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Healthcare Reform:
                            A Winning Prognosis for Medical Office Investments
  Healthcare reform has emerged as a top priority for the new administration, and opportunities within
  medical office investments bear close monitoring as a result. At present, rising medical costs, a lack of
  access and quality concerns are preventing many Americans from seeking regular care. Compounding
  these problems are economic uncertainty, extreme job losses and corporate benefit cuts. In spite of the
  issues, the medical office sector is outperforming traditional office properties, and demand should increase
  considerably as a growing share of the population is covered by health insurance.

  Healthcare Cost-Prohibitive for Many Americans.                                                          Number of Uninsured Americans at All-Time High
  When managed care became prevalent in the 1980s,
  healthcare costs constituted roughly 9 percent of                                                   50

  GDP; costs have since surged to almost 17 percent.

                                                                               Uninsured (Millions)
  Likewise, annual per capita costs jumped from                                                       45
  $1,100 in 1980 to almost $7,800 last year. On
  average, Americans spend 5 percent of their pre-tax
                                                                                                      40
  income on healthcare, with those in lower income
  brackets paying 15 percent or more, leading many
  lower-income families to forgo care and/or                                                          35
                                                                                                           00    01   02    03   04   05      06   07   08   09*
  insurance coverage.
                                                                            * Forecast
                                                                            Sources: Marcus & Millichap Research Services, CDC, Economy.com
  Lower Costs, Accessibility to Drive Surge. Despite
  higher costs, doctors’ office visits have increased 13.2 percent over the past 10 years. The administration is
  hoping to reduce costs, saving a typical family up to $2,500 per year as reforms are implemented.
  Proposals include a new public insurance plan based on benefits available to members of Congress that
  would allow individuals and small businesses to purchase affordable healthcare coverage. If costs decline
  as projected, insured and uninsured alike are expected to increase their utilization of primary and
  specialty care physicians. The resulting surge will intensify demand for physicians and nurses, which will,
  in turn, heighten the need for medical office space.

  Goals of Healthcare System Overhaul: Access,
  Quality and Affordability. The aim of the new                                               Healthcare Costs Surge
                                                                                               Per Capita Health Expenditures
  administration is to eventually cover all Americans         $8,200
  and reduce costs. More than 46 million Americans
                                                                              Dollars Spent/Person




  do not have health insurance. While the nation has          $6,150

  been on the verge of reform several times since the         $4,100
  1930s, a broad coalition of healthcare and doctor
  associations,      insurance    companies,       and        $2,050

  pharmaceutical companies is converging to support                $0
  this initiative. The group believes it can shave 1.5                   1960       1970     1980       1990     1995      2000    2005  2008 2010*

  percentage points from the growth rate of U.S.        * Forecast
                                                        Sources: Marcus & Millichap Research Services, BEA, CDC, OMB, U.S. Census Bureau
  healthcare costs over the next 10 years, a savings of
  approximately $2 trillion. Inroads have been made previously with the passage of Medicare and Medicaid
  in 1965. These programs made healthcare available to the elderly and the poor, but even these plans are in




© 2009 Marcus & Millichap                                                                                                                                    Page 1
need of an overhaul, as the trust funds set aside to finance them are dwindling at an accelerated pace due
  to the recession.

  Reform at the Start of a Long Journey. In the latest
  version of the administration’s budget, $630 billion             Primary Source of Payment for Healthcare Visits

  has been earmarked over the next 10 years for                              Physician Office Visits Emergency Room Visits

  financing reforms to the healthcare system.                  60%

  Furthermore,     the   American     Recovery      and




                                                                          Percent of Visits
                                                               40%
  Reinvestment Act of 2009 (ARRA) includes an
  allocation for prevention and wellness intervention          20%

  that places a stronger focus on primary care
  physicians. In the near term, this will generate              0%
                                                                       Insured    Medicare/Medicaid     Self-Pay     Other Sources
  increased demand for medical services in offices                                                    (Uninsured)

  while reducing pressure on emergency rooms. The Sources: Marcus & Millichap Research Services, CDC, U.S. Census Bureau
  uninsured and underinsured presently comprise
  nearly 17 percent of emergency room visits but only 4 percent of physician office appointments.

  Medical Sector Constantly Evolving. Technology, innovation, and research and development will play
  crucial roles in medical reform, providing yet another potential demand driver for office space. The
  medical landscape is changing rapidly as new treatments, drugs and devices become available. To
  facilitate continued research and development, the ARRA contains a $1.1 billion provision for medical
  research, including investments in studies into the comparative effectiveness of drugs and treatments. This
  will generate demand for R&D and traditional medical office space.

