Note: To follow is an excerpt of an interview with Scott Larche, Vice President of Investments, Kevin Maddron, Chief Operating Officer and Chief Financial Officer, and John Mark Ramsey, CEO of Servant Healthcare Investments, and Robert Smith, president of Lockard Companies, Inc. of Cedar Falls (IA). To listen to the show archive or download an MP3, go to www.IncomePropertyInvestmentTalk.com/032509.

Mosca: My special co-host today is Michael Anderson from RealSource. Michael, as you know, in many parts of the country the commercial real estate market is starting to look "”sick” but one niche market that does seem healthy is medical office buildings and senior living facilities. Even in recession, people still need health care. Add that to the country’s aging baby boomers, inadequate hospital infrastructure, and growing outpatient services and the market definitely has potential now and into the future. While commercial real estate is widely expected to contract due to the recession, medical buildings, senior living facilities are likely to expand. Can these types of investments be considered a recession proof asset?

Smith: We believe there is an important investment philosophy: go after quality investments that are going to be consistent performers through time. One reason we are so excited about the medical office building and the healthcare field is we are developers and owners of these types of properties. We have outside investors that invest with us in these opportunities. It may not be the 20, 30, 40% returns that are being promised in so many of the distress in other areas of the real estate market places today, but these are consistent performers over time. As you stated, the healthcare industry is an industry that provides a service that is required in good times and bad. Most of the medical office buildings that we would be most excited about would not be the elective type procedures that may go up and down. There is a segment that goes with the economic cycle of the general economy but as far as the opportunity for a consistent investment over time we really see continued opportunities in many of these medical office buildings and healthcare facilities across the country.

Larche: I agree completely with what Bob says. I would say combining the aging population with the aging hospital and medical infrastructure and the new technology that is coming in that requires updated real estate for it to function properly in an economically efficient environment makes healthcare a really good place to be right now. That’s evidenced by the stable occupancy rates that we see in the facilities across the country as well as the lack of defaults on the loan portfolios when we go out and talk to lenders.

Mosca: What are some of the other benefits of investing in medical office buildings?

Maddron: There is a big shift in the last decade of providers wanting to diversify outside of the big hospital networks, either remaining on campus as part of providing services on behalf of the health system and even some cases going out to the suburbs and being off-campus. The ability to be able to attract equity for those types of products is actually very high right now. The returns seem to be fairly stable because what comes along with these buildings are typically your larger physician groups that are more on the specialty side of the business. The tenants seem to be more stable, which provides for a more stable return to the equity.

Ramsey: I would like to emphasize the changing demographics. In the next decade or two we expect to see the senior population, that being 65 and over, grow to one out of every five people in our country, the bulk of which is set to occur the next 10 or 15 years. In addition to that we are seeing significant increases in health care spending as a percentage of the GDP. We expect that by the year 2017, we’ll see one out of every five dollars spent in health care spending, so you can combine radical shifts in the demographic makeup of our country with significant increases in spending. Healthcare is the direct beneficiary of that and the real estate is a direct beneficiary of these macro transits we are observing.

Anderson: How much does location fit into your planning and investment strategies?

Ramsey: When we think about health care and the markets that we want to participate in, we network with the operators and developers that specialize in a given market. Tucson, your market, is a great example that has a very unique set of drivers that create maybe 20 or 30 sub markets for senior housing within that market. The way that we attack that opportunity is to partner with the operators of senior housing, the developers of surgery centers that are in and know that market well. It’s a very localized business and the real estate tends to function that way as well.

Maddron: We have to look at senior living and healthcare facilities separately. On the senior living side certainly there are big geographic areas. The southeast and northeast, California, Northwest and parts of the Midwest in major metropolitan areas are certainly big centers for senior living development opportunities. On a healthcare facility side that’s probably the same although some of that is driven by the statewide governments on what type of healthcare facilities can be built. The other influencer on senior living facilities is the desire to relocate near grandkids or to essentially move back to where their kids are living.

