President John Adams famously said, “Facts are a stubborn thing”. Likewise, the facts of changing demographics are stubborn and compelling; with significant impacts on real estate. The aging baby boomer generation is a prime example and is having a notable effect on medical delivery and facilities across the country. With over 9 million Americans crossing the 65-year age threshold over the next 5 years, demand for medical care will increase across the spectrum of healthcare disciplines. To meet this demand, 150,000 additional healthcare practitioners are expected to enter the national economy over the next 2 years alone and they’ll need a place to hang their stethoscopes.
Large healthcare organizations and institutional medical office investors have been acutely aware of these facts and invested heavily in medical office buildings (MOBs) over the past 8 years, in the wake of the Affordable Care Act. After declines in 2010-2012, absorption of medical office space has exceeded new supply every year since, resulting in an overall vacancy drop to 7.6% nationwide. Recent increases in cost of capital have slowed the pace of traditional medical REIT acquisitions and has created opportunity for other investors. No longer regarded as a niche investor market, medical office has gained favor approaching core asset class.
Medical demands have generated extraordinary innovation from healthcare providers in recent history. Breakthroughs in medical research and technology have expanded the range of healthcare procedures available and the facilities they occupy. Private surgery centers, specialty practices, and large physician groups are moving away from expensive hospital sites to off-campus alternatives and suburban MOB’s. This is changing the real estate landscape for medical office, including the trend of “retailization”, utilizing retail and commercial locations more inexpensively and closer to their patient base. Urgent care, dialysis centers and primary care clinics have become commonplace in retail centers and MOB’s. Based on these new user dynamics, we expect continued, gradual reduction in MOB vacancy with upward pressure on lease rates. Barriers to entry for new MOB development remain high and supply will likely trail overall demand.
This is a healthy trend for MOB owners across the nation, but how is this affecting medical office locally? San Diego is a vibrant reflection of these national trends. Our innovation economy is at the forefront of significant advances in genetics, biotechnology and medical device technology. Importantly, the ongoing collaboration with 5 regionally based and nationally acclaimed healthcare organizations has raised the level of care in our region and fueled demand for clinical medical office space in all submarkets. Solid net absorption of well over 100,000 SF in 2017 & 2018 has lowered the MOB vacancy factor to 6.1%. Our region has over 12 million SF of existing medical office but will require far more to keep up with a population base of 3.3 million and expected to grow to 4 million in the next 30 years. 500,000 people are 65 years or more, increasing by 18,000 per year over the next 5 years, mirroring the national trend. Planned multi-tenant MOB development over the next five years, however, is a fraction of the projected 100,000+ SF annual absorption.
Cap rates for MOB investments remain in the low 6% range, reflecting the safety, stability and long-term desirability of this asset class. We believe that the underlying medical office leases in a medical asset provide long term value with rising demand and rising lease rates. Despite changes in healthcare delivery and public policy, medical real estate in San Diego represents a sound investment opportunity for the long haul.
This is a healthy fact…for the region and for the asset class. At Intersection, we are focused on trends that impact our investors and owners. As available land for development is scarce and medical office vacancies decrease, we have looked for assets that can support medical use where historically those uses would not have been considered. This is not an easy proposition, but one which we are diagnosing wherever possible!