The Health of The Medical Real Estate Market
Despite challenging economic conditions and continued operational issues for healthcare providers, the medical commercial real estate sector remains a stable and strong asset class.
Revista tracks just over 20M sf of medical buildings in the Twin Cities market area that includes both multi and single tenant buildings. It shows a 93% occupied rate which has continued to hold strong throughout the pandemic and beyond. With higher interest rates, increased construction costs and material delays, we’ve seen increased renewal and expansion leases in existing product as opposed to new leases in new construction recently, which has kept net rates and occupancy up. Revista reports a 17.5% decline in new construction starts and a projected continual slowdown through the 2nd quarter.
A $22/rsf net average rate is reported, which includes some larger single tenant rates and lower rates on challenged assets that lower the overall average rate. We are seeing net rates for multi-tenant Class A space at an average of $24+/sf for existing buildings and $28–$34/sf for new construction. There is an annual increase of between 2.5–3%; this has been increasing due to higher inflation.
Lease terms for new leases remain long, often 10–20 years, so users can secure appropriate space and request high improvement allowances in the $100/sf+ range pending lease term, credit and rate.
Operating expenses continue to increase with rising real estate taxes, cleaning and utility costs averaging another $20/sf over the base rate. Gross rental rates can reach up to $50/sf which can be challenging for a sector pressured with lower reimbursements and high labor/operational costs.
Higher interest rates also slowed sale transactions and kept cap rates higher than historical levels but still in the 6% range for quality assets. However, if we see reductions in interest rates this year as projected, we anticipate increased transaction volume, including the larger REITs.
Medical building fundamentals remain strong compared to the general office market where work-from-home trends have shuttered many office buildings. An aging demographic has supported care closer to home and the desire for outpatient facilities. The healthcare sector has opted to rename the “O” in “MOB” (Medical Office Building) to Medical Outpatient Building, there are enough differentiators to warrant this effort.
With technological advancements and the need for more outpatient care, we forecast a continued strong and stable medical outpatient building sector into the future.