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New Medical Office Building Rents Substantially Higher Than Pre-Pandemic Era

Rents for medical office buildings are getting a closer look in this challenging economic period for commercial real estate as the sector’s defensive qualities can be a comfort for investors.

Medical office features long-term leases, reliable net operating income with predictable but modest rental increases, and steady average national occupancy at 92% through all cycles, according to JLL’s latest Healthcare Perspectives report.

These are an offset to higher rent growth from in-favor, high-growth sectors such as industrial and multifamily, with more cyclical characteristics.

“The current inflationary environment has presented headwinds on a relative basis for medical offices,” JLL said. “However, owners and purchasers of medical properties with leases signed prior to last year will likely benefit in the future from upward fair market rent adjustments from tenants that renew in place or new tenants that move in.”

Recently Constructed MOBs Performing Well

Rents for recently constructed and to-be-delivered MOBs are up substantially from the pre-pandemic era, JLL said.

Rent for a build-to-suit project commissioned today that is $11.53 per square foot higher or 53% more than a similar MOB built immediately prior to the pandemic increased from $21.91 per square foot in 2020 to $33.43 per square foot in 2023, JLL figured.

Meanwhile, property sectors such as industrial and multifamily have offered higher asking rent growth in the last three years, averaging 13.1% and 7.9%, respectively, compared to MOB which averaged just 5.2% growth during the same period.

JLL said the average medical office rent growth of 2% annually historically has been challenged in the current inflationary environment with CPI increasing 5% year-over-year through March 2023. That CPI read was the lowest monthly increase since fall 2021.

Investors can also take to heart that rents on renewals of in-place leases are frequently shown to be at 4% or more.

“Contractual annual rent escalations of 3% are becoming more universally accepted versus the historical 2% average,” according to the JLL report.


Source: GlobeSt.

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Why MOBs Offer Healthy Investor Appeal

The health-care sector has largely rebounded from the lockdowns that halted all but the most necessary doctor’s visits and procedures in 2020.

Most health systems reported that they were within 5 percent of pre-pandemic utilization volumes last year, according to Cushman & Wakefield’s most recent healthcare and medical office report.

That’s good news for medical office real estate, as is the expected 7.3 percent growth in outpatient services through 2026, reported Cushman & Wakefield, citing data from the Advisory Board, a healthcare research and analytical organization based in Washington, D.C.

Additionally, medical office buildings have an average occupancy rate of 92 percent, which represents gradual improvement since occupancy dipped in 2020. It’s also clear that while the growth of telehealth fulfilled a need during the lockdown, many ailments and checkups still require an in-person visit. Investors expect MOBs to register 2 percent to 4 percent rent growth this year, according to a JLL survey released in February. That would be consistent with the past two years, which have produced average rent increases of about 2.3 percent, JLL notes, and compares favorably with the 1.9 percent uptick for office rents over the same stretch.

As a result, investors are viewing medical office as a safe haven in a disrupted environment. Not only have rising interest rates cast general uncertainty on property values, but the slow return of employees to the workplace is also raising questions about demand for the office sector as a whole.

“We’re receiving a lot of calls from office owners who are looking for ways to deploy capital into medical office,” said Andrew Milne, senior managing director for JLL Capital Markets. “It isn’t a new trend, but a lot more are rethinking their traditional office portfolios.”

As with most asset categories, higher capital costs have made it challenging to deploy capital into medical office. MOB investors pulled back in the second half of 2022 as the bid-ask spread emerged and lending largely dried up, noted Lorie Damon, an executive managing director with Cushman & Wakefield’s health-care advisory unit. Still, the market remains liquid for trusted borrowers who bring attractive deals to the table.

“The limited capacity for accessing debt right now has certainly impacted medical office as well as every other property sector, but deals are getting done,” said Damon. “Health-care performs really well in recessionary times, because people still get pregnant and still get sick.”

