Why Now is the Time to Invest in Medical Outpatient Buildings

Amid the concerning updates surrounding the office sector, medical outpatient buildings (MOBs) remain a beacon of resilience. Compared to other asset classes, MOBs are advantageous for investors seeking stable and lucrative ventures. Their strength is derived from resilience to economic downturns, strong retention rates, longer average lease terms, and favorable demographic changes – primarily the aging Baby Boomer population, also known as the “Silver Tsunami.”

Healthcare Market Performance & MOBS

According to Forbes, the healthcare market is expanding rapidly, with a forecast value of $57.86 billion by the end of 2023. This upward trend is expected to continue, with the market projected to increase at a 10.4% annual rate (CAGR 2023-2027), reaching a projected volume of $85.95 billion by 2027. This high growth potential makes MOBs even more appealing to investors.

MOBs are typically within medical corridors that create a beneficial synergy among themselves. Investors can acquire and lease these properties to healthcare providers seeking to deliver services to their patient base.

These facilities address the requirements of numerous patients by offering top-notch infrastructure and convenient accessibility, thereby enhancing their attractiveness for investment. Patients now prioritize convenience and easy access over the traditional approach of visiting large hospital campuses that often pose challenges such as complicated or inconvenient parking.

Driving Forces of Growth

The healthcare industry, constituting 17% of the U.S. GDP, sees a substantial portion attributed to outpatient care and services provided in medical outpatient buildings.

The medical outpatient sector experienced an upsurge in demand due to the implementation of the Affordable Care Act, an aging demographic, a massive undersupply of MOBs, and advancements in medical technology facilitating more cost-effective and efficient outpatient procedures. The recently unveiled “Emerging Trends in Real Estate” report for 2024 by PWC and the Urban Land Institute underscores the heightened attention from investors toward this sector.

The PWC and Urban Land Institute report also highlights a shift in the sector towards a retail mindset, with healthcare providers and hospital systems actively seeking to attract new patients and expand their market presence, thereby driving demand for premium medical spaces. With this in mind, healthcare providers and dental offices have begun opening offices in shopping centers in both suburban and rural areas. Shopping centers offer more square footage than traditional office spaces, making them an excellent location for MOBs. These centers are typically situated in densely populated areas, enhancing patient accessibility. This move provides medical and dental care to more patients nationwide.

Ideal Tenancy & Lease Terms

Tenancy and lease considerations often benefit investors in healthcare real estate. Although accompanied by higher associated tenant improvement costs, landlords, in some cases, are able to obtain lease terms ranging from 10 to 15 years with accompanying annual rental escalators on average ranging from two percent to three percent (although sometimes higher). Additionally, investors are often exposed to tenant rosters with large health systems that may have investment-grade credit. Healthcare properties also have higher tenant retention rates, which often exceed 80% because providers like to operate close to their patient base and try to avoid relocation.   These factors contribute to the strength of healthcare real estate investments even during economic downturns.

The shift to a retail mindset has further contributed to the sector’s stability, as hospitals and providers focus on patient attraction and market share expansion in new areas. The report underscores the positive dynamics that have allowed the medical outpatient sector to maintain robust fundamentals.

Occupancy rates have increased in recent years, with absorption outpacing the addition of square footage. According to GlobeSt., as of Q2 2023, the occupancy rate stands at a commendable 92.8%, despite the slowdown in transaction volumes dropping from the peak of $30.2 billion in Q3 2022 to $20.2 billion in Q2 2023.

Medical tenants often make substantial investments in the buildout of their facilities. This significant financial commitment strongly incentivizes them to remain in a particular location for extended periods. Additionally, in many states, certain types of clinics are required to obtain specialized certifications, such as a Certificate of Need (CON). These certifications create a barrier for tenants to relocate easily, further encouraging them to stay in their existing premises for as long as possible. The combination of substantial buildout investments and regulatory requirements contributes to medical tenants’ stability and long-term commitment to their leased spaces.

Transaction Trends and Investment Outlook

The slowdown in transaction volume in 2023 is attributed to a “disconnect” in pricing between sellers and buyers, which resulted from challenging debt markets. However, an optimistic outlook suggests an increased volume when buyers and sellers can better connect and capital markets begin to recover. With over 1.5 billion square feet of current inventory, according to GlobeSt., the medical sector presents a substantial opportunity for investors to expand their ownership.

Ownership of the sector by square footage is divided, with over half held by users such as hospitals, providers, and physician groups and the remainder by REITs and private investors. Institutional investors often engage through operating partners with specialized regional or national firms that focus on developing, acquiring, and operating medical outpatient buildings.

According to a PWC and Urban Land Institute report, speculative development is infrequent, resulting in inventory growth primarily driven by tenant demand, currently at around 1%, seldom exceeding 2% annually. Surveyed experts express a largely favorable opinion, with 48% recommending buying, 46.4% suggesting holding, and only 5.8% advocating selling. While 34.3% consider the sector overpriced, this percentage is considerably lower than those viewing suburban and central-city offices as overvalued. A majority, 61.4%, believe medical outpatient buildings are fairly priced, and 4.3% perceive them as underpriced.

Takeaways

The medical outpatient sector has become an attractive and stable asset class within the CRE landscape, which is why now, more than ever, is a great time to invest in medical outpatient buildings. Investors who diversify their portfolios and capitalize on the continuous need for quality healthcare services can expect to see exceptional results in the coming years.