MOB Developers Opt for Adaptive Reuse

LOS ANGELES—Medical office building developers are choosing adaptive reuse or renovation projects over ground-up development, despite all-time low vacancies, according to panelists at the recent Healthcare Real Estate Executive Roundtable hosted by Cox, Castle & Nicholson and CBRE. The roundtable welcomed 40 healthcare professionals to discuss the evolving market and what is driving these changes. David Lari, a partner at Cox, Castle & Nicholson, moderated the discussion with partner David Waite and CBRE's Bryan Lewitt and Chris Bodnar. To get an insider's perspective, we sat down with Lari for en exclusive interview. Here, he talks about medical office development, the capital chasing these deals and leasing trends for these types of buildings.

GlobeSt.com: How are MOBs getting developed these days?

David Lari: There are a few macro issues here. First, many developers would rather renovate an MOB than build a new one, even in a market with non-occupancy rates less than eight percent. The reason is that doctors do not want to move because historically only about 20 percent of their patients will go with them.

Second, panelists shared that healthcare is becoming more decentralized, transitioning to more of a “hub and spoke” model for delivering patient care. With healthcare services moving closer to patients, developers are looking at adaptive use of other property types to open more medical facilities. Coming out of the recession, there were a lot of “dark” retail shopping centers and office buildings with substantial vacancies that represented opportunities for developers. They have found that that by placing healthcare service providers in these locations, developers can increase foot traffic and enable MOBs to adopt a retail approach. This is an emerging trend that we will continue to see.

Lastly, seismic safety requirements from OSHPD (Office of Statewide Health Planning and Development) for acute patient treatment facilities have become highly restrictive. Developers are looking at these standards very closely and, in some cases, the requirements are causing them to convert their properties to other asset classes, rather than healthcare.

GlobeSt.com: What does the availability of capital look like in healthcare real estate today?

Lari: There is a lot of capital in the market. CBRE estimates that there is upwards of $15.6 billion in capital to acquire product this year. To put that into perspective, last year, we saw $9.4 billion in transactional volume on the medical office side.

REITs are buying whatever they can get. Publicly traded healthcare REITs realized a 31-percent increase at the end of 2014, outperforming the entire REIT market. Non-traded healthcare REITs are paying six- to seven-percent dividends. There is a lot of money chasing product. And this dynamic is leading to a lot of consolidation.

There is strong interest from foreign investors in the healthcare sector. Interestingly, Middle Eastern investors, who want to avoid liquor and other cultural issues that arise in other property types, have been very active in this sector.  In addition, Chinese investors have shown tempered interest, but many are looking for big-dollar deals, and they often purchase several assets as a portfolio transaction to get the numbers they want.

Given the current state of foreign markets and the uncertainties in them, that many foreign investors view investments in the U.S. as a relatively safer choice and accordingly often will settle for lower returns.

GlobeSt.com: What are some of the leasing trends in Southern California that your roundtable discussed?

Lari: The average doctor's office has downsized from approximately 1,500 SF to 1,000 SF to make the space more efficient. Private offices and storage rooms are going away. Panelists have found that with physicians taking less space, they are losing leverage in lease negotiations. Sometimes, doctors will bring in a partner to help avoid downsizing. But larger tenants are moving in and “hoteling” doctors in open spaces that enable better integration between physicians.