2019 U.S. Medical Office Trends: Steady Market Fundamentals Supported Thriving Investor Demand

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U.S. medical office market fundamentals have been resilient in 2019.

Demographic and health-care industry trends are firmly entrenched and forecast to persist, supporting long-term demand for medical office space.

— The U.S. medical office vacancy rate remained stable at 10.3% through midyear 2019 despite a surge of completions of new medical office space. In addition, average asking rents stayed near record levels.

— There has been a dramatic decentralization of the health-care industry to provide services closer to the consumer through outpatient centers rather than more costly hospitals. Consolidation among healthcare providers has led to greater mergers and acquisitions activity of hospitals and health-care systems.

— Top-tier domestic institutional and foreign capital, as well as REITs, have fueled demand for medical office properties. Although medical office investment volume was down from 2018 through the first half of the year, the expectation for second half medical office investment volume remains strong.

For a complete copy of the report, please click here.

 

Source: HREI

2019 Medical Office Building Transaction Volumes 50% Higher Than Pre-Recession

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Increasing interest from institutional investors has helped to push the medical office sector to hefty transaction volumes and steady occupancy despite record construction in the second quarter.

A new report from CBRE notes that US transaction volumes this year for medical office properties are 50% higher than their pre-recession levels. Meanwhile, medical-office capitalization rates – a measure of a property’s income as a percentage of its price – have pulled even with those of conventional offices after years of registering higher.

Much of the market’s momentum comes from demographic trends toward longer lifespans and more healthcare consumption as well as a medical-industry shift toward more outpatient care. CBRE defines medical offices as office buildings in which at least half of leasable space is occupied by medical uses such as dental, surgical or special practitioners and services.

GlobeSt.com caught up with Ian Anderson, CBRE’s head of Americas Office Research, for an exclusive interview about the report’s findings on the medical office sector. Here are excerpts from that conversation.

GlobeSt.com: What about the medical office sector is most appealing to institutional investors and why are they jumping into the sector now rather than years earlier?

Ian Anderson: Medical office buildings have been an attractive target for institutional investors for many years, but this current cycle has been unique in accelerating that trend. The current expansion has seen a dramatic transformation in the way commercial real estate is being used, and that sometimes has negatively affected demand for space. That’s particular true for conventional offices, for which demand is influenced by workplace strategies and densification, and for retail space, which is adapting to e-commerce. As a result, many institutional investors have been forced to seek new opportunities that offer attractive returns. This has caused a surge of interest into alternative commercial real estate investments where growth is more robust, such as life sciences lab space, self-storage, and co-living, among others.

Aside from the ‘push’ by investors into emerging, alternative commercial real estate investments, the ‘pull’ of deeply entrenched and highly attractive demand drivers is what is really driving demand for medical office space. Any investor seeking to capitalize on the demographic and consumption trends unfolding in the United States wants to have a position in medical offices. Underlying these megatrends, though, is the continued shift by healthcare systems to provide services in a lower cost setting that is more convenient to the consumer. In other words, allowing consumers to obtain healthcare services near to their home, rather than venturing to the main hospital of a healthcare system. Finally, though, medical office investment is driven by the income derived from these properties, which are frequently supported by a variety of tenants with abundant demand and a reluctance to move upon the expiration of their lease.

GlobeSt.com: What has fueled demand for medical office space in markets where it is strongest, namely Chicago, Atlanta, New Jersey and Nashville?

Ian Anerson: Demand for medical office space varies from market to market due to several reasons. In some instances, we observe higher net absorption – demand – simply as a result of the delivery of new medical office buildings in markets where it is easier to build. For example, there are more medical offices under construction and waiting to be occupied in the Inland Empire than Los Angeles, where it is more difficult to build. In other instances, there are local trends in the healthcare industry, such as a merger between healthcare systems, that may affect demand for space. But generally speaking, higher demand for medical office space by market results from a combination of favorable demographics, either in the form of a growing total population or an existing, abundant elderly population, supported by attractive and growing incomes.

GlobeSt.com: Given the strong trends driving the sector, why aren’t we seeing more construction of medical office buildings? Does the pipeline include more deliveries on par with the record set in this year’s second quarter?

Ian Anderson: Like most types of commercial real estate today, construction of medical offices has remained in check with demand. Not surprisingly, the vacancy rate of US medical offices hasn’t budged by more than 20 basis points in the last two years. In the second half of 2018, we saw construction volume of medical offices drop significantly, which should help boost rent growth for investors in the near-term. Then construction activity picked up in 2019 to levels consistent with the average since 2010, but still well-below the peak of construction in 2016.

 

Source: GlobeSt

Medical Office Building Investors Will Be Chasing Deals In 2020

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As we prepare to swing into the new year, the outlook for the medical office sector is good…largely.

Underpinning the market, as it always has, is the continual aging of the population and the increased medical services that come along with it.

But, despite this sure-bet demand, the sector is not without its challenges, as Al Pontius, SVP and national director of Marcus & Millichap’s Office and Industrial divisions, makes clear. Those concerns arise as a result of the massive industry trend toward consolidation and the move on the part of many formerly independent care providers to saddle up with national care brands.

The firm’s second-half Medical Office Buildings Report defines the growth of the merger movement:

“Hospital and health-system merger activity continues to transform the medical office sector, driving a reduction in physician-owned practices in recent years. In 2012, nearly half of locations were physician-owned practices, but in 2018, just 31 percent were owned by doctors.”

And therein lie the concerns for the existing stock of medical office buildings (MOB).

“There’s a lot of older-vintage product that’s not located where the health systems want to be,” says Pontius. “Some assets may not accommodate the desired configuration of services that the major health systems see as appropriate, modern enough or technologically supportive enough. Consequently, there are a number of buildings that will under-perform relative to newer properties in the sector as well as other asset classes.”

But while there might be assets that sit on the sidelines as healthcare needs grow, few investors, be they institutional or private, are doing the same.

“The consolidation has supported investor sentiment as major providers create efficiencies and broaden service coverage,” says the report. “A sizable pipeline of new space and major expansions by high-credit tenants will sustain elevated investment activity through the end of this year.”

 

Source: GlobeSt.