Q&A Regarding Real Estate’s Fast-Emerging Frontier In Cancer Care And Research & Development

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Thomas Osha has a unique vantage point when it comes to innovation districts rooted in the life sciences. As executive vice president of Wexford Technology + Science out of Baltimore, he runs point for one of the most active U.S. developers of real estate used by major research universities and their private-sector partners.

He recently caught up with Ashley Fahey, The Business Journals’ national real estate editor, to talk about post-pandemic development and how demand is reshaping real estate needs in the realm of cancer-related R&D and treatment.

Below is an edited transcript of their conversation.

Ashley Fahey: Can you talk a little bit about what markets you want to be in?

Thomas Osha: One of the things that we have seen is an acceleration of a move by companies and startups to be near university research. It doesn’t necessarily matter where it is, it matters what it is. So we are seeing areas popping up in Sacramento, Phoenix, Providence, Winston-Salem, Charlotte. A number of cities, Baltimore, St. Louis, that aren’t necessarily considered the major hubs of life sciences, yet at each one of these there are scientists, there is intellectual capital and innovation that companies want to be near.

So it’s starting to branch out to some tertiary and secondary cities, and that’s where you guys are planning your next projects? Very much so. I’ve always said that talent is the currency of innovation.

Ashley Fahey: A lot of cities want to get in on life sciences. What are you seeing at Wexford?

Thomas Osha: I spend a lot of time with local mayors talking about what it is like to create an innovation district. So much of the conversation was around an innovation district being a place where people cluster and connect. It’s not just draw a line and say, “This is the district. You’re in, or you’re out.” In a lot of ways, this is about place making as much as it is about construction of buildings.

 

Click here to read the remainder of the interview.

The Medical Office Sector Continues To Hold Steady

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The medical office sector couldn’t be in better shape despite fears of the impact from telemedicine and given the demand for health care, the industry should be robust over the next 12 months, according to analysts.

A segment known for its stability and resistance to recessions set record highs for asking rents in 2021 as vacancies decreased–a trend expected through the next year and beyond. Development of new medical office buildings continues after a slowdown at the start of the COVID-19 pandemic, and for quality properties on the market, investors are gobbling them up quicker than ever. That’s coming off record highs in sales volume and pricing in 2021.

None of that demand is a surprise given an aging population along with migrations and relocations that have picked up since the start of the pandemic in 2020.

Maddie Holmes, a New York-based senior research health care analyst for JLL, said medical office absorption hit a record in 2021 at 18.5 million sq. ft. on a trailing fourth-quarter basis–nearly two times the typical rate going back to 2019 and previous years. That demand continues to be strong in 2022 despite telemedicine becoming a bigger part of the health care landscape.

“Health care is a contact sport in that you have to see your physician,” said Bryan Lewitt, a managing director for healthcare in JLL’s Southern California office. “Telemedicine and Facetime and other avenues of technology aren’t enough because they’re not diagnostic. When the hospitals closed because of COVID, most people delayed their health care visits, procedures. That has created a huge demand for these next two years.”

Travis Ives, an executive director with Cushman & Wakefield who heads its U.S. Healthcare capital markets team, said telehealth has even helped the medical office segment because it connects patients with physicians.

“That makes it more likely that a serious problem will be diagnosed and require treatment,” Ives said. “That treatment is going to occur in a medical office building rather than in an emergency situation like in a hospital. There’s just so much health care that can’t be delivered over the phone. It’s become another component to the delivery care continuum, but not something that’s going to replace medical offices.”

The State Of Medical Office Occupancies

During the pandemic when there was a slowdown in construction starts, coupled with those high rates of absorption, occupancy for medical offices moved from 91.3 percent during the first quarter of 2020 to 91.7 percent at the start of the first quarter of 2022, Holmes said.

Shawn Janus, national director of Healthcare Services for Colliers, reported five of the 10 leading U.S. markets started 2022 with vacancy rates lower than the national average of 8.3. percent. Boston had the lowest vacancy rate at 6.3 percent, followed by New York, 6.8 percent. Miami, Philadelphia, and Chicago were below the national average while Los Angeles was just above it. On the other side, Dallas and Houston had the highest vacancy rates among leading markets at 10.9 percent and 12.5 percent, respectively. Atlanta and Washington, D.C. exceeded 9 percent, Janus said.

