The Future of Medical Office Real Estate – and How It’s Affected by Healthcare

BLOG POST

02.27.2018

By Marina Hammersmith, CCIM
Senior VP, Healthcare Brokerage Services
Ensemble Real Estate Solutions

2017 marked an unprecedented year in real estate, leaving many to question what 2018 may have in store – particularly in the realm of medical office space. But to determine where we’re going, we need to look at where we ended in the previous year and examine the factors slated to impact the market in the near future.

Currently, the total vacancy in medical office space across Maricopa County is 25.1%, which is an increase from 22.6% at the end of 2016. Gross rents have also increased by 1%, gaining from $23.49 to $23.69.

From an investment standpoint, sales transactions dropped from 99 transactions in 2016 to 70 transactions in 2017, however, the dollar volume increased from just under $100,000,000 in sales to over $136,000,000 – and the price per foot increased from an average of $131.73 to $188. This accounts for a 43% increase in price per pound.

Meanwhile, cap rates dropped from 8.12% to 6.76% — and many investment brokers feel there’s room for further compression as investors continue to seek out MOB assets. Generally speaking, healthcare is seen as somewhat impervious to large market swings that can impact other asset classes.

To chart the course of healthcare real estate throughout 2018, we need to focus on the shifts happening throughout the healthcare landscape as the industry continues toward a consumerism mentality. The general population feels the burden of their individual healthcare costs, which is giving rise to the trend of “shopping” their healthcare. Now we’re all comparing prices, outcomes, patient reviews, and asking for alternatives.

Currently, healthcare operates under a hub-and-spoke model with hospitals acting as the hub of delivery, and spokes – in the form of off-campus facilities – reaching out into the communities they serve.  Delivering healthcare services within communities acts as a channel back to the “hub,” which increases the market share for hospital systems. This model also serves to curb delivery costs; off-campus facilities tend to be less expensive than those on-campus.

There are numerous factors that are now converging to drive down the cost of delivery – chiefly among them, mergers and acquisitions.

Over the last several years, headlines have focused on healthcare systems buying physician practices or entering to JV partnerships with larger specialty groups. That trend has slowed – and even stopped – for some systems, changing the focus to the acquisition of urgent care centers or other alignment opportunities that bring healthcare from the hub closer to the patients. Other merger and acquisition headlines have focused on expanding the delivery of healthcare in lower cost settings and leveraging size to increase bargaining power with healthcare suppliers. This was a motivation in the proposed CVS acquisition of Aetna.

In recent months, all eyes have been on Amazon in anticipation of their plans within this sector. With the announcement that Amazon is partnering with Berkshire Hathaway and JP Morgan to address healthcare for their employees, the trio is expected to influence an entire healthcare culture.   In 2018 and beyond, this mounting trend will create direct competition to local provider bases throughout the country. It’s a major disruptor that is sure to drive down the cost of delivery.

Technology is another significant disrupter in this space. New York-Presbyterian and Walgreens are collaborating to offer remote access to board-certified emergency room physicians though an interactive kiosk, where the ER physician can perform a physical examination through high-definition video conference and provide a diagnosis and treatment. CVS is doing something similar with Cleveland Clinic. This trend is extending to our mobile devices as well, with the technology expanding to allow providers to use the camera feature on our phones – and other potential plug-ins – to monitor vitals and offer treatments without us ever leaving our homes.

What this means for healthcare real estate is that the industry will have very diverse delivery options depending on the level of care required. Telemedicine and other technology options won’t eliminate the need for patients to visit their obstetricians, orthopedic surgeons and other specialists – they’ll still need brick and mortar offices. But the way they interact with these storefronts will change.

On-campus medical office buildings will house specialists who need proximity to the hospital for their patients. But off-campus medical office facilities will provide access points for patients who don’t want or need to commute to the hospital campus, offering treatments that can be successfully completed in an out-patient setting.

Investors are circling this space and regularly calling for off-market opportunities to enter the market or expand their portfolios. The primary driver toward this asset class is the perception of insulation against broader market conditions. We need health delivery outlets, and that need will only increase in the foreseeable future. Expect 2018 to be a robust year for this sector of real estate.

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