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The past year and a half have been enlightening for several reasons. One lesson learned: there’s no better time to own medical office real estate than during, and emerging from, a global pandemic.
Despite an otherwise dramatic shock to the global economy, medical office real estate has continued to perform well. While some asset classes – office, retail and hospitality most notably – suffered, medical offices continued to hold their own. Unlike other real estate property types whose performance is tied to the strength of the economy, medical offices are tied to a growing need for healthcare services. And as a result, even when the nation was faced with widespread lockdowns, medical office rent collections remained high.
The resiliency of medical offices is one of the many reasons investors are looking to add it to their portfolios, and by extension, why competition for medical office real estate is increasing. In this article, we look at what’s driving investor interest in medical office property.
Medical office real estate is a niche product type that tends to be grouped within the broader “office” classification. However, medical offices are distinct from traditional offices. It is specifically designed to accommodate healthcare providers as well as patients. Medical office buildings will often feature more robust HVAC systems, backup power sources, building security, patient waiting areas, expensive built-in medical equipment, and extensive parking.
Newly-built medical office properties also tend to have a few distinguishing characteristics, and are typically very utilitarian, using all the space efficiently with basic common areas but mostly utilized by the medical tenants.
Given its unique building and tenant profile, medical office has historically been overlooked by many real estate investors. However, the sector’s positive growth trajectory has landed it on more investors’ radars as of late. Both individual and institutional investors alike are starting to recognize the tremendous promise of medical office real estate.
In general, real estate is a good way for investors to diversify their portfolios away from more traditional stocks and bonds. Then, among real estate investments, medical offices provide further diversification. Medical offices, as we’ve seen during the COVID pandemic, continue to perform well even while other real estate asset classes struggle. Therefore, adding a medical office to one’s portfolio not only provides asset class diversification, but also serves as a risk-mitigation strategy.
What’s more, those who invest in medical offices will find that the product type is also diverse. There are opportunities to own many types of medical office, ranging from single-tenant buildings to more complex multi-tenant medical office properties or single purpose urgent care centers and more. There’s no “one size fits all” medical office building. Those looking for simplicity might opt for a single-tenant property that has a long-term lease with a physician’s group. Someone else, looking to mitigate the risk associated with tenant turnover, might opt for a multi-tenant building that is leased to an array of complementary medical office users.
As the needs of medical office users evolve, investors can also look to diversify by adding different vintage medical office properties to their portfolio. For example, someone might invest in a suburban medical office complex first constructed in the 1980s. This property may be a good candidate for a value-add investment strategy. Through various capital improvement projects, the property could be repositioned in a way that creates more value for the owners and investors. That same owner may also decide to invest in a newly-constructed medical office building that has modern-day features, such as a small retail storefront, that is already leased and fully stabilized.
Finally, medical office investors can further diversify their portfolios by investing in different geographic areas. In the Sun Belt region, for example, an influx of retired Baby Boomers has created new demand for medical office real estate. Broadly speaking, there continues to be demand for both urban and suburban MOB properties across the U.S., which allows investors to diversify into different areas.
In short, there are endless medical office opportunities for investors to consider when looking to diversify their investment portfolios.
Over the past decade, there have been at least two major shocks to the real estate market: the first was the 2008 housing market collapse that caused real estate values to bottom out in 2009-2010. The second, more recent, shock was brought on by the COVID-19 pandemic. In both instances, investors faced a real threat of default in situations where tenants stopped paying their rents on time.
Yet during both recessions, real estate performed (and recovered) faster than other asset classes. Medical office real estate proved to be especially resilient.
Investors looking for recession-resilient real estate will find medical office to be an excellent choice for the following reasons.
The first has to do with tenant retention. Medical office tenants are often described as “stickier” than traditional office tenants. In other words, medical office users are not as likely to up and leave. This is partially due to the high up-front buildout costs of their space. Specialized equipment, HVAC systems and the like are expensive and cannot be easily replicated elsewhere. (For example, an imaging center can easily cost upwards of a million dollars to build.)
Given that so many medical office tenants invest heavily in their space, they tend to remain in place for longer periods of time. Leases generally average somewhere between seven and 15 years—a long period for which investors can expect dependable cash flow.
Similarly, medical office tenants generally have strong ties to the community and want to provide care to their patients in a consistent, convenient location. This makes them more likely to re-sign leases than traditional office users whose physical location is perhaps less important, and therefore, it is easier for them to relocate to more affordable spaces during economic downturns.
Second, medical office is bolstered by changing demographics. According to the U.S. Census Bureau, the number of Americans aged 65 and older is expected to double over the next three decades. Older Americans will continue to provide sustained demand for medical care, often in more affordable, out-patient settings, which helps to strengthen the medical office sector. Moreover, unlike other real estate assets like retail and hospitality, healthcare is a needs-based industry. Regardless of how the economy is performing, Americans (especially older Americans) will continue to need medical care. They cannot forego certain treatments or procedures the same way people might forego a latte or vacation when the economy dips.
Having the right partner is the key to succuss, Alliance is here to help you traverse the complexities of Medical Office Real Estate. Call today.
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