“I think you’re seeing vacancy in older medical buildings that are now picking up office tenants, while class-A and class-B (medical offices) have lower vacancy. And if they are strictly medical they do much better,” said Susan Wilson, a healthcare real estate advisor for Lee & Associates and vice president of Lee Healthcare.

Medical office rents historically grow at a steady rate of 2 percent to 3 percent year–over-year, but that pattern is being challenged by current conditions.

“There’s very little supply coming online, and we have already fallen below 10 percent vacancy, which is not a healthy market for tenants,” Lewitt said. “The landlords are going to have a lot of leverage, plus you have increased construction costs that will make it difficult for providers to relocate. I suspect that rents are going to continue to go up because 80 percent of tenants renew their lease in health care. It’s a very sticky business.”

During the BOMA International’s Medical Office Buildings + Healthcare Real Estate Conference held in May in Nashville, Ives said this was the first time that every meeting they took with medical office building owners focused on rental growth.

“They are starting to push their annual escalations and wondering how far they can push their rents,” Ives said. “Most of them have portfolios that are getting up to 90 percent to 95 percent occupied and are starting to think ‘we may as well be asking for it at this point.’ I think rent growth will run hot here for a little bit. As long as vacancy remains tight and inflation is relatively high, I think you will see rent growth running higher than it has historically. Where it used to be the norm to ask for 2.5 percent to 3 percent annual increases on a new lease, in a lot of markets now it’s 3.5 percent to 4 percent-plus. That might not be a big deal in other products but for medical offices those are big escalations.”

Janus said there’s a lot of discussion with tenants about sharing inflation risks since a 2 percent increase doesn’t compensate owners costs with inflation currently running at 8 percent.

“I have heard 4 percent fixed-rate increases, which I have never seen in 20-plus years in this space,” Janus said. “There has been talk about going to CPI and doing it in a risk-sharing manner.”

While leases of 10 to 15 years give owners a security of income, they are looking at shorter term leases so they can bring it back up to the market given the volatility and inflation, Janus said.

“Providers are asking if we want shorter-term leases because inflation is high right now and when it comes back down, do we want to be caught in a 10-year lease that continues to escalate,” Janus said. “And if we can reset, the market may come back down.”

With this environment, Janus said some tenants are looking at whether they should now own their buildings rather than lease them.

There are limits, however, to how much medical office rents can grow, according to Chris Jacobson, a healthcare real estate advisor for Lee & Associates and vice president of Lee Healthcare.

“It’s never going to go through the roof,” Jacobson said. “They can only afford what they can afford with reimbursement from insurance. They can only see so many patients and do so many procedures a day. It’s not like they can sell more coffee.”

Lee Asher, who leads the Healthcare & Life Sciences Capital Markets at CBRE, cited how rental rates are trending up because of rising construction costs and increased tenant improvements. Rental rates across the country have been in the low $20s on a triple net basis while new construction is in the low $30s on a triple net basis, he said.

“If you’re an existing tenant that used to be in the low $20s and your alternative is to relocate to a new building that’s going to be $30, you’re going to think hard about staying,” Asher said. “The landlords recognize that and are able to push rates at their buildings to mid-$20s on a triple-net basis.”

For those who want to relocate, a tenant improvement package to upgrade and do a full build-out for new space is about $100 a sq. ft. and $150 if it’s specialized, Asher said. The tenants can stay where they’re at, and the landlord will increase rents and give $10 a sq. ft. in tenant improvements for paint, carpet and millwork.

“If you’re an existing owner, you’re probably at 85 percent to 90 percent retention,” Asher said. “The question is if you have a vacancy in your building, how do you fill it if no one is moving. What we are seeing is there’s still a lot of consolidation and expansion among physician groups. The No. 1 reason I hear from our leasing folks as to why someone would relocate is they’ve grown out of their space and the building can’t accommodate them. It creates a vacancy in the building, but there are other tenants expanding as well that can backfill that space.”

Entering 2022, average net asking rents for medical office space increased by 1.7 percent over 2021 to $22.61 per sq. ft., which is a new high, Janus said. Rent growth in 2021 was strongest in Los Angeles at 3 percent, followed by Chicago and New York with 2.2 percent.

Los Angeles has the highest average net asking rents at $35.13 per sq. ft. Boston and New York were the next highest at $26.70 per sq. ft. and $26.11 per sq. ft., respectively. Rents in the remaining markets range from $20 to $25 per sq. ft., Janus said.

