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Medical Offices Ready For Spike In Record High Number Of Insured

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The total number of uninsured in the US has reached a new low and the medical office asset class stands to benefit from it, according to Marcus & Millichap’s 2024 National Investment Office Forecast.

This robust demographic will need and seek more visits to healthcare providers, subsequently driving tenant demand for medical spaces, particularly in markets such as Louisville, Seattle-Tacoma, Portland, and Boston.

Those areas have sub-6.5 percent vacancy rates. Texas has the largest percentage of uninsured residents nationwide and carries an office vacancy rate above 15 percent in San Antonio, Houston, and Dallas-Fort Worth.

Arizona and Nevada, too, have high uninsured populations, with vacancies in Tucson, Phoenix, and Las Vegas above 12 percent.

In Florida, some metros notably refute this trend as the state’s uninsured rate is over 11 percent, but West Palm Beach and Miami-Dade have some of the lowest vacancies among major U.S. markets. Medical office projects are slated to constitute approximately 70 percent of the space completed in Tampa this year.

In 2023, fewer medical office assets changed hands than in 2022. However, transaction activity is above the 10-year average in most regions. An aging population will necessitate medical office expansions long-term.

Marcus & Millichap cited a challenged borrowing environment and said this pressure will likely ease in 2024 as many investors expect interest rate cuts.

“Additionally, private investors have become more active in the space as institutions pull back,” according to the report. “Deals in lower price tranches have increased the use of seller financing in some cases, circumventing lender-based headwinds.”

The report said that the new supply would fall to a nearly two-decade-low construction as it will be reduced by 8.5 million square feet to approximately 500,000 fewer square feet of medical office space this year compared to last. This will push total inventory up by just 0.7 percent.

“Limited additions will prevent any major supply headwinds going into 2024 and beyond as new starts decrease as well,” according to Marcus & Millichap.

Vacancy rates will climb by 20 bps to about 9.8%, according to the report. Meanwhile, medical office tenants will still grapple with a prevailing labor shortage, complicating operator expansion plans.

The average asking rent for medical office space will rise by 1.3% to $23.40 per square foot by December as new buildings come online, reaching a more than two-decade high. Metros such as West Palm Beach, Salt Lake City, and Portland are expected to lead the nation in rent growth, concurrent with local vacancy rates below the national average, according to the report.

 

Source: GlobeSt.

What Drives Investors To US Healthcare Real Estate

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US Healthcare real estate continues to buck the work-from-home trend that has stifled growth in office properties in all major economies post-Covid-19.

This is due to a number of factors, including the one-on-one nature of medical care and long-term growth trends in the medical sector in the US, which ensure that rentals and capital values for MOBs stay relatively stable.

The medical office market has consistently seen annual rent increases since 2012. Favourable lease terms support minimal tenant turnover, creating steady rental cash flow, thus benefiting both vacancy and rent trends. According to a report from Colliers, despite the rise in average rentals in MOBs, vacancies have declined to 8%, contrasting with vacancies in the office sector in general, which stand at 15.1% and growing.

Rentals for traditional offices usually rise faster than those for MOBs in upturns but MOB rentals tend to be more resilient during downturns. Since 2000, growth in MOB rentals has averaged 1.8% a year compared with 1.4% average growth for traditional office space.

Advantages Of Healthcare Real Estate Over Other Property Investments

These advantages arise due to several underlying drivers of MOBs.

One is that since the Affordable Care Act was passed in 2010, the number of Americans with health insurance has risen steadily. These trends are expected to continue. In June last year, the Office of the Actuary Centres for Medicare & Medicaid Services forecast that from 2022 to 2031 average growth in national health expenditure at 5.4% would outpace average GDP growth at 4.6% in the same period, resulting in an increase in the health spending share of GDP to 19.6% in 2031 from 18.3% in 2021. By 2031, 90.5% of the US population will have medical insurance (in 2009 it was 85%).

Another driver is the ageing US population. The number of people aged 65 and older in the US has risen by about 3% a year over the past decade, and older people are generally more likely to use medical services such as routine check-ups, dental cleaning and visiting specialists – which are increasingly happening in medical offices rather than hospitals.

