Development Is Big Story for Medical Office

• Construction level hits five-year high
• Maple Grove hospital approved; construction of ambulatory surgery and imaging facilities underway on both Fairview and North Memorial sites
• Centralized children’s hospital proposed
• Physician recruitment remains a major issue
• Collaboration between physician groups and hospital systems continues to be crucial

Tight Market Leads to Construction

The Twin Cities medical office market remains strong. Just 9.0% of the 4.6 million square feet of medical office space is vacant. Space is particularly tight on hospital campuses with many reporting limited or no vacancies, including St. John’s, Maplewood; North Memorial Medical Center, Robbinsdale; West Health, Plymouth; Fairview Riverside, Minneapolis; and Fairview Ridges, Burnsville. On-campus vacancy at mid-year was 6.3%. Off-campus space also fared well as physician groups continue to expand away from hospitals with vacancy at 13.9%.

This tight market is leading to development—both on-campus and off-campus. Projects recently completed and under construction total 835,000 sq. ft. Plus, several more projects are planned with anticipated groundbreakings in third- and fourth-quarter 2006. Development ranges from much-needed hospital expansions to medical office buildings in burgeoning, high-demand suburban markets like Lakeville, Maplewood, Woodbury and Maple Grove.

Maple Grove Hospital Approved

After extensive community and political debate, development is occurring in Maple Grove where a new hospital was approved. Gov. Tim Pawlenty signed the Maple Grove hospital bill into law in March, authorizing the North Memorial Health Care/Fairview Health Services partnership to move forward. The hospital will be developed on North’s site, near the intersection of I-94 and the future Highway 610. The hospital has high financial stakes due to exceptional market demographics and will drive future retail/office/healthcare development. Both North and Fairview broke ground on ambulatory care centers, and Ryan Companies US Inc. has a medical office building, The Grove, under construction.

The third player that had been competing for the hospital is Maple Grove Tri-Care, a joint bid by Park Nicollet Health System, Children’s Hospitals and Clinics and Allina Hospitals and Clinics. The partnership controls land on the south side of Highway 610. The future of this site is undetermined at this time and will surely be a significant topic of interest in the near future

Children’s Hospital Proposed

Children’s Hospitals and Clinics of Minnesota, University of Minnesota Children’s Hospital and Allina Hospitals & Clinics are collaborating to build a children’s hospital at the University of Minnesota, near the Fairview Riverside campus. Rather than closing, the proposal anticipates existing children’s hospitals would become more clinic-oriented. However, existing hospital campuses will likely feel some impact. Allina operates United Hospital in St. Paul and Abbott Northwestern Hospital in Minneapolis, both of which are adjacent to the major hospitals operated by Children’s. Children’s planned expansions at its Minneapolis and St. Paul sites could be affected by this venture.

Physician Recruitment Continues to be an Issue

Physician recruitment in Minnesota remains extremely competitive. Drawing physicians to the Twin Cities market continues to be challenging when competing with an abundance of job opportunities around the country, many of which have significantly higher pay scales and opportunities for growth.

Collaboration Between Physician Groups and Hospital Systems Continues

Physician groups continue to expand off-campus and add services to help generate new revenue. This forces continued discussions regarding how physician groups interact with hospitals when it comes to issues such as referrals.

The Outlook

Major healthcare systems have been making significant construction investments, and now the medical office market will undergo a period of lease-up. The record-setting pace of construction is not likely to continue.

High land and construction costs are driving rental rates up. This is especially true for in-fill, on-campus sites. Cost of new construction will also support higher rates in existing buildings, assuming the market does not get overbuilt.

Hospital campuses to watch include United Hospital, which is expanding with the addition of the 110,000-sq.-ft. SARA II building (SARA stands for Smith Avenue Realty Association), scheduled to open in the third quarter. Additional activity on the campus includes the much-needed renovation of the Doctors Professional building, scheduled to be completed in mid-2007. Waconia Ridgeview Hospital will expand with the addition of the 60,000-sq.-ft. Ridgeview Professional Building, which will focus on women’s health. Groundbreaking is scheduled for spring 2007. St. Francis in Shakopee has a 60,000-sq.-ft. medical office building planned as well.

With the hospital decision finally made in Maple Grove, peripheral development has taken off. Ryan is moving rapidly on a mixed-use retail development near the hospital campus in a project called The Grove. This property is anchored by a SuperTarget and Home Depot with a variety of retail space similar to the Main Street at Arbor Lakes. North Memorial purchased their 30-acre site from Ryan.

In off-campus activity, Lakeville, with its strong demographics along the Interstate 35 corridor, is ripe for healthcare development. High-growth cities like Lakeville are grabbing the attention of developers, who are trying to meet the healthcare demands in these markets, many of which are not served by hospitals.

Eden Prairie could also see new medical office development in the future. However, the question is where? The challenge in that market is the lack of a healthcare core. Also challenging are the soaring land prices in the suburb. One solution may be repositioning an existing building.

High land prices will continue to have a major impact on development and the viability of new medical office buildings. Medical users continue to think like retailers and want to be in or adjacent to high-traffic retail areas; however, they compete with retailers for prime land and cannot afford to pay these premium land costs.