Healthcare Real Estate I S N 1557457

March 2009

InsiahtsTM Vol. 7, No. 3 Published monlhly by

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Market Intelligence for Healthcare Real Estate Developers, Designers, Lenders, Contractors, Brokers, Investors and ExecutivesT"

Industry Pulse 1 Lessons of the recession WASHINGTON -As we all know by now, healthcare is not recession- proof. However, it was one of the few sectors to add jobs in 2008, as an estimated 371,600 healthcare jobs were added last year, according to the U.S. Bureau of Labor Statistics. In December 2008, as the rest of the economy was shedding jobs, the healthcare industry added 3 1,600 positions, the Bureau of Labor Statistics reports. Also, healthcare spending the United States accounted for 17 percent of the gross domestic product (GDP) in 2008, according to the National Coalition on Health Care. The coalition projects that healthcare spending will continue to rise and reach 20 percent of the GDP by 2017. With the population continuing to age, these statistics bode well for healthcare real estate professionals and service providers, such as developers, lenders, investors, brokers, construction firms, architects and consultants.

HEALTHCARE SECTOR MIGHT SEE LASTING CHANGES

By John Mugford

B y the end of 2009, some healthcare real estate experts predict a loosening of debt

and equity capital, and a revival of medical office building (MOB) sales transactions.

But they say we won't necessarily see a return to business as usual.

Healthcare has fared far better than most other forms of commercial real

could trigger tougher underwriting by lenders, more caution from investors, and a retreat by developers from the increasingly upscale design of many of the medical facilities built during the

everal years.

As the Healthcare Real Estate Insiahts' Editorial Advisow Board - meeting was winding down in Dallas in late 2008, the 19 hoard members

estate during the current economic in attendance were asked what they recession. Yet even this sector has thought would be the major topics experienced - and continues to endure concerning healthcare real estate a -some challenging times. year later, at the end of 2009.

Those negative experiences could leave a lasting impression on how

Their discussion took place in a conference room at the offices of

healthcare real estate firms do Trammel1 Crow Co. This is our final business, the experts say. The often installment h m that meeting. Past painful lessons of the financial crisis (Please see "Lessons" on Page 12)

I (See "Industry Pulse'kn Page 20) 1 Firm likes the Northeast Inside Special Report: 1

Economy is having an impact Q & A : 1

Noyack's Follini still bullish Capital Markets Snapshot: 2

Good news for debt rates? Transactions: 3

Lillibridge, Grubb still buying Outpatient Projects: 6 Several new MOBS under way

Inpatient Projects: 8 Plans still pushing forward

Companies: 12 Firms complete new projects

I NOYACK'S FOLLlNl REMAINS BULLISH ABOUT SECTOR

I By John Mugford

T he economic news in almost every business sector in almos every nook and cranny of the

country is not good, as we all know.

And even though healthcare is often regarded as an industry that can weather most economic storms, the current recession is taking a financial toll on physicians, hospitals and, as a result, healthcare real estate as well.

Iwever, on- : diraimes if t a E i i p K . J . Follini I -

Even in the current econumic quagmire, Mr. Follini remains enthusiastic and bullish about the medical office sector and healthcare real estate, especially in the Northeast, where Noyack does most of its business.

(Please see '%bllini" on Page 1.5)

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March 2009 Healthcare Real Estate Insightsm Page 15

FOLLlNl (Continued from Page 1 ) Mr. Follini had a hi&-pmfile commercial real estate background in New York prior to founding Noyack in 2001, as his family has long been involved in major construction pmjects throughout the tri-state area, including the building of the U.S. Open Tennis facility in Flushing, N.Y.

But Mr. Follini has also found plenty of success working on his own. For example, in the early 1990s he and New York-based Rockefeller Group were the codevelopers of a 400-acre expansion of the International Trade

Brent Tharp (lefl) comments on the financial I Center in Mount Olive, N.J. Mr. Folliii also made quite a profit on a Editorial Advisory Board meeting a s Greg Venn and Sharon Harper look on.