                                         Impact on Medical Office Property Sector

  Medical Office Outperforming. Despite the recession,                                                                 Vacancy Trends
  medical office properties have performed favorably,                                                            Traditional Office         Medical Office

  and demand is set to accelerate as medical reform is                                           20%

  phased in over the next several years. Unlike other
                                                                                  Vacancy Rate




  asset types, medical office properties continue to                                             15%

  garner investors’ demand by exhibiting considerable
  resistance to the economic downturn. Medical office                                            10%

  vacancy is currently 11.6 percent, up only 100 basis
  points from one year ago; traditional office vacancy, by                                       5%

  comparison, is 15.2 percent, a 240 basis point increase                                              00   01    02      03      04   05      06     07     08    09*
                                                                         * Forecast
  over the same period.                                                  Sources: Marcus & Millichap Research Services, CoStar Group, Inc., Reis



  Changes Under Way to Buoy Space Demand Through Downturn. The ARRA included a temporary
  provision to make insurance more affordable for unemployed individuals. This group will receive a tax
  credit to continue their health insurance through COBRA, which will benefit an estimated 7 million
  Americans. Healthcare demand will be supported further by the reauthorization of the Children’s Health
  Insurance Program (CHIP) for the next 4.5 years. The $33 billion legislation broadened coverage by 57
  percent, or 4 million children. The result is a forecast 5 percent increase in patient office visits for those
  under 18 years of age, or almost 10 million additional office visits per year.




© 2009 Marcus & Millichap                                                                                                                                         Page 2
Demographic Trends, Scientific Advancements Support Positive Outlook for Medical Office. The
  medical office sector’s resilience can be attributed to a combination of variables, including technological
  advances and medical innovations that continue to extend life spans, as well as the aging baby boomer
  generation. At present, baby boomers account for 29 percent of the total uninsured yet represent almost
  one-third of all physician office visits. Proposed changes to the healthcare system will dramatically
  increase demand for medical services among this group. Per person office visits for 45- to 64-year-olds
  have expanded by 7 percent over the past decade. Insuring 95 percent of this cohort could elevate
  physician office visits by 12 percent, or 34 million visits, annually. At the current average of 120 visits per
  week for primary care physicians, approximately 5,400 new general practitioners will be needed to handle
  the additional workload from this age group alone. The resulting demand for office space from these
  doctors would total nearly 10 million square feet.

                                Insured Baby Boomers Seek More Medical Care                                             Significant Share of Younger Population,
                                            Average Physician Visits/Under 18 yrs
                                                                                                                                Baby Boomers Uninsured
                                            Average Physician Visits/19-44 yrs.
                            5                                                                                     40%              Percent of Cohort Uninsured
                                            Average Physician Visits/45-64 yrs.
                                                                                          Percent of Age Cohort
                                                                                                                                   Percent of Total Doctor Visits from Cohort
    Visits/Insured Person




                                                                                                                  30%
                            4

                                                                                                                  20%

                            3
                                                                                                                  10%


                            2                                                                                     0%
                                       00                      05                   09*                                 Under 18          18-44            45-64            Over 65
   *Forecast
   Sources: Marcus & Millichap Research Services, CDC, OMB                                Sources: Marcus & Millichap Research Services, CDC




  Healthcare Reform Beneficial to Medical Office Investment. For insights into how the implementation of
  a national healthcare plan could affect the overall medical office market, we looked to Massachusetts,
  which implemented reform in 2006. So far, medical reform in Massachusetts has been a boon for the state’s
  medical office sector. Massachusetts’ version of universal healthcare has resulted in 97 percent coverage.
  Higher demand for healthcare, however, has been met with a shortage of providers. Nonetheless, the
  impact on medical office in the state has been significant.

                                Since passage of the plan in 2006, developers have added 1.8 million square feet of new medical
                                office space in Massachusetts, a roughly 14 percent increase to inventory. Absorption has been
                                robust, with 85 percent of the space already occupied and statewide vacancy holding firm in the
                                low-9 percent range, one of the lowest rates in the country.

                                Within the investment arena, sales of medical office properties in Massachusetts increased during
                                each of the past three years. Institutions dominated the local market in 2006 and early 2007, but
                                private investors have expanded their presence recently, purchasing smaller assets. Transaction
                                velocity in the state was up 32 percent in 2008, while dollar volume and transaction velocity for
                                properties under $10 million rose 55 percent and 40 percent, respectively. In contrast, dollar
                                volume and transaction velocity for similar assets nationwide fell 5.2 percent and 4.8 percent,
                                respectively, last year.




