Healthcare analysts suggest that based on recent trends, the medical office sector could remain robust for the next year. Thanks to continued demand for healthcare, and perhaps despite the continued popularity of telemedicine, the industry has remained relatively stable and recession-resistant.
In 2021, rents soared and vacancies decreased. While the pandemic, material shortages and supply chain challenges slowed the development of new medical office buildings, construction is beginning to pick up steam. And investors continue to make significant purchases in the sector.
Demand Remains Strong from 2021 to 2022
Last year saw record high sales volumes. Medical offices nearly doubled the absorption rate in 2019 and earlier – 19.5 million square feet in Q4. Demand will remain strong this year.
Also in demand? The need for procedures and office visits many people delayed in 2020 and 2021. While telehealth and virtual conferencing technology can address some issues, they’re not strong diagnostic tools. Patients need to see their doctors and specialists in person. One could also suggest that telehealth – because of its ability to connect patients and doctors – has helped increase demand because of that connection. With more patients having access to doctors, they’re seeing problems diagnosed and treatments recommended, and those treatments require in-office visits. Telehealth is here to stay as part of the healthcare continuum, but it can’t (and won’t) replace medical offices.
Medical Office Occupancies By the Numbers
When construction starts slowed and rates of absorption were high, medical office occupancies remained nearly stagnant at just over 91% between Q1 2020 and Q1 2021. Since 2022, vacancies continue shrinking.
Historically, medical office rent growth trends somewhere between 2% and 3% YOY. However, one healthcare managing director suggests that because supply is low and vacancies have fallen nationwide below 10%, landlords can increase rents more than the traditional amount. Rising construction costs, increased tenant improvements, and a dearth of appropriate office space is driving rents higher – and keeping medical providers from relocating to new spaces.
In fact, rental growth was a hot topic of conversation among medical office building owners during BOMA International’s Medical Office Buildings + Healthcare Real Estate Conference in May 2022. Experts predict that as investors’ portfolios see 90% to 95% occupancy, they’ll feel comfortable increasing annual rents 3.5% to 4% or more, which is fairly significant. Some analysts have said tenants and landlords are discussing how (or if) it makes sense to share inflation risks as a 2% increase doesn’t compensate owners faced with 8% inflation. Other trends include healthcare providers requesting shorter term leases, given the current inflation and volatility. It’s to their advantage to negotiate a shorter lease so they’re not trapped by increasing rents even after inflation begins to decrease.
Analysts do predict that rents will eventually hit the ceiling. After all, healthcare providers are limited by what they can afford, held in check both by the numbers of patients they can see and number of procedures they can do. At some point, it becomes impossible to add more people – or procedures – to the schedule. Another limit? The amount of reimbursement from insurance companies. Unlike other sectors such as retail or manufacturing, they can only increase “sales” so much.
But for right now, rental rates continue to rise. For example, on a triple-net basis, rentals nationwide were in the low $20s, and new construction in the low $30s. Landlords have been increasing their rates into the mid-$20s on a triple-net basis. Medical offices seeking to relocate and that need a tenant improvement package or a full-build out in their new space can expect to pay between $100 per square foot to $150 per square foot.
In Q1 2022, medical office space net asking rents saw an average increase of 1.7% to $22.61 per square foot. Los Angeles led the highest ($35.13 per square foot) with Boston ($26.70 per square foot) and New York ($26.11) the next highest markets. Elsewhere, rents for medical office space average between $20 and $25 per square foot.
Booming Medical Office Sales
High medical office occupancies, shifting demographics as people relocated during the pandemic, and private equity (PE) contributed to a banner 2021 with $19.6 billion in transaction volume. Sales grew over 40% from the previous year, with single asset transfers closing at $11.8 billion in volume, and nearly 35% higher than 2020.
Private equity investors comprised nearly three quarters of the sellers and PE interests accounted for 63% of sales volume. The West and Northeast yielded the highest prices. Cap rates dropped to 5.7%, which is the lowest average they’ve been in 20+ years.
If someone were to ask a Magic 8 Ball its prediction for growth within the medical office sector this year, chances are it would say, “Outlook good.” Based on current data and reports, industry analysts agree.