Rising Costs Forcing Medical Practices To Rethink Expansion Plans

As healthcare services continue moving away from hospitals and into outpatient settings, physician groups and regional providers need more locations that are accessible to patients. Yet the cost of developing and occupying new medical office space is making traditional expansion strategies considerably less feasible.

Rising land prices, construction expenses and financing costs have slowed speculative medical office development. New projects increasingly require substantial preleasing commitments before developers can move forward, leaving independent practices and smaller healthcare organizations with fewer affordable options.

Juan Vega, executive managing director at Colliers, pointed to North Tampa as an example of the changing economics. Recent estimates place medical office shell construction at approximately $250 per rentable square foot, with land adding roughly $65 per rentable square foot and tenant improvements frequently exceeding $300 per rentable square foot.

Those costs can translate into triple-net rents approaching $35 to $40 per square foot for newly built medical office space. In comparison, existing medical suites in some markets may still be available at rates in the mid-$20s.

That difference can have a significant impact on practices operating under capitated reimbursement arrangements or other payment models that place pressure on operating margins. Higher occupancy expenses may also contribute to further consolidation as independent groups seek the scale needed to manage rising costs.

Second-generation medical office space is consequently becoming a more important part of the expansion equation. Former medical suites may already contain exam rooms, waiting areas, reception space, plumbing and other improvements that would be costly and time-consuming to install in a newly delivered shell.

Existing medical buildings may also offer locations that are difficult to reproduce. Many are situated within established healthcare corridors near hospitals, outpatient campuses and residential communities where available development sites have become limited.

Traditional office buildings could provide another source of medical space. Some older office properties are selling well below the cost of constructing comparable buildings today, creating potential conversion opportunities for healthcare users and investors.

However, a favorable purchase price or rental rate does not necessarily mean that a property can support clinical operations. Medical users typically require greater electrical capacity, specialized HVAC systems, additional plumbing and dependable data infrastructure. Imaging, surgery and other equipment-intensive services can require particularly costly upgrades.

Parking and zoning must also be examined carefully. A parking ratio that accommodates an ordinary office tenant may be inadequate for a healthcare practice serving a steady flow of patients throughout the day. Providers must also confirm that their intended use is permitted and that the property meets accessibility, visibility and patient-convenience requirements.

The lease structure can be just as important as the building. Renewal options, expansion rights, responsibility for improvements and provisions addressing future infrastructure needs can help a practice avoid another costly move as it grows.

For investors, older medical buildings and suitable office properties may offer opportunities to acquire space at a fraction of current replacement cost. Vega noted that some vacant office buildings can be purchased for approximately $100 to $150 per square foot, potentially leaving room for renovations while keeping the overall investment below the cost of new development.

The changing market does not eliminate opportunities for regional providers, but it does require a more detailed evaluation of each property. Second-generation medical suites and carefully selected office conversions may provide the affordability, location and speed-to-occupancy that new construction can no longer deliver—provided that infrastructure and conversion costs are fully understood before a commitment is made.

Source: Healthcare Real Estate Insights