© 2009 Marcus & Millichap                                                                                                                                                       Page 3
Medical Office Demand Set to Rise. There are still unknowns regarding the methods that will be used to
  achieve nationwide coverage; however, if reform is even partially successful, demand for medical
  professionals and facilities will increase.

           It is estimated that a net addition of more
                                                                                                           Ratio of Medical Office Space per Insured Individual
           than 8,000 primary care physicians will                                                           Supply Could Fall Short as Coverage Expands
           be needed to care for the newly insured.                                                                  Medical Office Inventory        SF/Insured Individual
           While it will take time for the healthcare                                                550                                                                           0.6

           community to catch up with the increase




                                                                       Stock (Millions of Sq. Ft.)
           in demand for services, the addition of




                                                                                                                                                                                         Sq. Ft. per Insured
                                                                                                     500                                                                           0.5
           even half of these new doctors in the
           near term would generate demand for
           another 7 million square feet medical                                                     450                                                                           0.4
           office space, based on the current U.S.
           average of 1,780 square feet per primary
           care doctor.                                                                              400
                                                                                                           00   01      02      03      04      05   06     07      08       09*
                                                                                                                                                                                   0.3

                                                                    * Forecast

           The outlook is even more optimistic
                                                                    Sources: Marcus & Millichap Research Services, CDC, CoStar Group, Inc., TWR


           when viewed from the perspective of office space required per covered individual. Increasing the
           health insurance coverage rate to 95 percent of the population, up from 84 percent at present,
           would require an additional 21.4 million square feet of medical office space, based on the current
           ratio of approximately 0.5 square feet per insured individual.

  Healthcare Reform a Slow Process but Gaining Momentum. Healthcare reform will continue to evolve
  on Capitol Hill, but changes are becoming increasingly probable, which bodes well for the long-term
  health of the medical office sector. Overall, the task of insuring the uninsured and underinsured could
  result in 56 million extra patients, or roughly 20 percent of the population. This significant increase will not
  only generate greater demand for physicians and nursing but also require additional record processing
  and enrollment personnel, further driving demand for healthcare space and even nearby office properties.
  One major caveat is the potential shortage of physicians and skilled nurses. Recognizing this fact, however,
  several members of Congress have introduced legislation aimed at attracting and retaining healthcare
  professionals and direct-care workers.




  The information in this report is deemed to be reliable. Every effort was made to obtain accurate and complete information; however, no
  representation, warranty or guarantee, expressed or implied, may be made as to the accuracy or reliability of the information contained
  herein. Sources: Marcus & Millichap Research Services, BarackObama.com, Bureau of Economic Analysis (BEA), Bureau of Labor Statistics
  (BLS), Centers for Disease Control (CDC), Change.org, CoStar Group, Inc., Economy.com, National Ambulatory Medical Care Survey 2008,
  National Coalition on Healthcare, National Institutes of Health, Office of Management and Budget (OMB), U.S. Census Bureau.


                                             Written by Tom Hershey, Research Services - May 2009
                       For more information, contact John Chang, National Research Manager, at (602) 952-9669, ext. 669.

© 2009 Marcus & Millichap                                                                                                                                                          Page 4

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Healthcare Reform Outlook 2009

