Healthcare Real Estate Outlook Remains Bright in an Evolving Environment
The medical office sector continues to perform well, with low vacancy rates and record-setting asking rents. Robust demand is outpacing supply, yet many developers are hesitant to break ground due to elevated construction costs. Medical offices were not immune to the disruptions in the capital markets from the Federal Reserve’s aggressive rate increases. Consequently, sales volume declined noticeably in 2023, as higher cap rates and downward pricing pressure created a significant “bid-ask” spread. Despite these headwinds, the outlook for 2024 and beyond is bright. The demand for healthcare services should continue growing as the population grows and the youngest Baby Boomers turn 60. As we look ahead, we see opportunities and challenges that will shape the healthcare industry in the years to come.
- Artificial Intelligence (AI) Potential: Although in its early stages, AI holds the potential to revolutionize the healthcare sector, driving efficiencies and enhancing profitability.
- Behavioral Health Wave: The demand for mental health services has surged, accompanied by increased funding for critically needed facilities.
- Consolidations, Mergers & Acquisitions: Shrinking profit margins will compel healthcare organizations to scrutinize their operations and pursue strategies to expand market share, increase revenue, and diversify risk.
- Inflation and Interest Rate Dynamics: As inflationary pressures subside, the anticipated decline in interest rates is expected to stimulate deal activity in 2024 and beyond.
- Patient Accessibility: Healthcare providers continue to face challenges in meeting the increasing demand for medical services.
- Political Promises: Healthcare policies will be a key focus as candidates articulate campaign promises, with issues like Medicare/Medicaid, health insurance premiums, women’s healthcare, and prescription drug pricing taking center stage in 2024.
Medical Office Fundamentals: Key Takeaways
- Vacancy: In 2023, the medical outpatient building (MOB) sector vacancy rate declined 63 basis points, to 7.0%. In a stark contrast, the broader office sector’s vacancy increased 120 basis points, to 16.9%, during the same period.
- Absorption: Demand for medical outpatient space remains strong, outpacing new supply. Net absorption was 16.5 million square feet in 2023, up from 15.8 million square feet in 2022.
- Rents: Average net asking rents in the medical outpatient building sector reached an unprecedented high of $24.37 per square foot in 2023, 2.3% higher, a notable milestone.
- Construction: The delivery of a cumulative 10.8 million square feet of MOB space last year was a modest increase from 10.3 million square feet in 2022.
- Sales: Total investment in MOBs reached $7.3 billion in 2023, 62% below the record-setting $19.1 billion in 2022. Sales pricing fell from an average of $329 per square foot in 2022 to $292 per square foot in 2023. Meanwhile, average cap rates increased by 80 basis points in 2023, to 6.8%.
Rents Continue to Rise as Vacancy Falls
In 2023, rent growth in four of the top 10 leading U.S. MOB markets was above the national average of 2.25%. Miami led the pack with the highest growth, at 2.9%, closely followed by Atlanta, at 2.8%, and both Dallas and New York, 2.6%.
Los Angeles maintained its position in the top 10 markets with the highest average net MOB asking rents, at $35.26 per square foot; all other leading markets’ recorded rents were below $30 per square foot. These were New York ($29.23 per square foot), Washington, D.C. ($27.17 per square foot), Boston ($27.08 per square foot), and Miami ($27.02 per square foot).
Among the top 10 markets, five ended 2023 with vacancy rates well above the national average of 7.2% for the Top 100 markets. Houston stood out as the only leading market with a double-digit vacancy rate, at 11.7%, though that was 60 basis points lower than in 2022. Dallas and Washington, D.C., followed closely, with 9.1% and 8.9% vacancy rates, respectively. Conversely, New York boasted the lowest vacancy levels among the leading markets, at 6.0%, with Boston and Miami not far behind at 6.1%.
Higher Cost of Capital Leads to Falling MOB Construction
Even as delivered MOB space in 2023 was on par with that in 2022, construction starts fell 44.8% due to elevated borrowing and construction costs. Completions of 10.8 million square feet during 2023 were up marginally from 10.3 million square feet in 2022. But new project starts declined from 16.2 million square feet to 8.9 million square feet. As of the end of 2023, 31.9 million square feet were under construction.
Among the nearly 600 healthcare real estate projects underway across the Top 100 markets, 213 are focused on hospital developments. Of another 376 medical facilities under construction, 73% are off-campus, reflecting the shift toward outpatient clinics over in-patient hospital care.
Seven metropolitan areas had more than one million square feet of MOB construction in progressat the close of 2023, half the number of the previous year. Houston led with 2.0 million square feet, followed by New York with 1.9 million square feet, and Los Angeles and Washington, D.C., each with 1.6 million square feet.
Cap Rates Rise as Pricing Falls
After a record-setting year in 2022, MOB investment dropped significantly in 2023 as the Fed’s aggressive rate hike campaign seized capital markets. Total sales volume dropped from $19.1 billion in 2022 to $7.36 billion in 2023. Despite these conditions, continuing interest in the sector means sales could regain momentum, with interest rate cuts expected later this year.
Average MOB cap rates rose by 80 basis points during the year, to 6.7%, while average pricing fell from $329 per square foot to $292 at the end of 2023. Eleven metros had more than $500 million in MOB property sales in 2023, led by New York ($1.59 billion), Phoenix ($1.48 billion), Los Angeles ($1.45 billion), and Boston ($1.29 billion).
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