Hospital-Owned Business and Ambulatory Occupancies: Vacant Square Footage, Consolidations, and the Real Estate Cycle in a Post COVID Market

Background

To say that the past 4 years in healthcare have been extraordinary would be a massive understatement. Healthcare property management in Southeast Pennsylvania (SEPA) is no different. To my understanding, what we saw in SEPA was a microcosm of the entire country. The shift we saw toward outpatient care delivery accelerated by the passage of the ACA (from the heavy inpatient model) was temporarily halted as we addressed the pandemic. While this has driven a reconsideration needed for the preservation of inpatient capacity in new concept design, this is likely to become a flex capability model in most markets as we move forward. In other words, while we see the shift from semi-private occupancy continue, I expect there will be a large surge in capacity designed into inpatient and inpatient-capable facility construction and renovation. 

 Before the pandemic arrived on our shores, outpatient and elective surgery caseloads were consistent and profitable. However, once lockdown orders were issued, volumes quickly diminished, leaving hospital ORs to handle only emergency cases while ambulatory surgical centers ran without elective cases, providing each little to no revenue. This was a necessary step in controlling the spread, of course, but this drought meant a system built on outcome-based throughput was now without one of its most critical revenue streams. Surprisingly, during the pandemic, the urgent cares did not perform as well as one would expect, were one to gauge against historical flu season volume spikes. Today, the volumes of these facilities across the US remain stubbornly below pre-pandemic projections. 

The Real Estate Impact

The dearth of outpatient and surgical case revenue combined with a dynamic shift in care delivery has driven the most unprecedented rightsizing in healthcare real estate since the passage of the Hill-Burton Act. Practice and service line consolidation has become critical and commonplace as more services are offered in tele-format and via retail quick clinics. Like big-box stores relocating and leaving empty shells behind, the wake of this evolution is a massive vacant commercial real-estate portfolio weighing down the adaptation and advancement of healthcare and hospital systems. 

The occupancy contraction we have seen in the industry has left many buildings only partially occupied or completely vacant. To manage risk, facility owners must incur significant expenses. These facilities still require heating, cooling, security, access management, maintenance, and compliance management. A 2-story building with a hydraulic lift still requires annual inspections. A surgical facility with a UST still requires tank tightness tests and regular churn operations to keep the fuel somewhat fresh (although long-term inactivity usually requires the fuel to be polished). Any healthcare facility with the hope of re-licensure needs regular, continuous compliance maintenance. Every facility, regardless of occupancy status, requires ongoing inspection and maintenance of all fire safety features. All these things come with costs. 

An Example

This has become an expensive proposition for healthcare systems. Where previously premium healthcare real estate was a rare and very marketable building stock, we now see them sitting underutilized for extended time periods. In one case, I recently had the opportunity to tour a 23,000-square-foot ambulatory surgical center (ASC) less than five years old in a very attractive market location. 

It contained four 600 square-foot operating suites with ample oversized supply facilities, SPU, PACU, prep, waiting, and staff areas. The mechanical rooms appeared brand new. The backup generator covered the entire facility and was barely making a 30 percent load. 

To someone in my business, the facility was beautiful. It appeared you could change the shingle out front and reopen it tomorrow. It was clearly DOH survey-ready, and they had all the necessary continuous compliance documents. They could tell you down to the number of weeks (I believe it was in the 50s) until 4-year passive fire-damper inspections were due. It was vacant because their system was over-expanded before COVID. They had another larger ASC across the street from this one, and their surgeons preferred to work in that one. With their volumes and the difficulties that we’ve all experienced in staffing, it made more financial sense to shutter this facility in favor of fully staffing the other.

This left them with a hulking high holding cost facility demanding a premium rent for the near suburban Philadelphia market. But demanding and getting premium rent is not the same thing. The premium rent range in the near-Philadelphia market for this type of property in 2022 was $31.41-$37.91, according to Commercial Café. With this property in that range and being ultra-specialized, renting it requires no small effort. However, healthcare landlords are facing the reality that the commercial market is very loose. Worse, those who would normally rent it remain in a state of contraction. With an estimated 1 billion square feet of empty office space in the United States in 2023, moving commercial healthcare rentals is often a Herculean challenge.

"The dearth of outpatient and surgical case revenue combined with a dynamic shift in care delivery has driven the most unprecedented rightsizing in healthcare real estate since the passage of the Hill-Burton Act."

Conclusion

In the contemporary commercial real estate market, new ideas and realigning have become necessary to derive revenue from immovable assets. Some owners have used the spaces for pop-up retail and consignment opportunities. Some have set up work-sharing spaces. In healthcare, I’ve encountered proposals for thrift shops, transitional housing, emergency housing, and other creative uses. Unfortunately, many local jurisdictions have not adopted flexible zoning and building code provisions to help serve these efforts and allow ownership the ability to pivot. 

While I believe an equilibrium in the healthcare business-occupancy real estate market is beginning to set in, I also think we are a very long way from realizing the calm of a settled marketplace. Hospitals and healthcare organizations have pivoted from COVID response back to business development in a healthcare business landscape that guarantees only change. With that and the voluminous entrance of online healthcare providers, it’s anyone’s guess what this sector of the industry will look like in two years, let alone five. The consolidation has slowed, but I predict we will be in another significant market swing before the current disturbance is resolved. At this point, we’re still somewhere between the recession and recovery sections of the four stages in the real estate condition cycle. In my opinion, we’re much closer to the former than we are to the latter. However, there is reason for optimism as the market's progress toward recovery is evident.