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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

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

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