  • 1. Healthcare Reform: A Winning Prognosis for Medical Office Investments Healthcare reform has emerged as a top priority for the new administration, and opportunities within medical office investments bear close monitoring as a result. At present, rising medical costs, a lack of access and quality concerns are preventing many Americans from seeking regular care. Compounding these problems are economic uncertainty, extreme job losses and corporate benefit cuts. In spite of the issues, the medical office sector is outperforming traditional office properties, and demand should increase considerably as a growing share of the population is covered by health insurance. Healthcare Cost-Prohibitive for Many Americans. Number of Uninsured Americans at All-Time High When managed care became prevalent in the 1980s, healthcare costs constituted roughly 9 percent of 50 GDP; costs have since surged to almost 17 percent. Uninsured (Millions) Likewise, annual per capita costs jumped from 45 $1,100 in 1980 to almost $7,800 last year. On average, Americans spend 5 percent of their pre-tax 40 income on healthcare, with those in lower income brackets paying 15 percent or more, leading many lower-income families to forgo care and/or 35 00 01 02 03 04 05 06 07 08 09* insurance coverage. * Forecast Sources: Marcus & Millichap Research Services, CDC, Economy.com Lower Costs, Accessibility to Drive Surge. Despite higher costs, doctors’ office visits have increased 13.2 percent over the past 10 years. The administration is hoping to reduce costs, saving a typical family up to $2,500 per year as reforms are implemented. Proposals include a new public insurance plan based on benefits available to members of Congress that would allow individuals and small businesses to purchase affordable healthcare coverage. If costs decline as projected, insured and uninsured alike are expected to increase their utilization of primary and specialty care physicians. The resulting surge will intensify demand for physicians and nurses, which will, in turn, heighten the need for medical office space. Goals of Healthcare System Overhaul: Access, Quality and Affordability. The aim of the new Healthcare Costs Surge Per Capita Health Expenditures administration is to eventually cover all Americans $8,200 and reduce costs. More than 46 million Americans Dollars Spent/Person do not have health insurance. While the nation has $6,150 been on the verge of reform several times since the $4,100 1930s, a broad coalition of healthcare and doctor associations, insurance companies, and $2,050 pharmaceutical companies is converging to support $0 this initiative. The group believes it can shave 1.5 1960 1970 1980 1990 1995 2000 2005 2008 2010* percentage points from the growth rate of U.S. * Forecast Sources: Marcus & Millichap Research Services, BEA, CDC, OMB, U.S. Census Bureau healthcare costs over the next 10 years, a savings of approximately $2 trillion. Inroads have been made previously with the passage of Medicare and Medicaid in 1965. These programs made healthcare available to the elderly and the poor, but even these plans are in © 2009 Marcus & Millichap Page 1
  • 2. need of an overhaul, as the trust funds set aside to finance them are dwindling at an accelerated pace due to the recession. Reform at the Start of a Long Journey. In the latest version of the administration’s budget, $630 billion Primary Source of Payment for Healthcare Visits has been earmarked over the next 10 years for Physician Office Visits Emergency Room Visits financing reforms to the healthcare system. 60% Furthermore, the American Recovery and Percent of Visits 40% Reinvestment Act of 2009 (ARRA) includes an allocation for prevention and wellness intervention 20% that places a stronger focus on primary care physicians. In the near term, this will generate 0% Insured Medicare/Medicaid Self-Pay Other Sources increased demand for medical services in offices (Uninsured) while reducing pressure on emergency rooms. The Sources: Marcus & Millichap Research Services, CDC, U.S. Census Bureau uninsured and underinsured presently comprise nearly 17 percent of emergency room visits but only 4 percent of physician office appointments. Medical Sector Constantly Evolving. Technology, innovation, and research and development will play crucial roles in medical reform, providing yet another potential demand driver for office space. The medical landscape is changing rapidly as new treatments, drugs and devices become available. To facilitate continued research and development, the ARRA contains a $1.1 billion provision for medical research, including investments in studies into the comparative effectiveness of drugs and treatments. This will generate demand for R&D and traditional medical office space. Impact on Medical Office Property Sector Medical Office Outperforming. Despite the recession, Vacancy Trends medical office properties have performed favorably, Traditional Office Medical Office and demand is set to accelerate as medical reform is 20% phased in over the next several years. Unlike other Vacancy Rate asset types, medical office properties continue to 15% garner investors’ demand by exhibiting considerable resistance to the economic downturn. Medical office 10% vacancy is currently 11.6 percent, up only 100 basis points from one year ago; traditional office vacancy, by 5% comparison, is 15.2 percent, a 240 basis point increase 00 01 02 03 04 05 06 07 08 09* * Forecast over the same period. Sources: Marcus & Millichap Research Services, CoStar Group, Inc., Reis Changes Under Way to Buoy Space Demand Through Downturn. The ARRA included a temporary provision to make insurance more affordable for unemployed individuals. This group will receive a tax credit to continue their health insurance through COBRA, which will benefit an estimated 7 million Americans. Healthcare demand will be supported further by the reauthorization of the Children’s Health Insurance Program (CHIP) for the next 4.5 years. The $33 billion legislation broadened coverage by 57 percent, or 4 million children. The result is a forecast 5 percent increase in patient office visits for those under 18 years of age, or almost 10 million additional office visits per year. © 2009 Marcus & Millichap Page 2
