ENCINO, CA-As occupancies firm up and speculative construction comes to a near halt, the medical-office investment sector is expected to improve through year end, according to Marcus & Millichap’s Medical Office Research Report on the first half of 2012. More private investors are expected to step up to acquire healthcare assets, but REITs and institutions will dominate investment activity this year, and on-campus properties or institutional-quality, near-campus properties will drive demand.

“Medical-office properties appeal to a much broader array of investors than they have in the past,” Alan Pontius, managing director of the healthcare real estate group for Marcus & Millichap, tells GlobeSt.com. “Both private and public investors will continue to expand their MOB portfolios to take advantage of an anticipated surge in healthcare demand as baby boomers age. That said, the evolving healthcare model will drive more differentiation in prices by property size, quality and location, and could even render some aging properties obsolete.”

The report indicates that a near shutdown in speculative medical office development, coupled with rising space demand, will drive occupancy gains for this sector in 2012. However, rent growth will be slow during the next several quarters due to Medicare reimbursements remaining under pressure, which directly affects physicians’ revenues and therefore their ability to afford higher medical office space rents. “While vacancy will slip in 2012, uncertainty stemming from healthcare reform is likely to prevent many physicians from making any major business decisions, particularly with regard to extended leases,” Pontius tells GlobeSt.com. “The prevailing uncertainty and continue pressure to reimbursements will also limit rent growth.”

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Yet, despite general uncertainty, the report says that demographic trends undoubtedly point to substantial growth in the healthcare industry over the next decade. During this time period, the 65+ segment of the population will expand by roughly 36% as baby boomers continue to make their way toward the traditional retirement years. And since roughly half of an individual’s lifetime medical expenditures occur after age 65, growth in this cohort stands to drive substantial gains in healthcare demand and spending. Furthermore, if enacted in its current form, the heavily debated PPACA could provide coverage to an estimated 30 million to 35 million uninsured individuals, amplifying healthcare needs, which would then spur demand for healthcare assets.

The report indicates that not all medical properties will benefit to the same degree from these demographic shifts. For example, ever-growing regulatory requirements and escalating operating expenses will continue to drive consolidation throughout the healthcare industry, resulting in large and often hospital-affiliated practices and encouraging young doctors to pursue hospital employment, which will in most cases place older medical office properties built to house independent practitioners at a disadvantage and potentially render them functionally obsolete. On the other hand, assets with large floor plates that can accommodate high-tech equipment and systems should outperform, especially those suitable for use by multiple specialties.

When devising medical office investment strategies, the report says to include an ongoing push toward a more patient-centric delivery model, which includes greater access to care in ambulatory settings. Between 2010 and 2020, ambulatory-care facilities will drive healthcare-related job creation, with physician employment in this segment forecasted to rise by nearly 127,000 positions, accounting for three-quarters of all new physician jobs industry wide. In the near term, the report indicates that major property owners and lenders will continue to favor on-campus buildings, but the off-campus arena will heat up in the years ahead as health systems and other providers respond to patient demands for greater convenience and readily accessible care.

The report also indicates the following trends in other areas:

  • Construction—While demand for healthcare services translate into stronger medical office space needs, the widespread adoption of electronic records management will mean decreased storage-space needs and therefore less square footage. During 2012, approximately 6.3 million square feet of medical office space will be delivered, an increase from last year, but still more than 60% below the annual average from 2006 to 2008. Construction lenders will remain cautious in the near term, focusing on hospitals, hospital-affiliated buildings, ambulatory-care facilities and off-campus surgery and emergency centers.
  • Vacancy-Medical-office vacancy will slip below 11% this year for the first time since 2008. Last year, the medical-office sector recorded a 30-basis-point reduction in vacancy to 11.3%, led by improvement in the Northeast region, but also supported by modest tightening in Texas and the Midwest. Occupancy gains will broaden in 2012, but markets that experienced significant speculative development ahead of the housing bust (such as the Southwest/Mountain region) will lag. Other metros, such as Salt Lake City and Denver, post vacancy rate below the national average. The sector has also begun to see more competition from retail properties.
  • Rent-Owners have become conservative with regard to rents and more amenable to adjusting terms to attract and retain tenants. MOBs that cater to small practices will be at the most risk for revenue reductions, in terms of both declining market rents and rising concessions. Nationwide, asking rents for available medical-office space declined 1.9% in 2011, due in part to the omission of high-priced space from the rent survey due to absorption—particularly in the Northeast (Boston and New York), where a few major leases at top-tier medical-office properties removed a significant amount of high-rent square footage from the pool of available space. Owners of better-quality assets in supply-constrained markets will regain moderate pricing power as 2012 unfolds.
  • Investment-Nationwide, the average price for medical-office properties hovers near $165 per square foot, thought the most sought-after on-campus buildings can trade at prices roughly 1.5 to 2.5 times higher. Prices for best-of-class assets and aging, low-quality buildings stand to diverge further in the future as the evolving healthcare model prompts more consolidation and influences leasing trends.

Pontius reveals to GlobeSt.com that indicators point to a bright future, but long-term forecasts for MOB will become more challenging as the correlation between healthcare needs and space demand weakens. “Advancing technology and tele-health systems will provide more opportunities for patients to receive care without visiting an office. In addition, downward pressure on reimbursements will encourage physicians to extend office hours, limiting their need for additional space as demand rises.”