Medical Office Spaces Still Smart Buys in Arkansas on Arkansas Medical News Inc.

Medical Office Spaces Still Smart Buys in Arkansas

By: JENNIFER BOULDEN

Autumn Road Plaza is a 66,000 SF class "A" medical/office building at 904 Autumn Road in west Little Rock. The building has five floors and is made up of 40% medical and 60% general office space.

Realtors Offer Creative Strategies for Physician Investors

The home mortgage markets may be a mess, but with a little strategy, guidance and flexibility to imagine new practice options, the time may never be better to invest in Arkansas medical office space.

Nationally, the medical office commercial real estate market is still going strong, and Arkansas is no exception, realtors say. Although there has been some subtle slowing in the general commercial sector, medical space is still considered as solid an investment as they come, said Helen Selig, executive broker at PDC Companies in Hot Springs.

"It's strong," she said. "The healthcare industry here is one of our leading industries and it is our leading employer. The population of Arkansas, and particularly the Hot Springs area, has a high concentration of older people, so there's a higher demand for health services here."

Statewide, she cited new hospitals and office parks under construction or planned.

Little Rock developer John Kincaid, principal of Kincaid Development Partners, agreed. "From an investment perspective, I personally feel the market is strong and will continue that trend. Most physicians want to own but to adequately prepare themselves for the "boom" they will or should be more focused on efficiency; a location and building that best suits their needs for the next 15 years. Now is the time for this to occur, despite the construction and credit markets at present," he said.

Selig explained why medical space is a good investment. "People like to buy healthcare facilities, own medical office buildings because it's a very stable business, and there's no question that it's going to grow, just based on the demographic projections," she said.

An article published in the February 2008 issue of National Real Estate Investor reported that factors driving the medical office trend include the "building binge" by hospitals for the past five years, which has spawned development of neighboring medical offices, a move by practitioners to smaller, suburban stand-alone facilities that are nearer to patients, and growth in the health sector overall due to the aging population's increasing need for medical services.

Similarly, a recent Marcus and Millichap report points to a rosy outlook for the medical office market nationally, stating: "Once viewed as a higher-risk specialty asset, medical office properties have clearly become main stream for private and institutional investors. Long-term leases and low tenant turnover, combined with a stable market outlook and advancing medical technology, point to a positive future."

That parallels what Stuart Mackey, vice president, Coldwell Banker Commercial, The Hathaway Group, is seeing in the state.

"We're seeing some interesting things in terms of trending, especially in the auxiliary practices," Mackey said. More healthcare providers are working out of multiple offices, particularly having one in Little Rock and one in their hometown. "They'll practice here two or three days a week and practice at home a day or two. So throughout the state there is some additional medical office space that is dark for more than the traditional weekend, but both spaces are getting use."

The New Construction Dilemma

Although much construction is still underway in the state, creating a ripple effect as practitioners seek to keep up with the times and their competition's new facilities, it's not as easy as it was a few years ago.

"Because so much of the new equipment and technology is reduced in size, some doctors are now looking at the functional obsolescence of their building that was built in the 60s to early 80s. They're deciding to move into a space that's more in keeping with where medicine is now," Mackey said.

The problem physicians interested in constructing new space are starting to encounter is that construction costs have just made a jump to a new threshold, Mackey said, costs which can offset the money saved by the new efficiencies.

"We see that in real estate, where there's a 12 to 18 percent price jump suddenly. It doesn't creep up, it's just a suddenly a big bump, then you move around that number for a while—it may be five years, maybe 25 years—and then there's another significant bump in those numbers," he explained. "What we saw over the past 18 months has given a new baseline since construction costs have gone up. There are new numbers that are required to prepare space. That varies according to whether you need a lot of MRI space, or you've got a lot of exam rooms and need hand wash sinks. There are just a lot of variables. Medical office space is the most expensive kind of space to construct in our marketplace."

One way to circumvent that problem, he tells clients, it to think beyond the stand-alone small medical practice.

"What doctors miss sometimes when they're looking at opportunities for relocation is that a traditional medical office space isn't always the answer.

Sometimes they can create a space for themselves, but make it bigger than their needs and be able to provide for growth for their own purposes, but then have other businesses that come in and provide some support and traffic at the center."

For example, a recent client of Mackey's in the education business had a larger than necessary building, and had a business plan that included leasing the additional space exclusively to general practitioners and dentists. "They knew family practice doctors and dentists would bring a lot of foot traffic of similar clients to their building, and thought the partnership would be a good opportunity to promote their educational services," Mackey said. "That can work both ways, as physicians find other partners to lease their extra space until their practice grows into it."

Good Timing, Smart Strategies Available Now

Selig said that the rising construction costs, paired with national economic statistics and a general sense of unease about the economy, are having some effect on commercial investors, but those only increase the incentives for buyers.

"Coming up into the final quarter of the year, for people who want to make wise real estate investments and choices, this is the best time. They can make some very good buys and get moving on it. If a person really, truly needs to sell something by the end of the year, for financial, tax, or other reasons, then they're usually willing to take reduced offers," she said.

Owning property beats renting every time, she said, especially with the numerous benefits and tax shelters available for medical office space.

"There are several tax shelters and depreciations that doctors can take against their income so that at the end of the day, they have a much improved bottom line," Selig said. "Then, when they decide to retire, they have a facility they can sell under a 1031 Exchange and pay no tax on the profits."

She explained that the 1031 Exchange is a federal law that if you own a medical office building and decide you are going to retire, you might sell it or trade it, and neither party pays any tax.

"Say I own a Walgreens, and you trade it to me, I wouldn't pay any tax and you wouldn't pay any tax. Or if you found something else you wanted to buy, say a restaurant, you could do a 1031 single-party exchange and buy the restaurant by reinvesting your money from the sale of your medical office building and you pay no taxes, and the tax obligation goes away when you die," she said. "It gives you more options for when you retire and gives you a long-term financial boost. It's a very good thing to do, either by yourself or in partnership with someone else."

Mackey said investing in real estate might mean investing in property that is not medical office space.