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March 4-March 17, 2015 — COLORADO REAL ESTATE JOURNAL — Page 3B
U ntil roughly the
past 12 months, the
Colorado Springs
medical office market had
been in a state of flux for
the past five-plus years (in
addition to the uncertainty the
industry has been experiencing
nationally), however, out of
this turmoil and transition, a
few key benchmarks have been
set that will define the market
going forward.
As some background, in late
2012 the city-owned Memorial
Hospital System (inclusive of
two of the city’s four major
in-patient hospitals) was voted
to be under the long-term
lease/control of University of
Colorado Health System. This
represented a monumental
shift in the operation of
the system and the overall
validation of the market with
the UCH brand. Prior to the
agreement, many of the large
and small local practices had
been in limbo from a growth
and affiliation standpoint,
not knowing where or with
whom to align going forward
– the three largest systems in
town are UCH/Memorial,
Penrose-St. Francis/Centura
and Colorado Springs Health
Partners.
The second major transition
in the market was the
completion of the two new
hospitals in the northern part
of town, St. Francis Medical
Center and Memorial Hospital
North. These were constructed
in the 2005-2007 timeframe to
accommodate the continued
growth of the city to the north
and east. Along with the
hospital development came
the speculative construction
of nearly 600,000 square feet
of on- or near-campus medical
office buildings, all built within
a four year period starting
in 2006. The developers of
these projects ranged from
large organizations such
as HCI Inc. (118,000 sf on
campus at Memorial North)
and Healthcare Realty Trust
(170,000 sf across Briargate
Parkway from Memorial
North) to local partnerships
with various sized projects.
The combination of these
two significant advancements
to the Colorado Springs
medical market impacted the
real estate market in many ways
that one would expect, but
there are two results that have
changed, and will continue to
change the market into the
foreseeable future.
First, with solidification
of the Memorial/UCH
relationship, many private
practices either aligned
themselves with one system or
the other (Centura or UCH)
or were acquired and became
part of the system. This results
in a natural migration of
practices needing to be on or
near campus.
Second, with the speculative
construction, came a natural
“flight to quality” as tenants
looked to capitalize on a
tenant-friendly depressed
real estate market and an
opportunity to upgrade image,
quality and location.
Given all of the factors, we
expect the trend to continue
to have tenants seeking north
Colorado Springs locations in
high-quality assets while the
older, less desirable buildings
will struggle to compete.
While there are no pure
speculative projects currently
being announced, there are
two to three well-located sites;
developers will need about 50
percent preleasing and could
start construction right away.
As we see the highest-quality
assets continue to absorb
space, rates are climbing back
up and concessions decreasing.
While there has not been the
type of velocity in the market
to warrant large spikes in rent,
we anticipate rates to gradually
climb up to where they are
comparable to justify new
construction on a speculative
basis.
I n 2010 the Affordable
Care Act became law,
dramatically changing
the landscape of medicine in
the United States. While it has
been a hot topic of debate
among all Americans, it has
seriously affected the medical
office real estate market. While
some of the changes in the
market can be traced directly
to this legislation, many of
these wheels had been in
motion for several years.
One of the common themes
we started to see in recent
years is that hospital systems
have showed a desire to divest
their real estate holdings.
We have recently seen
several hospital systems sell
their existing medical office
buildings, including on-campus
properties, to third-party
investors and developers.
Hospital systems are also
increasingly working directly
with third-party developers to
build on-campus medical office
buildings that the developer/
investor will own and manage.
In many instances, the hospital
system agrees to occupy a
significant portion of the
property on long-term leases.
In both instances, the investor/
developer purchases a well-
located building with solid
cash flow and long-term leases.
The tenants in these buildings,
including the hospital system,
tend to remain in the building
due to their relationships with
the hospitals, providing the
purchaser with a long-term,
predictable income stream.
The advantage for the hospital
system is that it is able to
eliminate the risk of owning a
building and the various costs
associated with the building’s
management, leasing, etc.
Another related development
is that hospital systems are
beginning to consider divesting
100 percent of their real
estate holdings, including the
medical centers themselves. In
the future it is quite possible
that a hospital system would
work directly with a third-
party developer to design and
construct a medical center for
the hospital system, then lease
it back from the developer over
a 25- to 30-year lease. These
hospital systems could then
eliminate the costs associated
with owning property, allowing
all of the risk to be transferred
to the developer. The
developer, as in the previous
example, would gain a long-
term, predictable income
stream.
Another development we are
seeing in the medical office
market is hospital systems
purchasing various high-end
medical practices and moving
them to the hospital. These
practices include cardiology,
radiology, oncology and other
specialists whose fees tend
to be relatively high. When
this happens, the physician
groups typically abandon
their current office buildings,
leaving blocks of space in
multitenant buildings or
leaving owner/user buildings
completely vacant. Many
Class B and C medical office
buildings that appeared to be
great investments eight to 10
years ago now have significant
vacancy due to the fact that
these practices have, in
essence, disappeared.
We are also seeing buildings
that were owned and occupied
by these medical practices
selling at prices significantly
lower than their purchase
prices. This is typically due to
the functional obsolescence
of the property or, in most
cases, because the buildings
are purchased by general office
users who will need to invest a
significant amount of money to
remodel the buildings for their
use.
Finally, in the last couple
of years, we have started to
see hospital systems, such as
University of Colorado Health
and Centura Health Systems,
purchase existing primary-care
practices. In many cases, they
will buy out the physicians and
turn around and hire them as
employees.
Hospital systems now
recognize that primary care
can be a means to capture the
patient at the beginning of
the care process. At that point,
if any referrals to specialties
are required, the hospital
system will be able to refer the
patient’s care to the hospital
systems’ own specialists. This
allows the hospital system to
generate additional revenue
from the patient’s visit to the
specialist.
In many of these scenarios,
however, the hospital systems
are only interested in the
medical practice itself, not the
real estate. Often the hospital
systems either will assume the
lease of the medical practice
or, when the practice owns its
building, sell the building on a
sale-lease back premise.
In conclusion, we have seen
that the recent legislation has
and will continue to change
the landscape of medical office
space. I have no doubt that as
this legislation continues to
be implemented, we will see
the market continue to ebb
and flow. Hospital systems
will continue to look for new
streams of revenue while
investors and developers will
continue to find new ways to
profit from the market.
Peter Scoville
Principal, Colorado Springs
Commercial, Cushman & Wakefield,
Colorado Springs
Ted Link
Broker/owner, Cascade Commercial
Group, Colorado Springs
With the
speculative
construction
came a natural
‘flight to quality’
as tenants looked
to capitalize on
a tenant-friendly
depressed real
estate market and
an opportunity
to upgrade image,
quality and
location.
Another related
development
is that hospital
systems are
beginning to
consider divesting
100 percent of
their real estate
holdings,
including the
medical
centers
themselves.