The Medical Office Investment Sales Climate

The medical office sector is building off a record year in 2021 for sales that resulted in $15.4 billion in transaction volume, according to Todd Perman, vice chairman of global healthcare services for Newmark. Perman said he doesn’t expect hospitals to use general offices as much going forward when employees can work from home.. That was a 23 percent increase over 2020 and 142 percent increase over 10 years. The price at $358 per sq. ft. reached its highest value in 20 years. Cap rates have compressed to the lowest average in more than 20 years at 5.9 percent. Private equity, strong medical office occupiers, and shifting demographics contributed to the banner year, Perman said. Because of recession resiliency, new domestic and foreign investors are seeking out acquisitions, he added.

“In recessionary periods, there’s always been a flight to quality and health care is one of those areas people fly to,” Perman said. “They flock to invest in health care when other areas like retail and other sectors are not performing as well, and there’s more risk in those sectors. We have seen through the pandemic that we have new investors in this space and billions of dollars invested on top of what was already here because of that flight to quality.”

Private equity interests led the way accounting for 63 percent of sales volume, according to Revista. PE investors also made up 75 percent of the sellers.

“There is a lot more money going after buildings than there are buildings for sale,” Wilson said. “If an investor wants to sell the building, it will probably never make the market if it’s fully leased. If it’s 100 percent medical and good credit tenants, it will be gone in a week.”

Janus said pricing was highest in the West and Northeast at $515 and $420 per sq. ft. The Southwest was third at $361 per sq. ft. The Midwest has the lowest average pricing of the six U.S. regions at $280 per sq. ft., he said. There have been sub-4 percent cap rates for prime medical office buildings, he said.

Jacobson said he recently saw a 2.7 cap rate in California.

Analysts said they don’t think the new cap-rate lows can sustain themselves but flatten out. There’s no shortage of capital, and there’s a lot of competition for assets and thus a positive outlook for medical office demand.

Lewitt added, however, that given inflation at 8 percent and rising interest rates, there’s some pause at the moment among investors to figure out the returns.

 

Source: Wealth Management

U.S. Demographic Trends Strongly Favor Medical Office Real Estate

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The dislocation caused by COVID impacted all areas of life and transformed work and leisure for tens of millions of Americans.

The health crisis also prompted an unprecedented population shift over the past two years, which along with an accommodative Federal Reserve, stimulus payments, and a buoyant stock market contributed to a dramatic rise of residential real estate prices in the United States.

The availability of remote work, a tight labor market which shifted power to employees to demand more flexible work arrangements, escape from strict pandemic-related public health measures, a general interest of people to move to a warmer climate, more tax-friendly locations, with better job and salary prospects, a buoyant stock market that lifted household wealth and, of course, rising home prices, and a frantic search for a shrinking inventory of affordable homes all contributed to an unprecedented population shift over the past couple of years.

These trends also favor another area of real estate favored by sophisticated individual investors and institutions, healthcare real estate.

“Before the pandemic, the healthcare sector was characterized by long-term leases, stable occupancy, consistent income streams and quality tenants with stable, long-term leases and high credit ratings,” says Martin Freeman, OrbVest CEO, “as the pandemic recedes we see even more reason for long-term optimism for individuals and institutional investors considering opportunities in this sector.”

OrbVest is a global real estate company investing in income-producing medical commercial real estate in the United States, and is one of a growing number of companies looking to capitalize on the growth and potential of US healthcare real estate.

What Are The Trends?

The National Association of Realtors recently highlighted metropolitan areas in the Sunbelt and Mountain states that saw the highest yearly price gains: Punta Gorda, Fla. (28.7%); Ocala, Fla. (28.2%); Austin-Round Rock, Texas (25.8%); Phoenix-Mesa-Scottsdale, Ariz. (25.7%); Sherman-Denison, Texas (25.1%); Tucson, Ariz. (24.9%); Las Vegas-Henderson-Paradise, Nev. (24.7%); Ogden-Clearfield, Utah (24.7%); Salt Lake City, Utah (24.4%); and Boise City-Nampa, Idaho (24.3%).

Chicago, Milwaukee, New York City, and San Francisco all saw a population decline during the pandemic because of fewer jobs and unfavorable demographic trends.  In 2021, New York, California, and Illinois each lost over 100,000 people to outmigration.

According to Redfin, a record 32% of users nationwide were looking to move to a different metro area during the first quarter of 2022.

