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With the stock market at or near all-time highs, more investors are looking to mitigate risk by diversifying their portfolios through some combination of alternative investments. Commercial real estate, which often tends to have a low correlation with the stock market, has caught the attention of small and large investors alike. In turn, cap rates among the most “popular” asset classes, like multifamily and retail, have plummeted recently. The double-digit returns that many commercial real estate investors experienced at one point are increasingly harder to come by.
Commercial real estate investors looking for yield are starting to look at more “niche” product types, like medical offices. Medical office buildings are considered a subset of the office sector, but these buildings are decidedly different than a traditional office. Medical office buildings, or “MOBs” for short, are specifically tailored to meet the needs of healthcare practitioners like doctors, dentists, and other clinicians.
This article looks at the many factors driving investor demand in medical office buildings.
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Medical office properties are often considered a “steady eddy” within the commercial real estate industry. These properties tend not to fluctuate in value as dramatically as other asset classes. Tenants tend to be stable, provide reliable cash flow, and often sign long-term leases. This factor provides an essential hedge for investors looking to mitigate risk associated with economic downturns, as we’ll discuss in more detail below.
However, medical offices have historically had high barriers to entry. Few individual investors would purchase MOB properties. Typically, medical office buildings belong to physicians’ groups, hospital systems, real estate investment trusts, or large institutional investors like insurance corporations or pension funds.
Yet growing demand for medical office space, and therefore, the delivery of new MOB properties, has opened the door for individual investors looking to access the sector. Increasingly, there are ways to invest alongside adept real estate sponsors who oversee medical office syndicates and funds.
America’s aging population is creating a record demand for health care services. This is especially true among the Baby Boomer generation. According to some estimates, 10,000 people turn 65 years old each day. As Baby Boomers age, their need for health care begins to rise. Whereas someone in their 20s might visit the doctor just once annually (or less), someone in their 60s, 70s and 80s will often seek medical care every month or more regularly.
This element has put unprecedented pressure on the nation’s health care system. There is a drastic shortage of doctors and medical staff and a lack of MOB properties to house them. Absent significant new MOB construction (which is slow to come online), demand for existing medical office buildings has skyrocketed, and interest in new construction is as high as ever. This is driving prices (and rents) for MOB properties- something that has caught the attention of real estate investors far and wide.
Increased demand, especially among aging populations, also creates demand for specialized health care services. For example, standalone imaging and radiology clinics are a direct response to patients seeking more convenient outpatient care. Many of these patients also have significant disposable income. As such, they are willing to pay a premium for care, specialized healthcare products, and devices if they are readily available and easy to access. As the need for these specialized services increases, investors will have more opportunities to access the medical office sector.
Medical office buildings are often referred to as “recession-proof,” but that is an oversimplification to some degree. Medical office buildings certainly did experience some disruption during the most recent economic downturn, especially among buildings leased to providers who offer elective procedures- a significant driver of physician revenue that was temporarily put on hold during the depths of the COVID-19 pandemic.
That said, few physicians groups went out of business during this time. Compared to other types of real estate sectors, like retail and hospitality, medical office buildings continued to perform well. Medical office buildings also took less of a hit than traditional office buildings and were faster to rebound than their conventional office counterparts.
There are several reasons why this happened. First, healthcare is a basic human need. Whereas people can forgo dining for some time, and whereas many people can work remotely, there are many instances in which people cannot delay medical care. If someone has a heart condition, they will seek medical care. If someone needs kidney dialysis, they are going to maintain their care. It does not matter whether the stock market is up or down that day- the need for certain health care services simply cannot be ignored. This props up the healthcare system and bolsters tenants’ revenues even during economic downturns.
Moreover, the introduction of the Affordable Care Act in 2010 has allowed more people to obtain health care insurance, either public or private. In either case, people continue paying for their health insurance regardless of economic circumstances. Those covered will typically continue seeking medical care even during an economic downturn, given that the costs are not directly impacting their finances (if paid for by insurance). Again, this creates sustained demand for health care services– and by extension– for medical office buildings, which continue to lure more investors to the sector.
There are many ways for individuals to invest in medical office real estate. Those with a shorter-term investment horizon can invest in healthcare real estate investment trusts (REITs) specializing in medical office real estate. This factor allows investors to preserve liquidity as they can usually buy and sell shares relatively easily, just as they buy and sell other equities.
Some investors may instead pursue mid-term investment opportunities. That generally entails investing in a syndicate where a sponsor is pursuing a value-add medical office strategy. In other cases, someone might invest with a MOB developer planning to construct a built-to-suit medical office building for a known tenant. Other investors might look to release an existing MOB property and then, upon building stabilization, will sell the asset. Each of these investments can typically be exited within three to five years.
However, by and large, most MOB investors are purchasing properties with the intent of holding the asset long-term.
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Another reason why people invest in a medical office is due to the cap-rate compression being felt among other, more “traditional” real estate product types like multifamily, retail and industrial. Those asset classes have historically been better understood by investors, and therefore, tend to attract the most broad-based interest from the investment community. However, as more capital has flowed into these sectors, the cap rates have compressed. The risk-adjusted returns that investors had come to expect are no longer as attractive as they once were.
