Five members of ULI’s new Health Care and Life Sciences Product Council speak about the potential impacts of health care reform on real estate development, financing strategies for development in tough economic times, the effects of changing demographics on real estate needs, and other potential trends.
At the 2010 ULI Real Estate Summit at the Spring Council Forum in Boston this April, representatives from health care institutions, private investors interested in medical real estate, developers, architects, designers, and other professionals who support the health care industry came together to discuss the future of health care and life sciences real estate—as well as formation of a new ULI product council to continue the conversation. This summer, the Urban Land Institute gave formal approval to the Health Care and Life Sciences Council.
Five of the organizers speak about the reasons for forming the council, the potential impacts of health care reform on real estate development, financing strategies for developing in tough economic times, the effects of changing demographics on real estate needs, and other trends on the horizon.
What led to the creation of the Health Care and Life Sciences Council?
KATHY WEST: About a year ago, Tim and I started working on trying to either find or create something in the ULI organization that would speak to our particular interests. The two of us are in the real estate and facilities department of Partners HealthCare System, and our two academic medical centers are in very urban locations, so we are landlocked and constrained in terms of building. We thought there were other urban hospitals like us, or urban medical schools, or even universities that would be interested in sharing some of their experiences.
PETER CALKINS: At the same time, other people in ULI were talking about putting together a council on the health care and life sciences front, so the two ideas consolidated together into one. It seemed like a great opportunity to pull together a group of people with a more specific industry focus than possible in the Urban Development/Mixed-Use councils.
What issues are you interested in addressing with this new council?
TIM PATTISON: The kinds of topics that were covered at the April meeting are typical of what we’ll be covering going forward. In April, we had a keynote address on health care reform, a session on the use of private capital to develop a hospital building on a hospital campus, a presentation on the locational decisions made by life sciences organizations, a site visit to Massachusetts General Hospital, and a session about new methods of delivering medical real estate projects. The planned agenda for this fall is equally broad.
CALKINS: I think the council will focus on best practices in the development of health care and life sciences real estate: everything from urban institutional hospital systems to suburban community hospitals, life sciences, pharmaceuticals, biotech—what do those buildings mean for our built environment? There will be a lot of discussion about efficient strategies for developing, owning, and managing real estate for institutional health care and for corporate life science. Institutions and corporations are looking for ways to manage their money most effectively, put their resources toward their core business, and find ways to off-load some of the ancillary activities, such as real estate.
ERIC FISCHER: I’d like to see the council focus on the highest and best use of medical real estate from a functional and operational perspective. Health care is a very expensive part of our life, and real estate plays a role in that. So what can we do as leaders in this industry to better design, better develop, better create solutions for long-term adaptive use and create a better patient and healing environment? It’s a great opportunity to bring together architects and designers, bankers, health care executives, health care strategists, health care theorists, and developers who can create some exciting, progressive thinking about the delivery models of health care facilities.
How might health care reform affect real estate development?
FISCHER: You can ask 30 people and you’ll get 30 answers. There will be continued pressure to reduce the amounts that hospitals are paid and that doctors receive for providing care. Whether you are a cardiologist or a nephrologist, the money that you received for a procedure in 2005 is going to be less in 2013 because the health care reform bill is trying to rebalance the distribution of payments. The health care reform bill, in effect, insures individuals who have not previously had adequate access to health care. So a possible outcome will be a rapid influx of more people accessing health care. That could result in some heavy pressures on our current medical real estate structure.
CALKINS: On the life sciences side, as more people get health care coverage, there will be a greater need for drugs and medical devices. But it’s likely that most of that need will be in the generics, not the cutting-edge drugs, so I don’t know that that will have a significant effect on the biotech and life sciences industry. There may be increased demand for generic manufacturing facilities, which tend to be located primarily in low-cost, often offshore locations.
What are some of the trends and challenges in financing health care and life sciences development?
JEFFREY COOPER: The best-rated hospitals and hospital systems are not going to have much trouble. They’ll probably use bond issues to construct facilities. But they can’t do that if there are any outside medical practices in the building. The question is, how will they finance it? Will they go to public entities like the REITs [real estate investment trusts]? Will they take it to private entities? Will they finance it themselves on a cash-flow basis? At the same time, there are changes going on in the whole accounting treatment of hospital real estate. If you have a lease, you’re going to have to look at putting it on your balance sheet just like debt. Will hospitals feel that if they enter into a lot of leases, that may affect their credit rating? Will they rent or own? There’s a lot of turbulence. The most important unknown is what’s going to happen with Medicare, which is a big funder right now of medical care. There’s so much pressure on the economic side; are doctors going to be able to pay the rent?