The 2021 U.S. Moving Migration Patterns Report from North American Moving Services also showed that Illinois, New York, California, New Jersey, and Michigan were the top five states for outbound moves, while Idaho, Arizona, South Carolina, Tennessee, North Carolina, Florida, Texas, and Utah were the top states for inbound moves.

Redfin noted the top 10 places where Americans are considering moving include: Miami; Phoenix, Las Vegas; Sacramento; Tampa; Dallas; Cape Coral, Fla.; North Port, Fla.; San Antonio; Atlanta.

The Marcus & Millichap multifamily market forecast primarily reflects these statistics and trends. The company specifically cited that the Sunbelt and Mountain regions should thrive. Even before the pandemic, the Sunbelt saw significant in-migration, household formation, and employment growth. During the pandemic, this region saw fewer job losses, mainly due to public policy regarding restrictions. The Mountain region is also seeing momentum thanks to rapidly growing populations, a strong quality of life, and affordable living costs.

Let’s take a deeper look at what could be driving these migration trends.

COVID-19

A Pew Research Center study conducted in June 2020 found that over a quarter (28%) cited COVID-19 as a significant driver for why they moved. Many people relocated due to fear of catching the virus while others moved to escape restrictions.

A worldwide pandemic would not have necessarily been a migration driver pre-2020. However, the pandemic indeed exposed a divide between how to handle the pandemic. Blue states such as California, New York, and Illinois had some of the harshest coronavirus restrictions. Michigan also saw significant out-migration due to the collapse of the auto industry and COVID-related public policy. Red states, on the other hand, such as Texas and Florida, kept their conditions largely open. This undoubtedly led to a short-term migration driver for people seeking to earn a living and escape restrictions.

Take New York City, for example.  In March 2020, there was a 256% increase in people moving out of the city compared to the same month in 2019. Between March and August 2020, 246,000 people filed a change of address request- an almost 100% increase compared to the same period in 2019.

Remote Work And Learning

Somewhat related to COVID and its shutdown restrictions, the rise of remote work and learning has been another driver for migration. Many students could also be taking advantage of online learning to save money on housing and living expenses.

Climate

The 2020 U.S. Moving Migration Patterns Report noted that the Northwest and Midwest were the regions in the U.S. experiencing the most outbound migrations. Harsh winters are certainly a contributing factor. Meanwhile, the same report cited climate and open space availability as reasons for southern states experiencing great inbound migrations.

According to Moving.com, the weather is the number one reason people move to Florida, for example. Despite hot and humid summers, the state has about 200 sunshine-filled days a year and seasons that tend to be mostly mild and warm. Average winter temperatures also appear to range between the 60s and 70s.

Not every state can boast the same climate that Florida has. However, other places in the Sunbelt and South have mild temperatures of their own that might be contributing to the amount of inbound migration.

Job Growth/Availability

In the Pew Research survey we previously mentioned, a total of 18% gave financial reasons, including job loss, as their motivation to relocate. This driver is also correlated with COVID-19 and policy restrictions. While states hit hardest by restrictions and job losses saw the most out-migration, those who stayed relatively open and kept their job market afloat saw the most in-migration.

Multiple sources and indications show that the Sunbelt, the South, and the Mountain regions are the best locations for job opportunities and job growth.

According to U.S. News, the Top 5 states for job growth are as follows: That’s 2 Sunbelt states, 2 Mountain states, and 1 Southern state.

Other data corroborates this too. According to the Seidman Institute, Idaho was the ONLY state in the U.S. to experience year-over-year job growth for total nonfarm payrolls in January 2021 and is leading year-to-date too.

4 of the Top 5 states leading in job growth based on a 12-month moving average are also all Mountain states: Idaho, Utah, Arkansas, Montana, and South Dakota.

This interactive map from the WorldPopulationReview depicting “Job Growth by State 2021” seems to expand on this data. Notice which regions of the country are lighter shaded (less job growth) and which areas are darker shaded (more job growth).

Income Tax/Affordability

“An income tax increase in a state may cause individuals to out-migrate over time,” says the Cato Institute.

Because of the economic hardships that many Americans have faced, the correlation between state income tax rates, affordability, and migration is not coincidental.

3 of the Top 8 states for in-migration- Florida, Tennessee, and Texas- do not collect state income tax. Meanwhile, other top states for in-migration, Arizona, North Carolina, and South Carolina, have a minimal state income tax.

