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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

The Risks For New Investors In Healthcare

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There’s a lot to like about the healthcare sector right now.

While other commercial sectors struggled during the recession, healthcare persevered. And, with 10,000 people turning 65 each day and then living longer, demand should remain strong for the sector.

“The overall demand for health care is incredibly high and growing,” David Lari, partner at Cox, Castle & Nicholson LLP tells GlobeSt.com. “Trips to the doctor for healthcare services are high and very likely to continue to increase. The medical sector—doctors, physician groups and hospitals—tend to be pretty good tenants, especially if you compare it to retail, for instance, where a lot of tenants have gone out of business.”

Investors from around the globe see these positive demographic trends. For instance, Lari says Asian investors, in particular, have been targeting American healthcare properties because their populations are also aging.

“By all accounts they understand how senior facilities work, from their experiences in their home country,” Lari says. “We’re also seeing Middle Eastern money coming into various health care facilities as they understand it more and see it as a way to diversify their portfolios. We’re also seeing a lot of large institutional private equity groups and pension fund groups get into the space where maybe they weren’t before.”

While the traditional players—healthcare REITs and institutional players—have the industry knowledge and know the major players and key issues, these newcomers often have to get up to speed. Just because the demographics are pointing in the right direction doesn’t mean they aren’t plenty of risks for healthcare investors.

“I think there are higher barriers to entry than some other classes of real estate, especially when you’re dealing with the acquisition of licensed facilities, such as a hospital, senior living facility or skilled nursing facility,” Lari says. “If you’re dealing with an on-campus medical office building, many of them tend to be ground lease and you need to navigate through those issues.”

Investment groups also need to understand their tenant mix and the long-term desires of the local hospital system when they purchase on-campus buildings.

“In essence you’re doing a joint venture when you’re buying an on-campus asset, which has restrictions with the hospital system,” Lari says. “If you’re not well aware of their short- and long-term plans and how you’re going to fit into those, you could get burnt quite easily.”

Lari says investment groups also need to spend time thinking about tenant acquisition. If they’re banking on getting physician groups to move from far away to their location, they may need to rethink their strategy.

“Typically speaking, physicians and physician groups don’t want to move too far,” Lari says. “If they do, oftentimes they will lose their patient base.”

Healthcare investors also need to be aware of the merger-and-acquisition environment in this era of healthcare consolidation, such as the mergers of Advocate Health Care and Aurora Health Care and Beth Israel Deaconness Medical Center and Lahey Health.

“You need to know how your particular assets fit into the growth strategy of the acquiring entity,” Lari says. “If they’re going to consolidate, don’t need your particular location and are moving physicians and physician groups out of it, then it could be potentially detrimental to the real estate investor.”

Lari doesn’t think these challenges should push investors away from healthcare. They just need to understand that there is going to be a steep learning curve.

“The key is understanding where your asset is in the marketplace and what type of health care services are going to fit within your particular asset,” Lari says.

 

Source: GlobeSt.