"RE,- photo 12-acre brownfield site he acquired on the waterfront in Queens in 2000.

same pressure and the question of design and location of MOBS, as After buying the land for $9 million whether the physicians will be able they've been able to do in the past and embarking on a three-year to pay the rents in a new, on-campus environmental cleanup, Mr. Follini MOB," be said. 'That's still our "Patients wanted more convenient care sold the properly for $27.5 million. biggest issue that we have to get over -they wanted satellite facilities. Is on every single deal. The existing that still going to he the driver?" A h the dot-com crash in the buildings on a campus are already four late 1990s. Mr. Follini did his due to five bucks lower (per square foot) Mr. Cozzi of Ventas said he believes diligence in looking for a real estate than the building we're developing." there will be fewer pmjects in which sector with long-term stability. He

MOBS are designed to look l i e day came upon medical real estate and spas and hospitals are designed to look established Noyack in 2001. Since

Less opulent? like fancy hotels. then, Mr. Follini and the firm have accumulated a medical office portfolio

Board members were then asked, "I think some of the over-design and totaling about $125 million and as the economy continues to be in some of the over-expense that has between 150,000 square feet and trouble, whether building designs will gone into buildings in the last couple 200,000 sqm feet of space - rather become more basic. years is likely to fall away as both the modest square footage by national

physicians and the consumers look standards, but quite sizable in the "I think MOB developments will at that and say, "Well, maybe that's quirky, highly fragmented New York be more driven by location than by over the top in today's economic medical office market. the building itself," said Malcolm S. environment. "' Sina, CEO of Palm Beach Gardens, The firm's biggest deal so far, Fla.-based DASCO Cos. "We all Mr. Vogt of BremnerDuke added: however, looks to be the ongoing and have to make sure that we have the "You can talk about the consumer future redevelopment of the former right ceiling heights, the right floor- pushing these facilities out in the 23-acre St. Agnes Hospital campus to-ceiling heights . . . and the right suburbs and these off-campus in White Plains, N.Y. The total cost connectivity to the hospital. But I locations, but there are still plenty should exceed $150 million. think it's going to come down to being of physicians who have the power more location driven than the rest of and the income to stay independent - Mr. Folliii, Noyack and several it" usually they are in cardio, oaho and other real estate professionals formed

cancer. And they can tell the hospital, a partnership called Noah Street HREI" board members were then asked 'We want to be 10 minutes from our Community LLC to convert the whether patients and consumers will home so we can get to our kids' soccer former hospital campus into a senior continue to drive the development, matches at 6:30 or 7 o'clock.'" (Continued on next page)

Page 16

(Continuedfrom previous page) living development with 130 assisted living beds and 400 independent living units.

The North Street campus also has two existing medical office buildings (MOBS) with a total of about 140,000 square feet.

That portion of the project has undergone a renovation costing between $5 million to $7 million, with occupancy in one of the physician- occupied buildings increasing from 40 percent three years ago to 70 percent today. Mr. Follini says lease deals currently in the works are likely to bring occupancy to more than 90 percent during the next year or so.

The other MOB, which has about 55,000 square feet, is occupied by a children's rehabilitative center.

At the time of the following interview, North Street Community LLC had just signed a joint venture partnership deal that would result in Garden City, N.Y.- based Engel Burman Group developing and operating the independent living portion of the North Street project. Engel Burman, which has a long history in seniors housing, is launching its new independent living brand, Seasons, on the campus.

HREI": You are bullish on medical real estate in the Northeast. Why is that?

Follini: You hear all the tales of woe from throughout the country. But the Northeast is different and while there are certainly some concerns, we don't see as much trouble here. Transactions are taking place here.

HREIm: And why is that?

Follini: It's because of the demand for healthcare services, and also there are a lot of not-for-profit hospitals and systems throughout the Northeast and they are not suffering as much as the for-profit, private systems are. A lot of the not-for-profit systems include

Healthcare Real Estate Insightsm March 2009

the Catholic systems, the well-known Jewish systems and others. These not- for-profits don't expand as much during good times, and they don't contract as much during bad economic times. They are more stable.

HREI": Because of this strength in the Northeast, are you talking about growing your business?

Follini: Yes we are. We see better pricing and more opporhnities now, and we're working very hard on a big portfolio upwards of $70 million at a capitalization rate that was unheard of, in terms of attractiveness, just a year ago. For a few years, money was easy to get with 95 percent loan-to-value and low interest rates, prices were high and kept moving higher, and a lot of casual players got into the market. But now things have come back to normalcy and we're at the forefront. There are many deals out there that make sense in this environment - deals north of eight-and- a-half percent cap rates. These are the exact same deals that were priced at seven and seven-and-a-quarter cap rates a year ago. So there's nothing about the quality that is being reflected in that price, it is about the owners.

HREI": The owners? Can you explain?

Follini: Many of the owners of healthcare real estate in the Northeast have suffered in other areas of their businesses, as some of them are not focused only on medical real estate. A deal we're looking at is an off-market deal, a large portfolio, that involves a group of developers and owners that own many types of properties and they have suffered in other areas, such as residential. Well, they're looking for cash and liquidity and the only thing worth selling, and that others are willing to buy, are their medical real estate properties.