  • 3. Demographic Trends, Scientific Advancements Support Positive Outlook for Medical Office. The medical office sector’s resilience can be attributed to a combination of variables, including technological advances and medical innovations that continue to extend life spans, as well as the aging baby boomer generation. At present, baby boomers account for 29 percent of the total uninsured yet represent almost one-third of all physician office visits. Proposed changes to the healthcare system will dramatically increase demand for medical services among this group. Per person office visits for 45- to 64-year-olds have expanded by 7 percent over the past decade. Insuring 95 percent of this cohort could elevate physician office visits by 12 percent, or 34 million visits, annually. At the current average of 120 visits per week for primary care physicians, approximately 5,400 new general practitioners will be needed to handle the additional workload from this age group alone. The resulting demand for office space from these doctors would total nearly 10 million square feet. Insured Baby Boomers Seek More Medical Care Significant Share of Younger Population, Average Physician Visits/Under 18 yrs Baby Boomers Uninsured Average Physician Visits/19-44 yrs. 5 40% Percent of Cohort Uninsured Average Physician Visits/45-64 yrs. Percent of Age Cohort Percent of Total Doctor Visits from Cohort Visits/Insured Person 30% 4 20% 3 10% 2 0% 00 05 09* Under 18 18-44 45-64 Over 65 *Forecast Sources: Marcus & Millichap Research Services, CDC, OMB Sources: Marcus & Millichap Research Services, CDC Healthcare Reform Beneficial to Medical Office Investment. For insights into how the implementation of a national healthcare plan could affect the overall medical office market, we looked to Massachusetts, which implemented reform in 2006. So far, medical reform in Massachusetts has been a boon for the state’s medical office sector. Massachusetts’ version of universal healthcare has resulted in 97 percent coverage. Higher demand for healthcare, however, has been met with a shortage of providers. Nonetheless, the impact on medical office in the state has been significant. Since passage of the plan in 2006, developers have added 1.8 million square feet of new medical office space in Massachusetts, a roughly 14 percent increase to inventory. Absorption has been robust, with 85 percent of the space already occupied and statewide vacancy holding firm in the low-9 percent range, one of the lowest rates in the country. Within the investment arena, sales of medical office properties in Massachusetts increased during each of the past three years. Institutions dominated the local market in 2006 and early 2007, but private investors have expanded their presence recently, purchasing smaller assets. Transaction velocity in the state was up 32 percent in 2008, while dollar volume and transaction velocity for properties under $10 million rose 55 percent and 40 percent, respectively. In contrast, dollar volume and transaction velocity for similar assets nationwide fell 5.2 percent and 4.8 percent, respectively, last year. © 2009 Marcus & Millichap Page 3
  • 4. Medical Office Demand Set to Rise. There are still unknowns regarding the methods that will be used to achieve nationwide coverage; however, if reform is even partially successful, demand for medical professionals and facilities will increase. It is estimated that a net addition of more Ratio of Medical Office Space per Insured Individual than 8,000 primary care physicians will Supply Could Fall Short as Coverage Expands be needed to care for the newly insured. Medical Office Inventory SF/Insured Individual While it will take time for the healthcare 550 0.6 community to catch up with the increase Stock (Millions of Sq. Ft.) in demand for services, the addition of Sq. Ft. per Insured 500 0.5 even half of these new doctors in the near term would generate demand for another 7 million square feet medical 450 0.4 office space, based on the current U.S. average of 1,780 square feet per primary care doctor. 400 00 01 02 03 04 05 06 07 08 09* 0.3 * Forecast The outlook is even more optimistic Sources: Marcus & Millichap Research Services, CDC, CoStar Group, Inc., TWR when viewed from the perspective of office space required per covered individual. Increasing the health insurance coverage rate to 95 percent of the population, up from 84 percent at present, would require an additional 21.4 million square feet of medical office space, based on the current ratio of approximately 0.5 square feet per insured individual. Healthcare Reform a Slow Process but Gaining Momentum. Healthcare reform will continue to evolve on Capitol Hill, but changes are becoming increasingly probable, which bodes well for the long-term health of the medical office sector. Overall, the task of insuring the uninsured and underinsured could result in 56 million extra patients, or roughly 20 percent of the population. This significant increase will not only generate greater demand for physicians and nursing but also require additional record processing and enrollment personnel, further driving demand for healthcare space and even nearby office properties. One major caveat is the potential shortage of physicians and skilled nurses. Recognizing this fact, however, several members of Congress have introduced legislation aimed at attracting and retaining healthcare professionals and direct-care workers. The information in this report is deemed to be reliable. Every effort was made to obtain accurate and complete information; however, no representation, warranty or guarantee, expressed or implied, may be made as to the accuracy or reliability of the information contained herein. Sources: Marcus & Millichap Research Services, BarackObama.com, Bureau of Economic Analysis (BEA), Bureau of Labor Statistics (BLS), Centers for Disease Control (CDC), Change.org, CoStar Group, Inc., Economy.com, National Ambulatory Medical Care Survey 2008, National Coalition on Healthcare, National Institutes of Health, Office of Management and Budget (OMB), U.S. Census Bureau. Written by Tom Hershey, Research Services - May 2009 For more information, contact John Chang, National Research Manager, at (602) 952-9669, ext. 669. © 2009 Marcus & Millichap Page 4