Top Five Trends in Medical Office Leasing

January 28, 2011

With major changes occurring in healthcare reform, the economy, medical tourism, and the overall age and health of the American population, the medical office market has been greatly impacted. The following highlights the top five trends in medical office leasing and how these trends affect you, the tenant.

“If you build it, they will come” is a famous movie quote that is often misstated. The actual quote from the classic 1989 movie, “Field of Dreams,” is “if you build it, he will come.” We, as a culture, often adapt sayings and historical events to best suit our needs. The medical office building (MOB) developer and investor serves as a perfect example, as he believed during the mid-2000s to build it and “they” would come.

Much has changed in these last several years. With major changes occurring in healthcare reform, the economy, medical tourism, and the overall age and health of the American population, the medical office market has been greatly impacted. The following highlights the top five trends in medical office leasing and how these trends affect you, the tenant.

1. MOB sales volume has risen and capitalization rates have stabilized.
With over $1 billion of healthcare real estate said to have closed in the fourth quarter of 2010, this was the first billion-dollar quarter since 2008. What caused the stir in activity? The combination of sellers hoping to avoid the anticipated hike in capital gains tax and buyers having to allocate capital created this change. Researchers are expecting 2011 to have the same if not more sales activity. This will ultimately lead to a major shift in building ownership. For tenants, these expectations are important as new ownership affects pricing, management, leasing, and overall building knowledge.

2. Vacancy rates have started to stabilize.
During the “build it and they will come” phase of the mid-2000s, the MOB sector became the golden goose for many owners. These buildings were leasing as fast as they could be built. In 2006, this drastically changed. Construction started outweighing the absorption by 50 percent. For every square foot built, only half a foot was getting leased. This ultimately caused a glut of available space. The vacancy rates started climbing from 8 percent in 2006 and increased at a steady pace until it hit 11.9 percent in the fourth quarter of 2009. Marcus and Millichap Research reports that the vacancy rate is expected to level out around 12.2 percent by year end.

3. Rental rates are leveling out.
Vacancy rates are one of the main drivers of rental rates. The glut in vacancy from 2006 to 2009 had a drastic affect on rates. Landlords started getting very aggressive with decreases in rates and increases in tenant concessions. These concessions ranged from additional tenant improvements to abated rent. With vacancy statistics beginning to level out, rates and concessions are now following this leveling as well. Marcus and Millichap reported a 3.5 percent decrease in rates last year, but expectations for 2011 are only around one percent. Keep in mind that rates in the Southwest and Southeast regions could decrease slightly more due to higher than average vacancy rates in these areas. National averages vary greatly by regions but the overall average is around $22 per square foot.
 
4. Patients of elective procedures are expecting first class facilities.
With an increase in elective procedures such as Lasik eye surgery, plastic surgery, and hair restoration, the need for first class facilities that can accommodate these types of procedures has grown. The types of people who are electing to have these procedures tend to pay cash, instead of using insurance benefits. By paying cash, these patients have the ability to choose the doctor, location, and time of year for the completion of such procedures. In order to gain the business of these clients, doctors are required to have a first class facility that outshines the competition. First class not only means the look and feel of the building, suite or office, but the overall efficiency of how the business is managed.

5. Rising concern over the Affordable Care Act halting physician-owned hospitals
Costar, a national real estate research company, highlighted the effects of the Affordable Care Act, which places restrictions on new or expanding physician-owned hospitals. Over the past 20 years, the popularity of doctor-owned hospitals has increased dramatically. These hospitals are one of the key drivers of development in areas such as Texas. The new bill effectively halted the construction of these physician-owned specialty hospitals by eliminating any Medicare reimbursements. Many lawsuits were filed by physician groups that did not meet the construction deadline of December 31, 2010. A statement released by Physician Hospitals of America (PHA) warned that the reform bill “will have a devastating impact on physician-owned hospitals, the patients they treat and the communities they serve.”

Jason Lewis is an associate vice president/partner and head of the Medical Tenant Advisory Group for iCORE Global, a tenant representation firm with offices around the globe. Lewis’ focus is on assisting medical office tenants in the renewal, expansion, relocation, or purchase of medical office space. E-mail him here.