HREI*: How does the pricing work out in a transaction like that?

Follini: In these market conditions they have to price it attractively and

so we're reaping the benefit of their troubles in other asset classes. That's a typical situation that we're seeing replicated in the Northeast. Basically, a lot of companies and owners have trouble in their residential properties, and in some of their industrial properties. They're in different asset classes and they're saying sell the medical because that will gamer money. And we're like, 'Great, we have cash, but here's what we'll pay.'

HREI": Even though there are a lot of acquisition opporhmities, I would imagine you have to be somewhat selective and can't buy everything that comes along.

Follini: That's true, and while we're certainly looking at acquisitions, we are also spending much of our time on the management of our tenants than acquiring and doing other things. We are really focusing on sticking to our knitting, and that includes upgrading our buildings, making them more efficient - both sustainable in terms of operations and trying to get more cost savings for the tenants to keep them happier. We're spending a ton of time on improving the operations, efficiency and the amenities of our existing buildings. There are great acquisition oppotiunities out there and we're looking at them, but we are spending a lot of time with our existing tenants to maintain the price, which helps our reputation.

HREI": Do you have any examples of that?

Follini: Sure, the Concorde Medical space is a good example. (In late 2008, Noyack acquired a 20,000 square foof multi-tenant medical office condo in Manhattan for $13.5 million, or $675 per square foot, or PSF). The former owners did a very poor job of working with their tenants and of keeping the medical office space maintained. They were a couple of sisters, older, and they ran the building into the ground and we got it at a really good price. By the time we came in, the tenants were,

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March 2009 Healthcare Real Estate InsightsTU Page 17

understandably, very unhappy with the former owners. The first thing we did was have long meetings with each of them where we explained our philosophy, explained how we are going to renovate the building, which we are in the midst of putting hundreds of thousands of dollars into, and we are showing them how we do thimgs in our other properties. Those include things l i e savings on the utilities, and savings on what is paid to service providers such as cleaning and sanitation firms, everythmg. We generally have net leases here, hiple net or double net, so getting them cost savings makes their price more attractive. We need to make sure the tenants can afford to stay in our buildings, and we want them to see what we're doing it in all of our other buildings so they know we're serious about getting them cost savings, which has them saying that maybe they won't rush out and look for other space.

HREI": You paid more than $650 PSF for that Manhattan space. I would imagine folks in other parts of the country, even those who realize prices are higher in Manhattan, would think that sounds like a lot to pay. But you must, obviously, consider it a good investment.

Follini: Absolutely. We're going to re-condominium that condominium and our estimated sales figures are (significantly higher) than what we paid. In fact, several of the tenants want to buy their own units, which is also something tenants want to do at our medical office space in One Hanson Place. (In mid-2008 Noyack acquired a 3 1,856 square foot, multi- tenant MOB space inside One Hanson Place, a 512-foot tall redeveloped residential tower in Brooklyn. Noyack did not disclose the price paid, but Mr. Follini acknowledged last year that it was close to the asking price of $13 million.)

HREI": What's happened with the One Hanson Place medical space?

! ! Follini: When we bought it, it was

about 80 percent leased and now it's 100 percent leased. We just signed on a couple of tenants, and all of the tenants there want to buy their spaces. So, we're starting the condominium process, which must go through the attorney general's office, and that'll take about six to eight months. That was the plan all along, as we knew the tenants wanted to buy their spaces. But we bought it because no single doctor's practice there had the ability to buy the whole medical office space and then sell the spaces as condos, as we could do. As part of their leases, we had to offer to sell them their spaces within three years - it was parr of the deal.

HREI": Do you plan on continuing to concentrate your business in the Northeast, or do you look elsewhere as well?

Follini: We have a property in Evansville, Indiana, a typical, on- campus MOB. And in addition to that, we're working and looking elsewhere. But the opportunities are so numerous here in the Northeast and we know this area well. Plus, there is not all that much competition from firms who know medical and know our territoly as much as we do. Whereas if we go elsewhere, we'd be bumping up against competition that knows those areas well, like in California where we'd run into Pacific Medical Buildings. Or if you go down to Florida you run into developers and owners down there, like Rendina Cos. or DASCO. So here, we are in a way, the leading firm.

HREI": Do other firms stay away from the Northeast because it is such a different market?

FoUini: Other firms have come into the area and have done some deals in places like New Jersey, but they stick to the usual stuff, such as an on-campus medical office building, which you can find in New Jersey. But those aren't what I could call the real value-add opportunities or the

C.J. Follini

real return opportunities. We've found tremendous opportunities because we understand the nuances of working in Manhattan, Brooklyn and in places like downtown Portland, Maine. And we also understand what it means to work with service providers and medical infrastructure firms instead of just hospitals and physicians.

