Healthcare Reform Could Have A Significant Impact On Commercial Real Estate

as seen in Illinois Real Estate Journal, Jan/Feb 2010 issue:
Brian T. Edgerton

As the healthcare industry and U.S. population eagerly follow the healthcare debate in Washington, the medical office sector of commercial real estate also stands waiting to see how these historic changes could affect the demand for space within Medical Office Buildings (MOBs). Many experts agree that the prospect of providing healthcare coverage to a significant part of 46 million uninsured Americans, coupled with an aging Baby Boom population, will have a significant effect on the demand for the space in which healthcare service is delivered. The question is how much demand will be generated?

While the medical office segment of commercial real estate has historically performed stronger than other asset types (general office, industrial, retail), the current economic climate, pending healthcare reform, and rising medical costs have slowed demand as many wait on the sidelines to watch what unfolds in the coming weeks and months.

According to the CoStar Group, as of December 2009, the national vacancy rate for medical office space sits at 10.7 percent as compared to a traditional office vacancy rate of 13.1 percent. Here in Illinois, the vacancy rate for medical office is 11.9 percent as compared to the traditional office space vacancy rate of 15. 4 percent.

With so many factors at play, it is difficult to quantify the expected demand at this time. But we do know certain factors that will play a part in what we predict will ultimately lead to the steady positive absorption of current, quality, vacant medical space in addition to a demand for an additional supply of clinical and ambulatory care space in the near future if healthcare reform passes.

Massachusetts Healthcare Reform: A State-Sized Case Study

In 2006, the State of Massachusetts passed the Massachusetts Healthcare Reform Law which required nearly every resident in the State to obtain health insurance. For those residents who lived below the poverty level, the state partially or fully subsidized their healthcare coverage on a sliding scale based on income. This law was credited with adding 439,000 residents (6.8 percent of the state’s population) to the insurance rolls. According to the Massachusetts Division of Health Care and Policy, as of October 2009, the uninsurance rate in Massachusetts was 2.7 percent.

What was the effect of this sweeping healthcare reform on the state’s medical office space segment? According to the CoStar Group, in the three-year period since the legislation passed, Massachusetts increased their medical office inventory by approximately 2 million square feet (a 13.2 percent increase).

Here in Illinois, the Gilead Outreach and Referral Center and the University of Illinois at Chicago School of Public Health released a report in April 2009 which analyzed a 2008 Current Population Survey developed by the U.S. Census Bureau. The report entitled, Taking A Closer Look at Illinois’ Uninsured, stated that according to the 2007

U. S. Census data, the uninsurance rate in Illinois was 15 percent. The report goes on to state that it is important to remember that since this data was gathered, the U.S. entered a deep economic recession that has seen unemployment rise by nearly 3 percent and that recent studies suggest that a 1 percent increase in unemployment translates to 1 million more uninsured Americans.

If the case study above is any indication of the growth potential of this segment and the better part of the roughly 2 million uninsured Illinoisans gain coverage, the demand for additional quality medical office space here in Illinois will be significant over the next 5 to 10 years.

The Physicians: Supply & Demand

As the healthcare bill is being debated, several Democratic senators are weighing in on the issue of the country’s supply of primary care physicians.

They are highlighting the fact that the bill needs to address incentives that will ultimately increase the country’s stock of primary care doctors.

Janet Adamy reported in an article for the Wall Street Journal from November 2, 2009 that if the pending legislation passes, more than 30 million Americans will gain health insurance coverage and many previously uninsured people who have not had a regular doctor will need a primary care physician. Demand would also likely increase for nurse practitioners and general surgeons. On the flip side of this, Atul Grover, chief advocacy officer for the Association of American Medical Colleges, comments that, “We’re not going to have enough doctors, even if you don’t consider expanding insurance coverage to millions of people. It’s just a question of time before it leads to longer waits for all of us to get in to see the doctor.” According to the American Academy of Family Practice Physicians, the U.S. health care system currently has about 100,000 primary care physicians and will need approximately 139,000 in the next 10 years just to keep up with the demand of aging Baby Boom population.

The current environment is only attracting half the number to meet this demand. If congress passes healthcare reform, the disparity will become even higher.

Based on the case study of Massachusetts described previously, wait times to see certain physicians in Massachusetts are rising and some hospitals have shortages of general practice physicians. According to the Massachusetts Medical Society 2008 Physician Workforce Study, the percentage of family medicine physicians who are no longer accepting new patients has steadily increased from 25 percent in 2006 to 35 percent in 2008.

Both bills introduced to the House and Senate contain provisions addressing ways to promote the increase in the supply of doctors which include additional government funded graduate medical residency slots in primary care and general surgery. Additionally, the Senate bill addresses an increase in funding for the National Health Service Corps, which helps repay student loans for physicians who work in underserved parts of the country. The debate will continue regarding how the ultimate costs of these programs will be covered.

Obviously, the amount of general practice physicians and the rate at which they eventually begin working within the healthcare system will also affect the velocity at which the inventory of medical office space will be absorbed and further developed.

Expected Changes in the Delivery of Care

Another factor that will affect the demand for medical office space are the changes in how healthcare is delivered.

With an aging Baby Boom population and if millions of uninsured Americans gain insurance coverage and seek out a primary care physician, the demand for outpatient care space and ambulatory care facilities is expected to grow.

Much of the current supply of medical office space was developed at the time when the previous health care model was operating. Much of this space is becoming functionally obsolete and will need to be retrofitted based on today’s technology and demand for efficiencies.

The new model for the delivery of healthcare will focus on outpatient care which will efficiently combine an ambulatory care and/or outpatient surgery center with imaging and other complementary services, while also having a synergistic mix of physician practice space in the building or in a nearby MOB. This model relieves the pressure on area hospitals where normally, the uninsured public have no choice but to go to a hospital emergency room with even the most common of ailments. Having multiple conveniently accessible outpatient facilities also allows major hospital systems a way to expand out into the community from their major campus location and have their on-staff physicians treat new patients, which could ultimately lead to admittance to the main hospital if and when the need arises.

Other specialties will move to offcampus MOBs and ambulatory care centers to serve our aging population including orthopedics, physical rehabilitation and therapy as this can be an expensive waste of space if located on a main hospital campus. Also, the American Recovery and Reinvestment Act of 2009 has allocated approximately $19 billion to aid and assist in the development of electronic medical records technology, which, in turn, could drive an increase in the demand for data center tenants to occupy space in or near MOBs.

Forecast

With many healthcare groups in a holding pattern about expansion and patients postponing routine visits and elective procedures, the passing of healthcare reform could lead to a burst in pent-up demand. The effect this will have on the Medical Office Building segment will be the eventual positive absorption and declining vacancy rates as well as the new development of state-of-the-art MOBs in well located areas. On a national level, it is not outside the realm of possibility to forecast that this industry segment will need between 30 million and 45 million square feet of additional inventory over the next 10 years, assuming that some kind of healthcare reform passes and there are enough physicians to handle the influx of patients.

Source: Illinois Real Estate Journal