Looming Repeal of Affordable Care Act Shakes Up Otherwise Healthy Forecast for Healthcare Real Estate
In 2016, the national vacancy rate for medical office buildings hit an all-time low, net absorption rose to its highest mark since 2008, rents grew and investment activity remained strong.
But despite last year’s strong performance, Colliers International’s 2017 Health Care Marketplace Report shows that questions loom for the year ahead in the medical office space. While every administration change causes some degree of uncertainty, this year’s shift is markedly different as healthcare providers and system owners face the possible repeal of the Affordable Care Act and the details of the coverage set to replace it.
Healthcare providers are also grappling with the implementation of the final terms for the site-neutral payment rule — which limits the way off-campus facilities are reimbursed by Medicare — and a continued rise in costs, from services provided to construction materials and labor.
The report predicts that decision-making in the sector is likely to be delayed for a time, especially if policy changes surrounding the Affordable Care Act evolve over a protracted process.
An additional burden to the healthcare industry is the continued aging of a large segment of the U.S. population. Healthcare expenditures per capita surpassed $10,000 in 2016, and are forecast to grow at an average annual rate of 5.8 percent through 2025.
At the same time, providers are receiving less insurance income and are under constant pressure to protect operating margins while still innovating, improving and enhancing services.
With these complications ahead, Colliers continues to tout the solid fundamentals seen last year, and notes that the industry will likely remain buoyed by consumer demand.
Vacancy Falls, Rents Rise
Taking a deeper look into the top 10 U.S. markets that garnered the most investor interest in 2016 — Atlanta, Boston, Chicago, Dallas-Fort Worth, Houston, Los Angeles, Phoenix, San Diego, Seattle and Washington, D.C. — vacancy rates for medical office buildings vary significantly.
Boston, Houston, Los Angeles, San Diego and Seattle all saw vacancy rates well below 10 percent at the end of 2016. Seattle ranked the lowest, with a vacancy rate of 4.9 percent, while over-saturated markets like Phoenix ranked significantly higher at 14.3 percent.
The majority of the 10 leading markets saw rents ranging from $21 to $24 per square foot, with Southern California achieving the highest rents at $31.02 per square foot in San Diego and $29.72 per square foot in Los Angeles.
Though not one of the top 10 markets, New York exhibits a massive difference between medical office building rents. In New York City, rents clock in at an average of $72.07 per square foot. Across the entire New York MSA, rents averaged $22.93 per square foot.
The delivery total for medical office buildings in 2016 exceeded 22 million square feet, second only to the 2008 peak of 24.9 million. Colliers predicts that medical office building deliveries will remain elevated this year, with around 20 million square feet of completions expected for 2017.
The construction pipeline — combining properties already under construction and those at the proposed and planning stages — has the potential to generate more than 1,400 new healthcare properties, 46 percent of which are medical office buildings.
The median construction value per project in 2017 stands at $33 million for hospitals and $15 million for medical office buildings, while project sizes average 60,000 square feet and 45,000 square feet, respectively.
Analysis of 2015 and 2016 deliveries by Colliers showed a significant shift away from hospital construction and towards medical office buildings over the last two years. In 2015, the total amount of hospital space delivered was almost double the amount of medical office space.
This differential disappeared in 2016, with both property types forecast to account for an equal share of the 44.8 million square feet of healthcare real estate set to deliver. While the total pipeline of future construction is still weighted to hospitals moving forward, new hospital development is becoming less prevalent. Of the 283 hospital projects set to deliver in 2016, 83 percent involved the expansion of existing facilities.
As of the start of 2017, the Centers for Medicare and Medicaid Services stopped paying for services provided by hospital’s off-campus sites at the same rate as hospital-based outpatient sites through the implementation of the Site-Neutral Payment Rule. The impact of this change on healthcare providers and their real estate decisions is potentially significant.
For new and planned off-site campuses, providers will need to assess whether they can operate profitably with the lower payments from Medicare, likely delaying some new projects or canceling some real estate deals altogether.
The stability provided by the growing aging population is expected to continue to garner investor interest in the sector as the year progresses, despite government-sponsored changes.
Fueled by the momentum of 2016 and strategic decision-making in the face of market changes, Colliers expects 2017 to bring valuable opportunities for investors and providers alike.
— Katie Sloan