This has created an opportunity for the medical office to shine. Medical office properties, which have conventionally provided higher returns, are proving to be more profitable on a risk-adjusted basis than other property types, given that the sector has historically had less competition than other real estate asset classes.
Choosing the kind of real estate investment properties you want to add to your ever-growing portfolio can be a challenge, mainly since there are so many types to choose from. Thankfully, our team of experts here at Alliance is ready and eager to help you locate the perfect property to meet your risk and profit goals this year.
Medical office building purchase and sale activity are usually slower than one might expect among other real estate asset classes. However, the recent consolidation of the tenants who occupy medical office properties has created new demand for adding MOB properties to their portfolios.
This consolidation of physicians’ practices- many of whom are owned by aging physicians looking to sell their practice and retire- has increased the creditworthiness of the MOB tenant base. Now, instead of Dr. Joe paying rent for his space, the rent checks are being paid by larger healthcare systems with more substantial balance sheets. For example, insurance companies like United Health and Blue Cross Blue Shield are buying out the leases of individual physicians’ groups at record speed. Now, MOB investors have properties leased to well-heeled, institutional-caliber tenants, inherently making these assets more valuable.
Widespread physician group consolidation has created an uptick in acquisition activity, as MOB investors– large and small alike– seek out relatively “safe” opportunities. Investors are looking to acquire these properties, often at a premium, knowing that the leases are guaranteed by larger high-credit, stable health care systems and groups. This is very similar to the high demand for retail properties that have been leased by large national companies like CVS and Walgreens. Now MOB investors have similar creditworthy tenants backing their leases and paying the rent.
Medical office buildings also generate predictable revenue for investors. There are several important reasons for this. For example, America’s aging population will likely create sustained demand for health care services. This demand makes MOB tenants less susceptible to failing, in general, because they have a growing patient base to pull from to sustain their operational needs.
One strategy for prospective MOB investors to consider is to look at properties located in areas with a growing and aging population. Properties can then be tailored to meet the needs of this demographic. This will help to increase the odds that the tenants who lease the MOB space will be successful long-term.
Evidence from during the pandemic supports the predictability of MOB revenue. In a survey of medical office building owners, rent collections during the depths of the pandemic were reported to be more than 95 percent. Despite some momentary business interruptions (e.g., a temporary pause on elective procedures), most medical office tenants were able to keep paying their rent on time and in full during the worst of the pandemic. What’s more, as restrictions began to ease, those who had put their health care needs on the backburner (elective or otherwise) once again sought out care that again bolstered MOB tenants’ revenue.
One of the primary reasons investors are interested in medical office buildings is that the tenants are highly reliable. Doctors, clinicians, and other health care practitioners will often make substantial investments in their physical location. They do so intending to put down roots in the community. Unlike traditional office tenants who can more readily move every three to five years, MOB tenants’ costs when relocating to a new space tend to be prohibitively high. Few MOB tenants want to re-invest in a new facility after investing heavily in their existing location.
Moreover, physicians often spend years building their presence and reputation in a marketplace. After establishing their patient base, few clinicians will want to relocate at the risk of losing these hard-earned clients.
This element creates “sticky” tenants that investors can rely on, staying put for years on end.
Commercial real estate has always provided investors with some degree of stability, in general. Medical office real estate, specifically, offers additional stability. This element is especially true in recent years as physician groups consolidate and have more substantial balance sheets than in decades past. MOB properties that were once owned or leased to small physician groups are now being leased to much larger conglomerates, ensuring investors’ more substantial stability and revenue predictability. This, in turn, significantly drives up the value of MOB assets, creating increased interest in the sector.
However, one of the reasons these medical office tenants are getting bigger is because their revenues are growing. Said growth is because they have spent 20, 30, or even 40 years establishing themselves in the local marketplace. As the local population ages and creates new demand for these services, physicians can respond in one of two ways: increasing the rates they charge for their services or growing their practice to accommodate new patient growth. In either case, this creates even more stability within the sector. Tenants with a long-established patient base are exceptionally stable and appeal to MOB investors of all kinds.
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Any type of investor who’s looking to diversify their portfolio will undoubtedly want to consider adding commercial real estate to the mix. More specifically, those looking to de-risk their investments will want to consider medical office real estate. As shown here, the health care sector is snowballing. The MOB sector’s underlying solid fundamentals make it appealing for several reasons– from both a risk and return perspective.
Although medical office buildings are unique and typically considered a “niche” product, they offer tremendous value for investors willing to understand the sector’s nuances.
Of course, individual investors are cautioned not to approach MOB investments independently- at least not if investing for the first time. Most will want to consider partnering with a medical office sponsor or developer who understands the micro and macro-level demand drivers and makes wise investments on their partners’ behalf to increase the likelihood of success.
Are you considering adding a quality medical office building to your growing investment portfolio? Our team of trusted experts here at Alliance can help you locate the best possible property to meet your risk, and income needs so you can be as secure as possible regarding your future financial success.
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