With an aging U.S. population and the fate of President Obama’s healthcare reform law settled, the medical-office sector faces a promising future.
That was the prevailing opinion voiced by my guests on a recent episode of the “Commercial Real Estate Show” radio program. The episode took an enlightening look at the sector and explored a variety of topics related to medical-office buildings, including vacancy rates, cap rates, property-management challenges, overall strengths and possible challenges for the sector.
Bullish on Medical
Walter Page, the director of research for CoStar Group and a renowned commercial real estate analyst, began the show with some stats illuminating the solid performance of the medical-office sector, even during this still somewhat-sluggish economy.
The national vacancy rate for medical office buildings is currently 10.9 percent, which is significantly lower than the 12.5 rate for the office sector as a whole, Page said. He also noted that net absorption continues to remain positive in the sector.
“To me, it’s a recession-resistant,” said Page. “It has had good occupancy over long periods of time, and consistent occupancy is the number-one driver of returns. The demand is great in that you have demographics in your favor with the Baby Boomers aging. Also, you now have the expansion of medical services to a broader part of the population.”
Occupancy should continue to be a positive for the healthcare sector in part “because the job numbers that drive medical office are exceptionally strong,” Page added.
The U.S. Supreme Court’s decision this past summer to uphold the federal Affordable Care Act has strengthened the medical-office sector, said Mark Engstrom, executive vice president of acquisitions for Healthcare Trust of America.
“Health-care systems are starting to make decisions, to take on additional space for their growth,” Engstrom said. “We see the same thing with physicians: they’re now more willing to sign longer-term leases because the [law] is here to stay.”
Not Without Its Challenges
Short-term challenges to the sector’s performance include the so-called “fiscal cliff” and potential cuts in Medicare spending, according to Page. An oversupply of buildings may become an issue in certain markets as well, he added.
The sector is more challenging for property owners and landlords than normal office because the healthcare industry is so heavily regulated. Medical tenants and buildings require more intense management, said Paul Zeman, a partner with Bull Realty who oversees the firm’s Healthcare Real Estate Services Group. You have issues like Certificate of Need, Stark and how the tenants compete or refer each other patients in a building.
“Plus preventive maintenance is huge,” Zeman said. “There’s a lot of high-dollar equipment in the buildings that has to be monitored for function and air temperature – and regulations that you have to stay on top of, like OSHA, HIPAA and so forth.”
Growing Investor Interest
Investment sales of medical-office properties are increasing, according to Zeman. Approximately $5 billion of healthcare property sales will take place in 2012, and that figure should rise by 10 percent next year.
A surge in sales could take place in the fourth quarter of this year, as investors seek to complete transactions before potentially less favorable tax laws are implemented in 2013, Zeman added.
Core, stable assets that are fairly new and have long-term leases in place are selling with cap rates between 7.2 and 7.8 percent, according to Zeman. “Some degree of cap rate compression” should be expected in 2013, he said.
Noting that cap rates for medical-office properties are historically 70 basis points higher than those for traditional office facilities, Page noted, “That’s like saying medical office buildings are 8 percent less expensive than the typical office building for the same level of revenue.”
“It’s an exciting time to be in this space,” Engstrom said. “It’s a maturing asset class and one that has a lot of [positives] in an uncertain economy. It’s defensive; it’s conservative; it’s something that’s very stable. And that sometimes isn’t very exciting, but in an environment and an economy like we’re looking at for 2013, that’s pretty attractive to investors these days.”