Fresno, CA -- (SBWIRE) -- 11/07/2014 -- The medical office market is exceptionally strong as health care systems consolidate and federal health care reform brings in new patients and begins to transform the way care is delivered, said Davis, principal of the Minneapolis-based Davis Group.

“It’s been an excellent time, not without its trials and tribulations, of course,” Davis said.

But getting financing hasn’t been a problem, he said.

Erwin Effler III, vice president of development of health care at Minneapolis-based Ryan Cos. US Inc., said financing for medical projects has rarely been this strong.

“I would say there’s just an unprecedented amount of capital chasing the sector right now,” Effler said. “There’s a lot of different financing available, whether it’s banks, private equity or privately or publicly traded REITS, in the market. We’ve done a lot of our projects with private capital and traditional bank lending sources.”

Developers or the health care institutions are often investing in properties, too. Ryan is building a 115,000-square-foot, $48 million specialty clinic for Park Nicollet at 15800 95th Ave. N. in Maple Grove. Park Nicollet will own the building and occupy much of it, he said.

Ryan is also among the investors, along with Bremer Bank, in a new 41,000-square-foot multitenant medical office building at 9360 Grove Circle N. in Maple Grove, Effler noted. The Grove Health West building, which is near the Maple Grove Hospital, will have Golden Valley-based Twin Cities Orthopedics as a tenant on the second floor and other providers on the first floor. “Leasing is very positive and we expect to have tenants announced soon,” he said.

Among the big banks financing deals in this market are Minneapolis-based U.S. Bank; San Francisco-based Wells Fargo, which has a long history in the region, and Charlotte, North Carolina-basedBank of America, said Chris Jacobson, an associate at Bloomington-based CBRE specializing in medical office development.

“It really runs the gamut, from local lenders to insurance companies to national lenders who go after this kind of building,” he said. “It’s a good stable, long-term investment that’s part of many lenders’ platform.”

An attractive market
So what do investors like about the medical office sector? Stephen Brown, executive director of the Healthcare Advisory Group for Bloomington-based Cushman & Wakefield/NorthMarq, points to health care reform. The Patient Protection and Affordable Care Act is rewarding health care providers for better results and is encouraging consolidation, he said.

Keeping people out of hospitals is expected to result in less expensive care delivered in attractive clinic environments that are more comfortable for doctors and patients. New clinics are also part of a plan to have patients receive all their health care at one clinic rather than several, potentially boosting per-patient revenue while locking them into a care system for all their needs.

“This is the integrated care model, with everything under one roof,” Brown said.

Colliers International’s Medical Office Trends and 2014 Outlook report published earlier this year echoes the sense that the sector’s shining light is far from dimming. The $2.47 billion spent on medical office transactions in the fourth quarter of last year was the “highest since Q4 2006,” according to the report. “2014 should be a strong year, given scarcity of properties, availability of capital, and opportunities in secondary/tertiary markets.”

Gene Cross, executive vice president of Minnesota Bank & Trust in Edina, has served as a lender on a number of medical office projects in the region, including a few refinancing projects. From a banker’s perspective, he said, the market “is very competitive” with many lenders vying to finance medical office loans.

“In this market, medical office is strong in part because it’s not like other markets that have cyclicality,” he said. “There is great stability of cash flow and the reality is people are always needing medical care. It’s definitely a growth area.”

Developer Mark Davis says he has a strong relationship with Wells Fargo, which has financed eight of his group’s medical office projects, totaling 375,000 square feet, in the past four years.

“We have a great relationship with them,” said Davis, whose company owns or manages 1.1 million square feet of medical office space. “Interest rates have been favorable. The only obstacle we’ve seen is rising construction costs of 10 to 12 percent, which has offset a bit that lower interest rate.”

Developers see gold in the local market, too. Effler points out that he recently joined Ryan after working for an Ohio real estate investment trust because Ryan has begun to aggressively pursue the health care market. Ryan also hired Steve Stecker, formerly of Welsh Cos., to serve as division manager for health care.

A closer look At deals
Typically, medical office projects have a lead tenant that takes as much as 65 percent to 70 percent of the space, said Effler. It’s rare to see a spec medical office building, he said, if only because finding an anchor tenant in today’s market isn’t hard.

Sometimes the lead tenant ends up taking all the space. The Davis Group’s initial plan for the Minnetonka Medical Center called for the Robbinsdale-based North Memorial Health Care to lease 35,000 square feet. Then North Memorial asked for 42,000 square feet before simply taking the entire 63,000-square-foot building at 15400 Highway 7, Davis said.

Although North Memorial isn’t new to Minnetonka, it is new to that area of the city. Dr. J. Kevin Croston, chief medical officer for North Memorial, said his organization’s thinking about the building evolved over time. North Memorial ultimately decided to lease all the space to offer a one-stop shop that will create strong clinic-patient relationships, he said.

Investors like the medical market not only because absorption for new buildings is relatively easy but also because tenants sign long-term leases of 10 to 15 years with renewable options equally as long, said Jacobson. In contrast a commercial office lease may run from three to seven years, on average.

The reason is the space is built to suit, and moving every five to seven years would be cost- prohibitive, Effler said. Tenant improvement allowances for medical offices tend to be high, so practices have to stay long enough to recoup their investments in that infrastructure, he said.

The lease rates also are slightly higher than office rents, although with some caveats. The C&W/NorthMarq Compass Report placed medical office rates in the region at $18 to the low $20s per square foot compared with $16 to $20 for Class A commercial space.

Still, the construction costs of medical office projects are higher. Commercial spaces have open floor plans, while medical offices have many rooms and expensive heating, plumbing, cooling and electrical equipment, said Effler. Tenant improvement allowances are substantially more than a traditional office, he said, and the health care providers might pay only 25 percent to 50 percent of that cost in cash or financing.

That leaves the developer with the weight of tenant improvements that must be recaptured in higher lease rates, Effler said. So a medical office deal that might require $50 per square foot in tenant improvements results in a landlord paying half or more, he noted.

“I would not say medical office is more favorable because you can get higher rents than other spaces,” he said. “Construction costs are higher.”

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