Crain's Clevleand Business: Medical buildings attract more attention

October 29th, 2016

New medical office buildings are transforming the landscape throughout Northeast Ohio and increasingly attracting big sales transactions. However, they remain a specialized niche in the commercial real estate business, albeit a growing one.

Robert Nosal, managing director of Newmark Grubb Knight Frank's Cleveland office, has worked on multiple medical office building sales but considers them a sideline within the firm's activities. The reason is simple.

"Some properties may command a great price, but transactions are generally few and far between," Nosal said. "Hospital systems primarily control the medical office market."

While the current crop of medical office buildings attracts real estate types typically as buyers of office-zoned sites or parcels in existing business parks, it is more attractive to them than in the 1980s when office expansion was the order of the day.

At that time, some office developers would eschew medical office tenants because they require substantial parking to accommodate patients. However, that is changing - and a primary example is at Woodside Health LLC, a Cleveland-based acquirer and operator of medical office buildings here as well as in Texas, Florida and other parts of the Sun Belt.

Since its founding in 2011, Woodside has acquired 21 properties for a total of more than $133 million, according to Ben Sheridan, one of three co-founders of the concern. Sheridan, a veteran of the insurance business, launched the medical office focused business with business partners Ted Barr and Joe Greulich, both long-term veterans of commercial real estate and operators of Crescendo Real Estate of Cleveland, which oversees management and leasing of Woodside's properties.

While most people think of medical office buildings with the Cleveland Clinic's logo gleaming on them, that's not Woodside's target. Such properties usually are not available because hospitals happily own them. Instead, Woodside focuses on medical office buildings that real estate developers may want to sell or physician groups want to shed for retirement or estate planning.

Although Woodside's first investment was in Middleburg Heights, finding available properties often puts the principals on planes to scout acquisitions.

"We're out to find hidden gems," Sheridan said, which already have cash flow. "Perfect buildings are too expensive and don't provide good returns." The firm's goal is to provide an 8% annual cash-on-cash return and structures each purchase as an individual investment.

The group's first investment was likely its riskiest: a newly built but empty 75,000-square-foot building at 18780 Bagley Road in Middleburg Heights that the principals purchased for $6 million in a lender-directed sale, according to Cuyahoga County land records. Now half the building is occupied by tenants associated with Southwest General Health Center and Heritage College, which trains medical professionals.

While others are less enthusiastic about medical office buildings because big investments for medical practitioners reduces returns, Woodside finds them to its liking.

"If times get bad in a recession, medical offices are more stable. Both political parties are committed to more health care," Sheridan said. "We have an aging population. As we age, we all need more health care."

The final factor is that patients get used to seeing their docs in the same location. Physicians often stay in the same suite for decades, Sheridan said.

Woodside generally plans to hold its properties for a decade. However, Sheridan said, it sold a building in the Dallas area after five years when Woodside got "an offer we couldn't refuse."

Woodside recently hired three investment analysts to increase its acquisition pace to eight properties from a goal of doing two deals a year, one Woodside frequently exceeded.

Even so, Sheridan said, if the firm finds only two deals it likes, that's all it will buy.

"At the end of the day, we are just numbers people," Sheridan said. "We don't fall in love. We save that for other parts of our life."

While many may criticize medical office buildings as investments because some independently owned buildings have suffered after physicians sold their practices to large health systems and moved on, the right building at the right location may prove lucrative. That is especially the case if they fit the appetite of out-of-town real estate investment trusts focused on medical properties.

A stellar example is the sale in April 2016 of Rockside Medical Center, 6701 Rockside Road in Independence, to Community Health Care Trust, a publicly trade company based in Franklin, Tenn., by a local investor group. The 54,000-square-foot building fetched $10 million - a price rarely achieved by typical suburban buildings dating from 1980. The reason? It features a state-of-the art surgery center. Moreover, St. Vincent Charity Medical Center and the Cleveland Clinic lease 65% of the buildings.

Another example of growth in the medical properties business is found at Marcus & Millichap's office in Independence.

Just four years ago, when Chris Mitchel joined the firm as an associate to build a practice handling medical properties from office buildings to optical and surgery centers, colleagues told him they did not think he could make a go of it. Today, he and another associate and two fledgling sales agents in Columbus have sold five buildings this year in Ohio, western New York state and Pennsylvania. Another six deals are likely to close this year.

Mitchel argues, much like Sheridan, large social and economic trends are on his side, including low interest rates and the Affordable Care Act. Meantime, some brokers and investors salivate over the idea major health care systems may someday shed their medical office empires.

"Most everyone in the industry," Mitchel said, "has that thought in the back of their mind."

Author: Stan Bullard


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