Checking the Pulse of the Medical Office Sector

Date: 02/03/2014

The Affordable Care Act (ACA) is expected to have a huge impact on the medical office sector. Investors are eying medical office buildings, and developers are preparing to build more space to accommodate the influx of new patients.

Those were a few of the points raised during the most recent episode of the “Commercial Real Estate Show” radio program, on which my guests and I discussed medical office space needs, construction and investor interest.

Space Demands

By 2016, approximately 30 million more people will have access to healthcare as a result of “Obamacare,” as the ACA has become commonly known, said Rob Grossman, principal of Deloitte & Touche.

With the wave of new people that have access to healthcare, there will obviously be demand for additional medical office space, guests said. “The estimate we’ve seen is 1.9 square feet for every new patient,” said Kenneth Meyer, principal of Deloitte & Touche. “Therefore, 30 million new patients would mean approximately 57 million square feet of space, focused primarily in more densely populated areas.”

“Even without Obamacare, we have seen significant growth in demand for healthcare services,” said Paul Zeman, president of Bull Realty’s National Healthcare Capital Markets Group. “In Atlanta, 10 or 15 years ago you could drive right up to your doctor’s building. Now, you are buried in the back of a parking garage.”

As demand generally increases, one would expect that rents will increase everywhere as well, however, the impact on rents will depend on the market, Meyer added. “It’s not that simple because medical office space has to be aligned with centers that are going to thrive,” he said. “In the right markets and right space, the uptick in demand will be very positive.”

It’s possible that the increase in healthcare demand could create opportunities for traditional office space as well, guests said. “There will definitely be additional work and people to support,” Meyer said. “What remains to be seen is how that work will be organized. If that work is moved offshore, it won’t have an impact on the U.S. market.”

Construction Picks Up

“After the credit crisis, we didn’t see new construction for several years,” Grossman said. “However, in 2013 we’ve seen 10.3 million square feet of medical office space under construction. Overall, construction starts are expected to be 68 million square feet in 2014.”

The majority of medical office construction is on-campus and hospital-sponsored, Zeman said. “A lot of developers are bashful until they have a firm commitment on 60 percent of the space or more,” he added. “Savvy tenants want exclusions or rights to be the only tenant of their nature in the building, which will restrict some tenants from leasing space. A good tenant mix is important. It’s nice when you have a synergy, and they can refer to each other.”

As medical office users begin to look for space to expand, some will likely take advantage of empty retail space, Meyer said. “People have argued over the years that retail is the most under-demolished asset class,” he added. “Being able to re-purpose retail space to serve medical or healthcare users is important because retail space offers benefits like access to mass transit and plenty of parking.”

Investor Interest Rises

Investors are attracted to medical office space because of the long lease terms doctors typically have and their ability to always pay their bills, Zeman said.

“For 2013, we are going to wind up around $6 billion in sales of medical office space, which is about where we ended up last year,” Zeman said. “We need more medical office space, and we’re seeing more under construction, so that will tailor to higher figures two or three years down the road.”

Cap rates in 2013 remained steady, around 7 percent, but a lot of factors come into play, so some properties did see lower cap rates, Zeman said. “Location, hospital sponsorship and lease structure are a few factors that can impact cap rates,” he added. “In 2014, we’re going to see cap rates in the same window, 7 percent to 7.3 percent on average. However, we may see some raising interest rates which should bump cap rates up.”

The entire episode on the medical office sector is available for download at www.CREshow.com.