Medical Offices Prove
To Be a Healthy Asset

After years of flying under the radar, medical office buildings are emerging as an attractive commercial real-estate asset, thanks to strong fundamentals and sky-high prices for other types of properties.

Medical office buildings, or MOBs, represent a tiny niche of the broader office-building sector. They have often been overlooked not only because they lack the pizazz of gleaming skyscrapers, but because their complex operating structures can scare off traditional office investors, analysts say.

Now, with so much capital chasing all types of commercial real estate, "MOBs have become more mainstream...and a growing number of capital providers are now investing in the sector," says Jim Sullivan, an analyst at Green Street Advisors, a real-estate research firm in Newport Beach, Calif.

Health-care real-estate investment trusts, including many of the nation's largest ones, have been among the most aggressive buyers. Last month, Health Care REIT Inc., based in Toledo, Ohio, acquired 17 MOBs across 10 states. Healthcare Realty Trust Inc., Nashville, Tenn., is close to selling the last of its senior-housing properties, which had a total value of $400 million, so it can focus exclusively on MOBs, its original business.

Jerry Doctrow, an analyst at Stifel, Nicolaus & Co. in Baltimore, notes that at a recent REIT-industry conference, certain health-care REITs said they were turning to MOBs partly because the price of one of their mainstay holdings -- private-pay senior housing -- has been bid up by competitors. These REITS are also uncomfortable with the risks of remaining, lesser-quality properties available in the marketplace.

MOBs are seen as an attractive alternative in part because health-care REITs believe the baby boomers eligible for Medicare at age 65 will have more time to head to the doctor upon retirement. "MOBs are where the baby boomers are going to touch the health-care system first," says Debra Cafaro, chief executive of Ventas Inc., a health-care REIT based in Louisville, Ky., that is looking to expand its MOB holdings.

Another plus: Rent growth is steadier than in traditional office buildings, where imbalances in supply and demand have historically resulted in volatility, says Green Street's Mr. Sullivan.

Tenant retention rates tend to be high, particularly in buildings located on hospital campuses. "The tenants are doctors who have patients who are being treated at that adjacent hospital and that creates a strong tenant demand. We like that," says Mark Wallace, chief financial officer of Health Care Property Investors Inc., the nation's biggest health-care REIT by market value. MOBs are now 28% of the Long Beach, Calif.-based REIT's total portfolio, up from 23% at the end of 2002.

Shortened hospital stays also work in favor of MOBs, adds Richard Anderson, a senior REIT analyst at BMO Capital Markets. "That's a really good trend that isn't going to reverse," he says.

MOBs also have some risks. Analysts note they tend to be management intensive. "Doctors can be difficult [tenants] because they've got bigger things to talk about than rent payments," says Mr. Anderson.

Medicare can also cause complications. In a MOB, there can be lots of doctors dealing with different specialties, all subject to myriad forms of Medicare reimbursement. "If for any reason Medicare takes a hit, that can be an issue in the valuation of the building," says Mr. Anderson.

And although not as pricey as some other types of commercial real estate, MOB assets, and the REITs that own them, are becoming more expensive because investors consider them prime takeover candidates. The fact that four of the biggest health-care REITs have signaled their intention to expand into the sector could drive prices up even more.

In addition, certain non-REITs and traditional office REITs have increased their MOB holdings. Some analysts expect increased interest from private-equity firms that have snapped up other forms of real estate, though the management nuances of running a MOB portfolio could make it a more difficult transaction for firms that often quickly sell off rather than manage properties.

The recent focus on MOBs has caused capitalization rates, or the return on investment during the first year of ownership, to compress, just as it has with other property types. Mr. Anderson says that MOBs have become increasingly expensive relative to historic pricing. "The cap rate for a good-quality MOB is well into the 6% range, whereas the cap rate for a good-quality traditional office building can be below 5," adds Mr. Anderson.

But that, of course, could soon change. Some equity analysts are assuming a higher increase in capitalization rates over the next year across all sectors because of higher debt costs and modestly slower growth assumptions.

Email your comments to rjeditor@dowjones.com.