Pressure On Values

Some $19.3 billion in medical office buildings traded in 2022, a $1 billion increase over the prior year, according to New York-based MSCI Real Assets. However, it’s worth noting that a single deal, Healthcare Realty Trust’s acquisition of Healthcare Trust of America, accounted for nearly $8 billion of that total. In the second half of 2022, rising capital costs and recession fears cut MOB transaction volume sharply year-over-year.

Though that REIT deal was a dominant factor in investment volume, private buyers accounted for 72 percent of all transactions in 2022, reported MSCI Real Assets. Health-care REITs pulled out of the market early last year as stock prices fell, observers say. The REITs ended the year down more than 22 percent, according to NAREIT, although they generated total returns of nearly 13 percent in January.

Sources: Revista, CBRE Econometric Advisors, CBRE research

Sources: Revista, CBRE Econometric Advisors, CBRE Research

The dive in health-care REIT values further indicates that a repricing is underway and trickling down to the private market. The median cap rate for medical office ticked up to 5.9 percent by the end of the year, according to research by CBRE and Revista. Gauging true value change is difficult, however, because core asset owners who may have wanted to dispose of properties last year ended up holding onto them, limiting the dataset to value-add and core plus transactions, Cushman & Wakefield noted.

“But in San Francisco, cap rates for surgery centers with credit tenants have climbed to as much as 6.5 percent, or about 200 basis points higher than before the pandemic,” said Edward Del Beccaro, executive vice president and the San Francisco Bay Area regional manager with TRI Commercial/CORFAC International.

Many sellers still hope that interest rates will come down and that prior pricing power returns, he added, but he anticipates that the Federal Reserve will raise the benchmark federal funds an additional 100 basis points in 2023.

“Medical office cap rates will be under further pressure to move higher, and I don’t see them going down at all in 2023,” Del Becarro predicted. “But as inflation is tamed and the market settles out, I think medical office will be one of the winners.”

Stabilizing Market

Some observers anticipate a rebound in investment sales activity this year as debt markets stabilize. After some fluctuation during the fall and winter, the yield on the 10-year Treasury reached nearly 4 percent by the end of February. That has generally translated into interest rates between 5.5 percent and 7 percent or more for medical office. Some lenders had reached capacity as last year drew to a close, but lending has ticked up with new allocations for 2023, reported Warren Hitchcock, senior vice president & managing director with Northmarq.

At the same time, the amount of leverage available has dwindled. But some developers can still find favorable terms. A year ago, Hitchcock secured bank financing for 85 percent of cost for a project that was more than 80 percent preleased. Later in the year, a similar deal still managed to muster a loan for 75 percent of cost.

“Not every lender understands medical office,” Hitchcock added. “But the lenders that do know it and understand it are aggressive on it.”

Lender Interest Grows

“Indeed, just as medical office space is attracting a wider group in investors, more lenders are gravitating toward it,” said Lee Asher, vice chairman with CBRE’s Healthcare and Life Sciences Capital Markets. “Among other attractions, medical tenants deliver solid rent coverage thanks to strong earnings before rent costs and other expenses. What’s more, rent makes up only 5 percent of operating expenses for medical tenants, which is typically much lower than occupiers in other property categories. Because physicians want to remain near their patients, tenant retention also tends to be high.”

Meanwhile, on the equity side, medical office assets that come to the market are still fetching multiple offers even though some buyers are still on the sidelines, reported John Chun, a managing director on JLL’s Capital Markets team. But to those investors who are active, the retreat of treasury rates along with a decline in corporate bond spreads and SOFR swap rates (secured financing overnight rate) are providing more certainty to the market than was present just a few months ago.

“It’s still a very fluid and liquid market,” Chun said. “And we’re starting to see all-in interest rates decrease to a level that should benefit medical office deals this year.”


Source: Commercial Property Executive

As 2023 Recession Predictions Mount, Healthcare Real Estate Rises On CRE’s Most-Wanted List

With whispers about a 2023 recession growing louder in the CRE industry, many players are looking for safe asset classes to invest in and more eyes are making their way to healthcare real estate.

