Substance Use Disorder Treatment Facilities Attracting Investors

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With funding support from the federal government and the growing need for mental health facilities nationwide, this niche commercial real estate sector is evolving and emerging as a viable investment opportunity, including drawing the attention of REITs.

The Substance Abuse and Mental Health Services Administration noted in a 2021 survey that nearly 1 in 4 adults 18 and older, and 1 in 3 among adults aged 18 to 25, had a mental illness in the past year.

“The fastest growing sector in this asset class has primarily been the substance use disorder treatment facilities,” writes Justin Butler, leader of the Healthcare Valuation Practice Group for Colliers.

Most facilities that treat substance abuse disorder are not purpose-built, according to Butler, and many are adaptive reuses of nursing homes, assisted living facilities, hospitals, schools, large homes, and sometimes even apartments and office buildings.

 “The behavioral health industry is currently riding a hot wave in terms of funding from the federal government,” Doug King, Vice President and Healthcare Sector Lead at Project Management Advisors, tells GlobeSt.com. “While this could always turn around if the political winds shift, it’s great to see so many behavioral health and addiction centers opening in communities across the country right now.”

Unlike other medical facilities, which often require specialized technology and higher power needs, behavioral health clinics have about the same requirements as the average office, albeit with the addition of specialized anti-ligature devices and additional surveillance for patients of higher acuity, according to King.

“When looking to lease space for behavioral health centers, the ideal clinic should be located in a centralized place that’s easy to get to on public transportation,” King said. “Especially for behavioral health clinics that focus on addiction, it’s important to find a property with space for socialization, which can be essential for recovery. That’s why we see a lot of behavioral health clinics feature outdoor areas (as many patients are smokers), cafes, and even diners where patients can mingle with each other before and after treatment.They also need to be designed with mental health in mind — lots of natural light, comfortable seating and biophilia, and an array of private areas to accommodate different kinds of patients.”

When it comes to adaptive reuse, one area of opportunity for the CRE industry is the conversion of former retail properties in strip malls and downtown areas into behavioral health centers, King said.

“Not only are these spaces already sufficiently embedded into the community, but they also have enough space for clinics to expand and partner with other community organizations, such as medical nonprofits and housing programs,” said King.

Avison Young’s Brooks Hauf tells GlobeSt.com he has seen an increase in the demand for behavioral health services nationwide.

“The largest challenge for the sector is staffing related as the supply for talent is more specialized and not as deep as other labor sectors,” Hauf said. “With demand for behavioral health services expected to continue, staffing will remain very competitive and will drive decision-making on specific locations that have deeper talent pools.”

Butler said the costs for purpose-built facilities compared to adaptive reuse are considerable, and the increased cost often doesn’t provide comparable increased utility. However, there have been purpose-built facilities in operation.

Sale leaseback transactions generally see year-one yields in the 8% to 10% range, Butler said, but this can vary above and below that based on rent levels, tenant strength, quality of the real estate, and location. Rents are commonly in the $30 to $40 PSF NNN range, and many operators can afford rent at these levels, according to Butler.

“We would expect to see more purpose-built facilities, as well as larger operators with national networks and in-network insurance relationships,” Butler said. “There already have been some publicly traded healthcare and net lease REITs that have been purchased these facilities, “and we would expect that to continue.”

 

Source: GlobeSt.

Why Experts Say Now Is The Time To Buy Medical Office Buildings

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Despite all the doom and gloom of the news about the office sector, one component remains strong: medical office buildings.

It is buoyed by a stable clientele, long-term leases, and a slow pace of new entries. Even better, the buildings’ tenants can rely on a steady flow of customers in need of care. The flow has even increased as a result of passage of the Affordable Care Act, an aging population, and advances in medical technology that enable more procedures to be delivered in lower-cost, more efficient outpatient settings.

And investors are paying attention, according to the just-released 2024 report “Emerging Trends in Real Estate” issued by PWC and the Urban Land Institute. In total, the U.S. healthcare industry represents 17% of GDP. Outpatient care and care provided in medical office buildings is a significant share of the total.

“The sector has also been shifting to a retail mind-set, where hospital systems and providers look to attract new patients and build market share in new areas, contributing to the increased demand for high-quality medical space,” the report noted.