HREI": So, what are some of the nuances of being in the business in the Northeast, perhaps in New York, other than the fact that the price per foot is high?

Follini: Well, for one thing, doctors are doing well enough here and many of them want to own their own space. None of them are really getting into real estate in which they would buy a medical office building - they want factional ownership of just their space. 1 would say this idea that doctors want to own their own space is pretty popular from Maine down to Virginia.

HREI": Are there other places where you do work in the Northeast, such as Boston?

Follini: Funny you would mention Boston because we have options on an option on a development project there right now, in the well-known

(Continued on next page)

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Healthcare Real Estate InsightsTM March 2009

(Continuedfmm previouspage) Longwood Medical Area, which has biotech properties as well as hospitals and medical offices. In addition to having options on two sites, we have the approvals we need for the plans.

HREI": So wbat is your strategy moving fonvard to stick with acquisitions, do more development or the whole gamut?

Follini: We're doing acquisitions right now, and we'll be looking at doing quite a few acquisitions in the next six to 12 months, and the development will be in the next 12 to 18 months.

HREI": Any prediction on how much volume you'll do in acquisitions?

Follini: We're going to be announcing a very big one soon, a $70 million to $90 million acquisition, the off- market deal I talked about earlier. We're in discussions and I really can't say anything about it until we sign a contract.

HREI": In today's credit crunch, how do you finance an acquisition like that?

Follini: Actually, we're lucky in that one. While there is a significant equity piece to that, which we do have because we do have the cash and are fairly liquid and in good position, but in this case we're assuming the debt. It's a very attractive deal with in place debt, so it is a great situation, but still it's a significant equity slug, which we're lucky to be able to provide.

HREI": A lot of people in this industry are saying now would he a difficult time for a firm to get involved in healthcare real estate. Are they just saying that to keep the competition away, or do you feel that way as well?

Follioi: I agree with that. About the only thing worth buying right now in medical real estate are properties in the top 10 percentile, in terms of quality of the property, quality of the tenant. If you're not experienced

"You hear all the tales of woe from throughout the country. But the Northeast is different ... Transactions are taking place here."

C.J. Follini, Founder and M a n a g i n g Pr inc ipa l N o y a c k Medica l Partners LLC

enough to evaluate what makes up the top 10 percent, then you can fall into a trap where you acquire something that's substandard, a sub-performing property, or what will soon be a sub- performing property. And on top of that, your financing is probably not going to be as attractive as it was. In this market, you really have less margin for error.

HREI": How do you evaluate that?

Follini: We came up with our own scoring system that we've developed over the years. It's a 10-criteria scoring system that's weighted by the importance of that criterion that we actually grade all of the properties on. And so far, over the last five years, the grades have proven very effective. In fact, there were deals that we looked at, which might have looked good at first glance, that we didn't do because they didn't grade highly on our scale. And several of those properties have now come back on the market. Our scoring system was right.

HREI": Who put the grading system together and what are some of the criteria? Does on-campus versus off- campus make a difference, especially considering the fact that you're in the Northeast, where you say it is not as important. How about rent comparables?

Follini: Myself and Michael Urbanski, our portfolio manager, worked on this over a number of years. As for the criteria used, yes, one of the grading criterion is the fact that the proximity to a hospital is clearly part of it. But as you mentioned, for example, in the Northeast we lower the weight of being on a hospital campus, because

almost everything is off-campus. Parking ratio is another criterion, as are rents, like you say, where rents compare to other buildings in that market.

HREI": Let's finish up with talking about the development in White Plains, the North Street Community on the former St. Agnes hospital campus.

Follini: Well, to begin with, we had to go through about two-and-a-half years of entitlements on this development. We closed on the property on Jan. 13,2005, and received the approvals for the site plan in July of 2007. As for the medical office building on the site, we put a lot of money into the renovation, and the building is in a very unique project, an infill project in a major metropolitan area. There are three distinct, sizeable businesses that are part of this project as well. There's about 140,000 square feet of medical office space, there's going to be a 130-beds of assisted living in the old hospital building and 400 independent living condominiums, part of the new development on the site. And all of this is a half a mile from downtown White Plains. There's nothing else like it that I know of, perhaps in the country.

HREI": In this economy, how do you think you've been able to bring occupancy in the one MOB to 70 percent from 40 percent?

Follini: Because doctors in the area realize how unique of a project it is and they see it for wbat it is: along- term healthcare campus that will have strong demand for services, not only from the surrounding community but from the people living on the campus itself.

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