“There’s this growing chorus of economists suggesting that a recession could be a reality in 2023 — some say shallow, some say not so shallow,” Steve Bolen, U.S. head of Healthcare Real Estate at LaSalle Investment Management, told the audience at Bisnow’s New York Healthcare Summit. “That is a time when I think healthcare real estate will really shine.”

The past six months have sent shock waves through the CRE sector, with stubborn inflation, ever-rising construction costs and seven federal interest rate hikes sparing no sector from economic pain. And as investors examine where to allocate their dollars in 2023, many are doubling down in their search for asset classes a little more removed from economic cycles, a dynamic that CRE players at the event, held at 156 William St., said will favor healthcare real estate.

“It was already on LaSalle’s 2022 list of preferred asset classes to invest in,” Bolen said.  “And alongside industrial, multifamily and single-family rentals, remains on 2023’s list for LaSalle’s clients. It has historically been a recession-resistant asset class. We were not surprised at all to see healthcare real estate land again on the favored list for 2023.”

In particular, venture capital and private equity are looking to healthcare real estate as they seek shelter from the instability shaking the broader economy.

“That dynamic is challenging traditional health systems looking to raise capital for their real estate,” Mount Sinai Ventures Managing Director Brent Stackhouse told Bisnow’s audience. “In terms of what I’m seeing here in New York, there’s a big influx of private equity capital coming in to build new healthcare businesses. That is eroding away our base of business’s health systems, and we need to compete with that. Our strategy is to move towards joint ventures with some of those entities.”

Major players in New York City are looking to capitalize on healthcare consumer demand for convenience, targeting real estate investments in areas that their clientele moved to during the pandemic, Stackhouse said.

“One of the things that was really eye-opening for our health system was the tremendous success of CityMD. They put up urgent care centers on seemingly every corner, and in doing so created a new dynamic,” Stackhouse said. “People will get care — and at times, very intimate and sensitive care — with somebody they’ve never met before because it’s convenient. And that convenience outweighed those longstanding relationships between the patient and provider.”

The pandemic’s disruption of the healthcare industry has opened up new opportunities, said Joy Altimore, chief revenue officer at EHE Health. The early pandemic brought a revolution in virtual care, creating new opportunity and space for other types of innovative healthcare businesses.

“What we’re seeing right now, especially in 2022, 2023 — and particularly in the femtech space — we see a huge lead in freezing your eggs or family planning or IVF. These are high-tech experiences that have to happen in a location and cannot happen virtually,” Altimore said. “You have a company like Kindbody, that last year only had eight locations. By the end of next year, it will have almost 100 locations. Where is that going to go?”

Convenience of healthcare is a key theme permeating different aspects of the industry: Large NYC employers, thinking about benefit packages and employee retention, are also looking at ways to build on-site care centers, Altimore said.

“Employers need convenient options for their employees,” Altimore said, adding that hybrid and remote work add to the demand for diversified location selection for employer-based healthcare sites. “Employer populations are not monolithic. You have working moms, working families, you have younger generations coming in, they’re looking for different healthcare options.”

A growing aging population also presents a huge opportunity for the healthcare sector to examine its real estate decisions and adds to demand for convenience, Bolen said.

“Today’s senior citizens are quite a bit different from the senior citizens of times gone by. They are not satisfied to sit home and watch TV — it’s a very active senior citizen population,” Bolen said. “They want to stay healthy. If something hurts, they’re in their local physician’s office getting it fixed so they can go back to their lives of vitality and activity.”

Despite a seeming abundance of activity in 2022 and fresh opportunities for 2023, the healthcare real estate sector will face the same headwinds as any other real estate asset class, Rethink Healthcare Real Estate President Jonathan Winer said.

“A lot of people are focused on ambulatory real estate for next year. But the headwind against that, of course, is just pure capital allocation,” Winter said, citing dramatic changes to the spread between interest rates and cap rates leading to a 600-basis-point contraction over the past 12 months.

However, Winer stressed, fundamentals for healthcare real estate remain healthy.

“If you look at the last five years, the fundamentals for occupancy and rent growth have never been better,” Winter said. “This is a place investors want to be in times of economic stress, whenever that economic stress is.”


Source: Bisnow