PATTISON: From the institutional side, the question is how we will grow. Do we grow using our own capital? That’s more likely in our case, but we know that other institutions in the country do turn to private capital sources more readily. In the Northeast, we tend to use tax-exempt bond financing and philanthropy. We are fortunate that we have a good credit rating. It’s been easier for us, to date, to finance our projects that way, and less costly. We also have a preference for owning our own buildings.
WEST: One of the most interesting presentations at our spring program was about financing of an academic medical center building—a cancer center—on the campus of Baylor University in Waco, Texas. A private developer is building the facility and will operate it, leasing it back to the university.
What demographic trends will be affecting development in these areas, and how?
COOPER: You have more people living longer who are going to require health care. But I don’t know if the most critical issue is having the facilities or getting a sufficient number of physicians who are willing to do primary care and can make it work economically. A lot of them are now going to be in hospital-owned practices.
FISCHER: There will be more demand as baby boomers start to access the higher-acuity cycle of life. There will be greater challenges for access to health care. From a development perspective, we are probably going to see a more decentralized model, with more freestanding emergency departments and ambulatory care centers, more medical office facilities closer to high population densities. As opposed to patients traveling ten miles [16 km] to the hospital, they may now travel three miles [4.8 km] to a local clinic in a shopping mall or some other form of commercial development close to where they live.
What other trends and issues do you see in the health care/life sciences development fields?
WEST: There are technological trends that are going to impact development as much as demographic trends. Hospitals can do a lot of procedures now on an outpatient basis that no one would ever have dreamed of doing on an outpatient basis even five years ago. So there will be some adjusting of how much care will be delivered on an inpatient basis. Also, the ability for health care providers to monitor patients’ chronic conditions remotely will continue to advance. These things will have a big impact on the way all of us in the industry think about real estate. The other thing that we are struggling with at the moment is trying to understand the impact that the economic downturn is having and may continue to have on volume and utilization of health care facilities.
COOPER: One of the big issues is what kind of capital hospitals should use to develop real estate, because the cap rates at which people buy or build facilities are higher, so the rates of return are higher than the cost of tax-exempt debt. For example, if I can borrow at 3.5 percent but I have to pay someone 8 percent to build, or if I can sell my facility at 7.5 percent and lease it back at that rate, am I better off just using my bonding authority, am I better off just borrowing, or should I have someone own it and just lease it from them? The trend has been moving back and forth. When the bond markets tanked, it was very hard to sell municipal or tax-exempt debt, and people had to go with more conventional ways to finance their real estate. They would sell it and lease it back, or they’d have someone build it for them and then lease it. Now the trend has moved back the other way.
PATTISON: Medical buildings, particularly the more sophisticated clinical buildings and life science research buildings, are inherently more complicated pieces of real estate to create and operate compared with a typical commercial office building. The council will likely have some discussions about those issues. And at some point, we’ll talk about the concerns we have as urban, landlocked institutions. There isn’t much room to expand facilities, and the challenges of getting building permits and working with neighbors are different from the challenges of building on greenfield sites. When we build parking, for one thing, we have to go underground.
FISCHER: There’s a definite trend toward tying quality and delivery satisfaction to reimbursements. So if a patient has a total hip replacement, the health care system will be paid a certain amount for the procedure, but it will be responsible not only for managing the physical delivery of that medicine, but also for making sure that the outcome will be productive—that the patient won’t experience postsurgical infection, that the patient will be back to work in a certain period of time.
CALKINS: The life science industry has been globalizing recently as life sciences companies seek to place facilities in what they view as the best value locations worldwide. A great example of this is the Swiss pharmaceutical [firm] Novartis, which conducted a worldwide search and decided to relocate its biomedical research operations to Cambridge, Massachusetts, about eight years ago. There’s a reconfiguration going on in the pharmaceutical industry to some extent. A lot of patents are on the verge of expiring, so the pharmaceutical companies are concerned about cash flow in the near term, and that’s causing them to outsource some of their activities. There’s also a diversification from a real estate perspective. Traditionally, a pharmaceutical company might have its own million-square-foot [93,000-sq-m] campus with a single gate—a very controlled environment. Now, larger companies are seeing the value of placing their employees in research parks where there is a variety of companies, offering them a more diverse and intellectually stimulating environment.
Contributing their insights are Peter Calkins, executive vice president and chief operating officer of Forest City’s Science + Technology Group in Cambridge, Massachusetts; Jeffrey Cooper, executive managing director of Savills New York in New York City and chair of the council; Eric Fischer, principal of Trammell Crow in Washington, D.C.; Tim Pattison, director of real estate for Partners HealthCare System in Boston, Massachusetts, and membership vice chair of the council; and Kathy West, vice president of real estate and facilities for Partners HealthCare System in Boston and assistant chair of the council.