While growing Mountain States, such as Idaho, do have state-income tax, Mountain States are generally more affordable and have a slower life pace. Compare that to states such as California, New Jersey, and New York. All three of those states are in the Top 5 for most out-migration, and unsurprisingly, their state income tax rates are 13.3%, 10.75%, and 8.82%, respectively.

Impact On The Healthcare Industry

The Sunbelt, South, and Mountain regions have experienced the most in-migration. It is not a coincidence that these regions are also seeing the highest volume of medical office sales.

Medical office sales volume totaled $19.6 billion in 2021 a 40.1% increase from 2020, a significant increase from prior years’ sales ranges of $13 to $14 billion.

The five states with the most MOB square footage under construction are California, Florida, and Texas, New York and Ohio.  The same five states also top the list of hospital construction activity.

Houston, Texas is the leading metro market for construction, and other Sun Belt areas like Orlando, Miami, and Atlanta are all in the top 10.

There is a direct correlation between healthcare real estate, demographics, and migration. Sunbelt states have seen investor interest in medical office buildings due to pleasant year-round climates attracting aging boomers and young families seeking to enjoy better weather and a more active lifestyle.

You have to consider the cost of living and the cost of healthcare as well. For the younger population, it is much more affordable to raise a family in the Sunbelt and the South compared to New York City and San Francisco, especially when you consider the cost of healthcare.

For our aging population, consider the essential needs for affordable and convenient healthcare as the 80+ demographic is growing quickly, and outspending every other age on healthcare combined.

The 65-and-older population has increased from 12.8 percent of the population to 16.1 percent. By 2030, it may comprise more than 1/5 of the U.S. population. This has a direct and critical impact on healthcare. According to data from the 2010 Census, more than two-thirds of people in this age group (66.5 percent) see the doctor three or more times a year, up from less than half of those aged 46-64 (44.2 percent).

For one example of how demographics provide a tail wind for  segmented and specialized healthcare facilities, look to South Florida, home to the highest concentration of seniors in the country, with more than 3.3 million Floridians aged 65 and older, and 1 in 20 now 80 years old or older.

Migration and Demographics Fueling Medical Office Building Boom

We are witnessing a boom in the medical office building (MOB) real estate market.  MedCraft Investment Partners announced the launch of a $500 million joint venture for medical office acquisitions, and, Kayne Anderson Real Estate is getting ready to close a $2.5 billion fund of which approximately half will be allocated to medical offices.

In 2021, 280,000 square feet of medical office space was absorbed – a 77% increase from 2020, according to JLL.  medical office vacancy down two basis points to 5.8%, the lowest levels since 2006 and medical office rents rose 5.5% in 2021, according to JLL.

Average net asking rents for MOB space increased by 1.7% in 2021 to $22.61 per square foot — setting a new high for the sector, according to Colliers.

Companies with a track record for success like OrbVest, are able to navigate this competitive marketplace and are attracting a great deal of interest from individual and business investors around the world seeking dollar dividends and an inflation-resistant asset in times of volatility.

“We are mindful of the increasingly competitive market for prime assets and are constantly re-assessing and adjusting OrbVest’s business model to match evolving market conditions,” says Freeman. “We are fortunate that OrbVest is able to leverage the relationships it has built up with brokers and providers of these assets so we can continue to secure almost 75% of our deals off-market, providing a sustainable pipeline to meet investor expectations.”

Key Takeaways

For healthcare real estate, demographic shifts and population migration trends go hand in hand with location and its correlation to healthcare real estate trends.

America is rapidly changing and graying.  Our population is not only aging but also taking into account quality of lifestyle more than ever before.  Young families want a more affordable, lower-stress and higher-quality lifestyle. Seniors want to enjoy a better climate with affordable and convenient healthcare integrating with their lifestyles. These migration trends preceded the pandemic, but the pandemic accelerated these trends.

If you’re considering investing in healthcare real estate, consider how demographic changes, migration, and how people’s location preferences directly correlate with healthcare properties.

Suppose you can look into crystal ball not 5 years into the future but 10+. In that case, you can unlock a historically strong investment opportunity in medical office buildings and healthcare real estate.

“We believe that healthcare-related commercial real estate in the U.S. should continue its growth as an ageing population and technological progress drives increasing demand for these specialized buildings. We are very excited to be executing successfully in this rapidly growing space,” says Freeman.

 

Source: Global Banking & Finance Review