be innovative when it comes to being leaner. But strategies must be focused on the strategic growth of high-revenue operating systems. Groups still understand that growth is needed.”
Cibulka said that Ryan Companies is advising healthcare groups to look at real estate from a portfolio-wide perspective. Instead of focusing on individual acquisitions, providers need to evaluate their position overall in a market. The goal is to find high-revenue locations and expand those, Cibulka said.
They should also consider shedding low-revenue locations that are not producing, Cibulka said, and think about shifting their services to denser growth areas where they might enjoy a higher return of investment.
“As capital is constrained, providers have to be more data-driven on the decisions they are making,” Cibulka said. “They need to make more holistic real estate decisions.”
Cibulka points to a recent example. Ryan advised an existing client on a move from a small clinic in St. Paul to a larger, more modern facility across the street in the same market. By making even this short-distance move, the client would be able to offer more services, keep up with evolving technology and expand its market share.
The provider made the move and signed a long-term lease at the new facility, which allows it to compete with other healthcare providers in the same market that also boast more modern facilities.
“It’s about looking at facilities from a holistic perspective,” Cibulka said. “Even though you might have a location in a market, it might require new investment. This is a time in which groups need to get creative. These are tough financial times. To grow, they need to make strategic operational decisions.”
And it’s not just the cost of rent that matters, Cibulka said. Healthcare consumers are increasingly demanding higher-quality spaces in which to receive care. Medical providers that remain in outdated, unattractive facilities might find their patients gravitating elsewhere.
“The competition is fierce,” Cibulka said. “Consumers have a choice. Your physical base is incredibly important to the brand of an organization. Don’t just look at the cost of rent. What is the quality of care that you can provide and long-term ability to produce growth in that market? How is that facility servicing that vision?”
For healthcare providers, this often means a greater focus on building more ambulatory surgery centers, freestanding clinics and other outpatient facilities.
These satellite healthcare offices are no longer derisively referred to as “doc-in-a-box” centers. Instead, they have become key cogs in the portfolios of medical providers.
That’s partly because they are so popular. Lewin said that a growing number of patients view outpatient centers and ambulatory surgery centers as more pleasant places to receive medical care.
“More and more we are seeing procedures move to outpatient facilities, even small neurological and spine procedures that scare the living daylights out of you,” Lewin said. “Those procedures can now happen in a friendlier environment. There is still a difference when you walk into a hospital versus an outpatient center. The outpatient setting is more relaxed and casual versus a hospital that is more sterile, more chaotic.”
Office conversions a trend?
Some physician groups and healthcare providers are moving into pre-existing office spaces that were not designed originally for healthcare real estate. But not every empty office space can be converted to healthcare use, Cibulka said.
In some buildings, ceiling heights are too low. Others don’t have ample parking or are located too far from major highways or roads. Medical providers even need to consider the ability of pre-existing office space to handle the weights of their heaviest pieces of equipment.
“There are office buildings where it will work. We want to be as pragmatic and supportive of those options as possible,” Cibulka said. “But we need to be careful. How does the facility, besides the rent, serve your overall goals? Times are difficult in terms of high costs and inflation. But groups must prioritize their strategic needs. I see healthcare providers taking the time to evaluate that right now in the Twin Cities market.”
MedCraft is working with a client in St. Louis to convert an existing office property into medical space. This space works for such a conversion because it sits in an accessible location that is easy for patients to get to.
That doesn’t mean that the conversion doesn’t require significant work and expense. It’s not easy to turn traditional office space to healthcare space. There are times when it makes sense, such as with MedCraft’s client, but it is rarely a simple job.
“Basically, you are stripping the building down to its bones,” Lewin said. “You are changing how these buildings are being used.”
An example? In many office buildings, the elevators are located in the center of the space. In healthcare properties, it makes more sense for elevators to be in the fronts or backs of properties. That helps keep floorplates open for users. Other healthcare properties might need sinks in every room, another challenge when converting office buildings.
The way parking lots are used in office properties is different than how they are used in medical spaces, too. With office buildings, people generally park their cars at 8 a.m. and then drive away at 5 p.m. At medical properties, cars come and go all day. When MedCraft works with healthcare providers that are moving into traditional office space, the company must meet with cities about changing traffic patterns.
“Cities don’t mind that. They don’t push back at the idea of bringing healthcare users into traditional office space. But you still must work through those issues,” Lewin said. “Cities want their office properties filled. They understand that converting an office building that has lost its value is a good thing.”
Lewin says that the best traditional office properties are those located near services such as existing pharmacies, drug stores, physical therapy centers and other healthcare-related services.
“An office in a corporate park or industrial park? That has zero chance to be converted to healthcare use,” Lewin said. “It’s not going to work. But if it is in a suburban community at Main and Main? It has a pretty good chance.”