Medical Office Deal Flow Stalls, But Fundamentals Remain Strong

Rising interest rates is the largest concern facing MOB investment this year.

Transaction volume for healthcare real estate stalled in the latter half of 2022 as rising borrowing costs and mounting economic uncertainty pushed investors to the sidelines, according to a new report from JLL.

While medical office deal flow was buoyed by the merger of Healthcare Realty Trust and Healthcare Trust of America, quarterly transaction volume for the last two quarters of the year dropped sharply amid several hikes of the federal funds rate. Spreads between the 10-year Treasury and MOB cap rates also narrowed, dropping from 400 to 500 basis points in 2019-2021 to just over 230 basis points in Q4 2022.

“Cap rates have been impacted by rising treasury rates and rising costs of borrowing,” the JLL report notes. “In our investor survey 76% of respondents indicated that they expected cap rates to rise in the next 12 months. Cap rates are still low compared to historical levels, despite rising 50bp heading into January 2023.”

Overall, rising interest rates were cited as the largest concern facing the MOB investment landscape in the coming year, with many large domestic banks slowing lending activity as larger banks grapple with the higher capital reserved imposed on them by the Fed. Debt service coverage ratios have further constrained additional lending activity according to JLL, with conventional secured debt rates in December 2022 averaging 5.7% on a 10-year note, up 260 basis points since the prior year.

The JLL survey predicts rents to grow by between 2 and 4% for MOBs, noting that strong growth for medical office can temper a rise in cap rates. Institutional ownership in the asset class has cooled as REITs expand into the sector, with the latter controlling 13% of product.

“Currently the bid-ask spread is limiting transaction volume, as sellers’ pricing expectations are adjusting to the higher interest-rate environment,” the report states. However, MOB fundamentals continue to be healthy with strong occupancy and rent growth, making it an appealing sector compared with traditional office. Strong NOI growth at 2.7% in Q3 2022, despite high expenses, and acceptance of 3% escalations (up 100bp), make MOBs a resilient asset class in a cloudy economic climate.”