Healthcare real estate is different from most other types of office building in that healthcare tenants are readier to sign long-term leases because they build up a reputation with patients in their vicinity and often require significant set up costs especially in the case of imaging, laboratories, theatres, oncology and even dentistry. For investors in these buildings, long leases provide predictable cash flow, lower tenant turnover (and associated sign-on costs) and lower vacancy rates.

Longer-Term Outlook For Healthcare Real Estate

While demand for healthcare real estate is growing, supply is restricted as banks are pulling back lending in an environment of high interest rates and construction costs, which deters new developments. In this environment, opportunities also arise to buy distressed assets at attractive entry points that will deliver superior returns over the long term.

According to a survey of 37 institutional healthcare investors by US-based management consultants KaufmanHall, which was published end-September 2023, almost 90% of survey respondents reported that occupancy rates had improved or stayed the same over the preceding 12 months. 86% of respondents expected their MOB portfolios would perform similarly or better in 2024, and almost the same proportion expected annual rentals to rise by 3% or more for new or renewed MOB leases.

Although the majority of respondents said tenant improvement packages were having to become more aggressive to persuade new tenants to sign or existing tenants to renew, only 16% said they had had to offer inducements such as a rental-free period. KaufmanHall suggested demands for better sign-on deals probably reflected rising costs due to inflation rather than more fundamental shifts.

“In short, the survey results indicate a market with significant fundamental strength despite capital market challenges. Cap rates are up, meaning valuations are down, and transaction volumes are also down. Past experience suggests that this dynamic may offer a significant opportunity to buy high performing assets at attractive historic relative valuations,” KaufmanHall said.

Conclusion

Steep increases in inflation and interest rates over the past couple of years have demonstrated that property is not always a safe haven. Investors in over-geared properties, or those where lease agreements provide no protection against rising tenant costs, are feeling the strain. There are an increasing number of distressed sales in the general office market. This is an environment where investors should pick their sector very carefully. Well-maintained and well-tenanted healthcare buildings in good locations, managed by an experienced team, stand out in this market.

 

Source: BizNews

Medical Office Real Estate Trends To Watch In 2024

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While the office sector is still far from recovering following the COVID-19 hit, the medical office building market continues to thrive, mainly due to asset specificity.

Typically, the sector has a low vacancy rate, with stable tenants occupying the properties for long periods of time. Additionally, the aging population and the advances in medical technology are both supporting demand for such spaces. No wonder that interest from investors in picking up MOB assets is on the rise.

Despite a lower transaction volume compared to previous years, the national average price per square foot stood at $296 in the first half of 2023, according to a CommercialEdge report. From 2017 to 2022, prices consistently hovered between $260 and $290.

For Kevin Smigiel, vice president of Healthcare Advisory Services with the Phoenix office of Transwestern, one of the biggest advantages that an increasing number of investors are now seeing in the health-care real estate sector is tenants’ willingness to sign long-term leases. This has prompted some traditional office owners to turn to this particular type of asset class, despite not pursuing such investments before the pandemic.

“The number of office owners who previously would not pursue a medical deal in their office building for fear of fending off office users are no longer holding that line and have become willing to chase medical deals in order to increase occupancy in their assets,” said Kenneth Smondrowski, senior vice president of Healthcare Advisory Services in the Bethesda, Md., office of Transwestern. “This makes perfect sense because it means longer deals, better credit and stickier tenancy.”

Until recently, MOBs were seen as an alternative asset class, but now they are more of a mainstream investment sector. Rahul Chhajed and Michael Moreno, both senior vice presidents & senior directors of health care with Matthews, agree that medical office buildings are a recession-proof asset class that is not only seen by investors as a way to broaden their portfolios, but they also provide opportunities for consolidation in the space.

“You can buy a building leased by a one-practice physician group, which then gets acquired, and now you go from a tenant with $5 million in assets to $5 billion. That is obviously going to increase the value of real estate,” Chhajed said.

Not Immune To Challenges

Despite some key elements that work in favor of the health-care real estate sector and that make it resilient in the face of economic uncertainty, Shawn Janus, national director of health care with Colliers, points out that the market did indeed experience a slowdown in transaction activity in 2023.