Mosca: In doing research for this program I noticed hospitals built 20 and 30 years ago were a lot larger than they are today. Today’s hospitals house about 80 to 100 patients whereas in the past it would be about 800 to a 1000. Is this trend toward smaller hospitals with adjunct medical office buildings having an impact on healthcare real estate investments?

Larche: Absolutely. The trend is driven primarily by advancements in technology over the last 20 years that have allowed the number of procedure types traditionally in a large 600 bed hospital environment to be able to take place in a smaller ambulatory surgery center environment. This is great for the patients, and it produces better outcomes. It allows them to get in and out quicker, to have their friends and family visit with less hassle and it also is much more efficient for the physicians. We are definitely seeing a trend in terms of more procedures being done in surgery centers as physicians partner more with the hospitals. Also, hospitals are coming to communities and rather than making a huge multi-hundred million dollar investment in a brand-new hospital they are putting their flags in those communities with smaller ambulatory surgery centers or outpatient clinics where they can see those patients, they can get their brand known in those communities, and if it works out later on, they can build a hospital there.

Anderson: What creates value in your industry? Is it this synergistic effect?

Larche: It’s all about creating the value for the physicians who are the tenants in these buildings, and the hospitals who are our customers or the landlords for them. The best way is to create a great tenant mix within those buildings, which is great for the physicians because they build referral patterns within the buildings and it’s very convenient for their customers who are of course the patients who are coming in to get their visits done. We do a lot of buildings that combine multiple facets of healthcare. We create destination healthcare environments, which is a relatively new trend but something we will see a lot more of in the future.

Ramsey: The patient gets a better result in that environment. It’s pretty widely accepted that that is the case for most procedure types: better results, quicker recoveries, and lower infection rates. It is more efficient from a business standpoint, but as a consumer, I am not stuck in a trauma situation and potentially I’m going to get a quicker recovery and better outcome as well.

Anderson: How much does having your healthcare insurance provider in that same area?

Maddron: Part of what we are seeing happening is as the baby boomers are moving through this age wave, one thing that is happening is that they become qualified for Medicare. A lot of the services that are being provided in these facilities are driven by Medicare reimbursement, which you can pretty much take anywhere with you, so some of that is impacted by the Medicare payment program. Typically the type of communities and facilities that we invest in our either private pay in nature or in markets where there is a heavy population of people who are employed obviously which have fairly good health programs that would impact reimbursement rate.

Smith: I want to stress the importance of that tenant mix but also the larger affect that that tenant mix has on an area. We do quite a few master-planned developments across the country and we see the medical and retirement sectors as being the catalyst if they’re done well with enough critical mass. The developments, the land values and the residential, retail, service, and other investments drive additional value for the entire community and specifically in the immediate surrounding areas. We see these medical office buildings and hospitals being developed in more green space and a lot of that is due to the fact that they recognize that they bring a large group of the following services and amenities that are required to help them be successful and also help build the community that they are serving.

Mosca: Could the talk in DC on healthcare stifle these opportunities that we’ve been talking about so far?

Maddron: We actually see that more as an opportunity than a threat. A recent Bank of America study indicated that over time a Democratic Congress has been more favorable to the healthcare stocks and healthcare properties than the other type of administration. As you look at the landscape of what President Obama is laying out today, he is actually bringing 25 percent of his $3.6 trillion budget for healthcare, which is the largest portion of the budget -- $70 billion more than defense. Healthcare is a national priority and it will continue to be that way for the foreseeable future.

Ramsey: One out of every five dollars in 2017 is projected to be spent on health care and we are obviously seeing that with the new budget. Kevin said it best, we actually see the political landscape as an opportunity. More healthcare dollars is a good thing but there could be some movement within the slice of the pie that we will continue to monitor. Spending is up, demographic trends are up, and it all adds up to more healthcare required.

Mosca: Bob; is that a good thing from a development point of view?

Smith: That is a very good thing with the tenant mix being a requirement. Medical office buildings next to hospitals that have some critical mass and are not single tenant in nature are opportunities for long-term returns that are strong and positive in nature. It continues to keep us excited about the opportunities in medical office buildings.