For landlords, medical offices are practically ideal tenants. They may sign leases of 15-20 years and are likely to renew them in order to remain close to their patient base.

“Typically, the renewal rate is 80% or more and rent growth generally ranges between two and three percent a year,” the report stated. “These dynamics have helped the medical office sector maintain healthy fundamentals throughout economic cycles.”

Furthermore, occupancy has risen in recent years as space absorption has outpaced square footage added. The occupancy rate was 92.8% in 2Q 2023.

Nevertheless, “after reaching peak investment volumes of $30.2 billion (annual basis) in the third quarter of 2022, medical office transaction volume has since slowed to $20.2 billion as of the second quarter of 2023,” the report noted.

But while it has slowed, it has not stopped. Transaction volume totaled $4.7 billion in the first half of 2023 – lower than the $10.1 billion sold in the same period of 2022, but consistent with levels seen from 2018 through 2021. Few distressed sales have occurred. The report attributed the lower transaction volumes to a “disconnect” between sellers and buyers.

“But the stage is set for increases in volumes when buyers and sellers can better come together and the capital markets begin to normalize,” it said. “The medical sector is large and investable, comprising over 1.5 billion SF of current inventory. A substantial amount of opportunity exists for investors to take on more ownership.”

By square footage, over half the sector is owned by users – hospitals, providers, and physician groups. The rest is owned by REITs and private investors who use a variety of structures and vehicles to make it work, the report noted. Institutional investors often invest through operating partners, frequently vertically integrated regional or national firms that specialize in the development, acquisition and operation of medical office buildings and often have deep relationships with hospitals, health systems and physician groups.

Speculative development is rare, leaving inventory to increase at a pace driven by tenant demand, currently around 1% and seldom rising more than 2% a year.

The opinion of experts surveyed for the report is largely favorable. Some 48% recommended buying, 46.4% said hold, and just 5.8% said sell. And while 34.3% considered the sector overpriced, that was a much smaller percentage than viewed suburban and central-city offices as overpriced. Some 61.4% thought medical offices were fairly priced and 4.3% thought they were underpriced.

“The medical office sector has matured into an attractive and stable CRE asset class of its own,” the report concluded.

 

Source: GlobeSt

Medical Office Building Sector Remains Stable, Attractive

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Having weathered recent headwinds, the medical office building sector is seeing a return to more stable property fundamentals, according to a new Medical Office National Report from Institutional Property Advisors.

There was a COVID-driven fall-off in medical visits in 2020, but this has “generally dissipated,” the report states, adding that “medical office vacancy has stayed between 8 and 10 percent and, in June 2023, the rate was just 50 basis points above the long-term average.”

Rising construction costs have helped to prevent overbuilding, with medical office space totaling only 10.7 percent of the overall office pipeline. IPA points to a very different factor limiting the product type: “… the sector’s main challenge is not supply, but rather a health-care labor shortage.” The pandemic has exacerbated an existing worker shortage that may hinder practices seeking to expand to meet future medical care demand.

High interest rates have affected both deal flow and pricing. Transaction velocity in the MOB sector fell by more than 30 percent over the 12 months that ended in June.

“The average sale price has begun to recalibrate accordingly,” IPA reported, “dropping 3 percent from the high reached in 2022 to $295 per square foot for the yearlong span ended in June.”

MOB regional performance

MOB regional performance. Table courtesy of IPA Research Services; Bureau of Labor Statistics; Federal Reserve; Centers for Medicare & Medicaid Services; Moody’s

On top of that, a paucity of transactions, especially those of $10 million or more, have hampered price discovery.

Geographic Diversity

A variety of regions across the country split up top marks for different performance metrics.

The Mid-Atlantic and the Southeast (driven by Florida) lead in terms of low average vacancies, and the former is tops for a falling overall vacancy, having dropped by 40 basis points year-over-year. The Mountain States too have seen a sizable fall in overall vacancy, by 30 basis points.

Asking rents are highest (at $32.74) in the Pacific region, and lowest in the Midwest ($17.50). Rental growth was far and away the highest in the Central Plains region, with 7.8 percent year-over-year. The Northeast (4.6 percent) and Southeast (4.5 percent) were essentially tied for a distant second place.

 

Source: Commercial Property Executive