- April 1, 2021: Vol. 8, Number 4

5 Questions: The prognosis for medical office

by J. Brannen Edge

The real estate investment business is rich with niche investment opportunities, and one of the best among them in recent years has been medical office buildings. MOBs, as they are often referred to, have recorded consistent growth and the outlook remains strong.

Among the avid observers and participants in the MOB investment trend is J. Brannen Edge, CEO of Flagship Healthcare Trust.

Where are the investment opportunities in medical office real estate coming from?

Twenty years ago, the real estate community didn’t know how to categorize medical real estate. Did it belong in the office category? Retail? Other? Since then, healthcare real estate has come into its own. Investor interest is at an all-time high and growing. Knowledge of the industry’s specific needs — both from development and management perspectives — has grown tremendously, and the “jack of all trades” operator is at a competitive disadvantage. Physicians who own their own buildings understand what their properties are worth in this environment, especially if they are willing to enter into new, longer-term leases. There is an element of investment diversification and risk mitigation. Providers from individual practices to healthcare systems recognize their highest priority is delivering quality care. Real estate can be a distraction and if not managed expertly, can actually detract from this goal. Healthcare systems also are acutely aware of potential Stark Law violations (regulations that govern financial relationships, including lease agreements, between providers). Finally, healthcare is a competitive and capital-intensive industry. Whether purchasing medical equipment, expanding into new locations or hiring providers, growth is expensive. The sale and leaseback of real estate can be useful in funding these priorities, without adding expense or detracting from the patient experience.

Where are the strongest medical office markets?

Americans 65 and older utilize medical office buildings at a significantly higher rate than the average. Those 75-plus utilize MOBs at exponentially higher levels. So where are the centers of population growth among those approaching retirement age? The Southeast and Sun Belt continue to be strong. Population growth overall, but especially among those 65 and older, truly bolsters the MOB market. Good weather, favorable cost of living, strong healthcare systems and proximity to family support those markets.

Who is occupying the facilities?

Clinical outpatient healthcare real estate may sound like a mouthful, but it can be defined very simply: a location where a provider delivers care to a patient without an overnight stay component. It may be easier to define by what it is not: senior housing, skilled nursing, acute care hospitals and other inpatient facilities. Outpatient facilities include ambulatory surgery centers (also known as same-day surgery centers, where a majority of surgeries in the United States now are performed) and offices for your internist, child’s pediatrician or orthodontist, or orthopedist. These practices may be owned and occupied by a healthcare system or by your next-door neighbor. The buildings could be located adjacent to a hospital or grocery store. Healthcare real estate continues to move closer to where patients live, work and play.

How many medical office properties are there nationally, and how brisk
is the new construction market?

Today, there are more than 36,000 medical office buildings and 5,000 ambulatory surgery centers in the United States, compared with 6,000 hospitals. Historically, new construction has represented 1.5 percent to 2 percent of existing inventory annually, and the industry continues to see positive absorption of new space that addresses growing demand and replacing obsolete buildings. Occupancy rates are consistently higher than for commercial office (historically by 100 basis points or more, even pre-COVID). New development has historically been led by healthcare systems self-developing, although the share of third-party developers has grown in recent years. The pandemic and capital constraints have likely increased that trend over the past year.

How have medical office property values fared during the past five or 10 years?

The medical office sector has enjoyed increased interest since the great financial crisis, as investors have been drawn to its durable investment qualities. As investor interest has grown, so has annual sales volume, which more than doubled from 2012 to 2017. Sales of MOBs exceeded $13 billion in each of the past three years. Buoyed by the strong performance of the asset class during COVID-19, medical office investors have continued to be aggressive buyers, and we have not witnessed a decline in values. Healthcare is not a luxury in the United States, it is more of a consumer staple. Based on fundamentals, demographic trends and increased institutional focus on the sector, I expect the industry to continue to perform well in the years ahead.

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