Anderson: As a private investor, how do I get involved in this kind of opportunity? Is there a specific kind of method that I can invest both individually or with others to take advantage of this?

Smith: At Lockard, we have structured partnerships with investment groups such as Servant Investments who bring in equity through their investment networks. Servant Healthcare understands not only understands the macro but micro markets and aligns themselves with developers, local developers, and owners that understand the local marketplace dynamic. Many development companies such as Lockard are consistently forming joint ventures with equity partners and providing great returns over time.

Ramsey: It’s a specialized business so unlike other core real estate types, we tend to see a reasonable premium for the unique nature of healthcare. From our perspective, there's a premium because it's different but the fundamentals are actually extremely good right now and will continue to be for the next 30 to 50 years. What plays to our strengths is specializing in healthcare. The underlying opportunities are what create the return premium and with expertise in those areas there are some great opportunities out there for investors.

Mosca: It seems like you have to have an expertise both from a real estate and also an operational perspective as well?

Ramsey: That speaks to our background. It gives us a unique opportunity to network with the developers and operators in healthcare real estate, understanding their business, and helping them where we can.

Mosca: What is your golden nugget for today?

Ramsey: Right now and in the foreseeable future the healthcare fundamentals that we are experiencing are very, very good and they are not directly impacted by what's going on with our economy. Healthcare presents a bit of a long-term defensive play with return premiums because of the unique nature of what we do.

Larche: Look to the stability of the cash flows in the medical office and senior housing sector, as physicians don’t move frequently. Retention rates in the medical office area are north of 90 percent. That creates a very good opportunity for stable cash flow, which is at a premium right now given where other asset classes are trading.

Maddron: Baby boomers that are aging 65 years or older, about 8,000 per day, are four times more likely to go to the doctor and when they go it is going to be in a healthcare real estate facility. There are simply not enough today to take care of that demand.

Smith: From a real estate perspective, medical office and healthcare facilities are specialized, from construction, to cash flows and the operator. Invest with a group that has deep experience and relationships, understands the local market but also understands the macro markets. There are great opportunities but make sure you team up with folks that are going to provide a track record that you can trust.

Mosca: Our last guest is Kevin Peay of RealSource. Can tell us about your current healthcare related offering investors with cash, IRA funds and equity can get involved in?

Peay: I learned a lot on this radio show this morning in regards to demographics, what people are looking for and it’s been fun at RealSource to be able to come into an environment where you meet a number of different people and professionals across the country who really have a pulse on what’s going on. We’ve had the opportunity to run across a number of different professionals inside the medical arena that have great investments in the right place at the right time. It's great to have that extension on top of what we do here at RealSource. That said we have dialysis centers in Houston on our radar screen now from one of our strategic partners. Dialysis centers are becoming the wave of the future but they are very strategic in certain locations. They still stay close to the insurance environment where you were able to use the Medicare and Medicaid opportunity with inside the payable strategy as well as the receivable strategy and be able to carve out a real solid investment as it pertains to dialysis. There are some great lease terms on this with solid.

Anderson: Is the Houston property new?

Peay: The dialysis center in Houston is brand-new. It’s completely built out. Management is in place and investors are coming in right now.

Mosca: I am not sitting on a boatload of dough and so when I hear things like this right away I say it's not for me. I cannot afford it. In this particular case, do you need hundreds of thousands of dollars to get involved?

Peay: No. If you've got cash or IRA funds, and can invest $25,000 and above, that’s the type of investment target this center will allow. These particular investments with the dialysis centers are not 1031 exchanged with debt so you are not going to satisfy your 1031 exchange off of this.

Anderson: If I wanted to put my retirement funds into something like that, what would I have to do?

Peay: Contact Jeremy Hanks and Michael Madsen at the RealSource Retirement Services division www.RealSource.net/retirementservices.htm. They have the experience and can help you with self-directing funds into real estate investments.