“Volumes were down, with portfolio transactions being particularly impacted. Smaller transactions and single-tenant transactions held up better,” Janus said. “The broader health-care industry also dealt with the changing macro environment. Key factors included the cost and availability of capital and skyrocketing labor costs. From a real estate perspective, health-care providers focused on their real estate strategy, evaluating lease versus own impacts.”

In the upcoming year, the performance of the health-care real estate sector will likely mirror 2023, according to Mervyn Alphonso, executive vice president of development and acquisitions & partner with Anchor Health Properties. High interest rates and construction costs, as well as uncertainty stemming from the geopolitical context, will continue to have an impact on the sector.

Additionally, Moreno believes that health care will be experiencing the same difficulties as other asset types in terms of financing due to interest rates staying up, and maturing debt potentially leading to lower values and distress in non-core assets.

“Health care has similar financing to other asset types, and rates have affected everybody. Many of the larger institutional lenders have also pulled out of the space, so it’s not the greatest financing market right now,” Moreno said.

Another challenge that Janus pointed out is related to the labor environment. Even though clinical space requirements are growing, staffing those clinical functions has caused some projects to be delayed.

“Administrative space, on the other hand, experienced a decrease in demand as providers looked to downsize or off-load space, due to the effects of remote working and/or flexible work schedules,” Janus said.

Many underused office buildings underwent conversions, including to medical office facilities, according to Smondrowski. One such example is Richardson Medical Center I in Richardson, Texas, a 118,472-square-foot property that Big Sky Medical recently acquired from Pillar Commercial. The new owner has rebranded the asset as a medical office building.

What To Keep An Eye On In 2024?

In the upcoming year, the health-care real estate sector will most likely continue to be impacted by high interest rates, even though the general consensus in the capital markets is that the Federal Reserve is either done with their tightening cycle, or close to it.

“While the prospect for rate cuts in 2024 is murky, having a more stable interest rate environment will allow pricing and underwriting to gain its footing,” Janus expects. “Unfortunately, the labor environment may continue to be challenging. The cost of labor may stabilize, but supply will continue to be a challenge.”

According to the Colliers expert, physician shortages have begun plaguing the industry as older specialists are retiring and the number of new entrants hasn’t kept up.

Nevertheless, the sector’s prospects are far from completely dire. Experts agree upon one thing: the rise of mental health-care clinics. As Smondrowski explains, there was less funding in the past for these types of clinics, but that is rapidly changing as these facilities become more in demand.

“Mental health providers are booming right now, with private-pay mental health practices opening everywhere,” Smondrowski said.

Janus also believes that behavioral health will have a growing impact on the MOB sector going forward. The specialist noticed that providers, investors, developers and lenders alike are intrigued with the potential opportunities in this space and are increasingly more interested in understanding this sub-sector and its financial viability.

From a developer-investor’s perspective, no drastic changes are expected in the market next year. Despite sustained demand, factors such as staff shortages and financing challenges will continue to impact the medical office sector, in Alphonso’s view.

“Medical outpatient construction spending reached a peak in 2023. The volume of projects steadily climbed since early 2022,” Alphonso said. “Given Anchor’s current solid development pipeline and additional pending opportunities in various geographic markets, I would expect the construction volume in the sector to be fairly steady in 2024.”

In the past year, Anchor started construction on several health-care real estate projects, with some of them set for completion either next year or in 2025. One of the largest developments they broke ground on was HonorHealth Medical Campus at Peoria, a 100,000-square-foot medical office project in Arizona. 

Other health-care real estate developers starting new projects include PMB and its partner Santa Clara Valley Healthcare which broke ground on a 230,000-square-foot medical office building in San Jose, Calif. The 10-story property is slated for delivery in 2025. In the same state, PMB and Sutter Health also began construction on a four-story, 100,000-square-foot medical office building on the Sutter Roseville Medical Center campus in Roseville. Meanwhile, Ryan Cos. broke ground on One Scottsdale Medical, a 101,136-rentable-square-foot medical office building in Scottsdale, Ariz., that is slated for completion next year.

All in all, the health-care real estate sector has remained resilient in the face of adverse conditions and will likely continue to perform well despite the lingering challenges impacting all asset classes.

“I have a positive view of the outlook for health care in 2024, recognizing that the macro environment will still be challenging,” Janus concluded.

 

Source: Commercial Property Executive