By Mike Wilson, Principal, Avison Young
As the commercial real estate industry shifts toward a new normal, there are several changes occurring in the medical office sector. This asset class has long been considered a safe haven, even in recessionary times, given its ties to the healthcare system and overall population growth. The onset of COVID-19 and the subsequent stay-at-home orders in many states have created challenges that also touch the medical office sector, although not nearly as deeply as other asset classes.
One shift occurring is a varying level of activity among medical office tenants, depending upon whether their services are deemed essential or nonessential. Tenants in essential buildings, particularly those tied to large healthcare systems, are still seeing patient throughput activity as healthcare needs remain. Some elective surgery centers and outpatient testing facilities, however, have seen a temporary pause as medical professionals retrenched due to the state closures. Landlords in turn have had to manage rent relief requests from tenants.
Mike Wilson, Avison Young
These changes are considered short-term and are not expected to have long-term effects on tenant activity or property investment levels. The medical office sector continues to draw the attention of a wide range of investors, due to its connection to the healthcare system and the country’s growing population that relies on medical providers.
Sales activity
Prior to COVID-19, medical office sales were strong across most U.S. markets. Sales increased 20.5 percent year-over-year (to $14.7 billion) for the 12 months ending in the first quarter of 2020, for example. A total of 1,586 buildings traded in the U.S. during that time, an increase of 30.3 percent, while the amount of square footage changing hands increased by 29.7 percent to 54.4 million square feet, according to research from Real Capital Analytics (RCA).
Across the Midwest, the number of properties that traded rose 7.5 percent over the last 12 months, ending with the first quarter of 2020, to 259. A look at the first quarter of 2020 shows year-over-year total volume down 16.6 percent to $323.9 million, with an average price per square foot of $221.
Private investors have expanded their presence in the Midwest, accounting for 65.4 percent of all buyers and 78.7 percent of sellers in the first four months of 2020. REITs and other listed entities accounted for 21.4 percent of all buyers, while institutional investors made up 12.4 percent of buyers. Institutional investors were missing from the first four months of 2020 but had made up 18.9 percent of sellers in 2019, according to RCA.
Several significant healthcare building transactions in the Midwest have closed amid the COVID-19 shutdowns. In Omaha, Nebraska, Dana Magid Development Co. sold the 96,764-square-foot Village Point Health Center for $30.1 million to Noddle Development. Avison Young recently completed the $26 million sale-leaseback of the 60,000-square-foot McLean County Orthopedics complex in Bloomington, Illinois, from McLean County Orthopedics to Hammes Partners. This was a sale-leaseback that allowed the medical practice to leverage capital from its real estate to grow its business.
Sale-leasebacks are a growing trend as owner/operator physician groups look for additional ways to raise capital and grow their practices, as well as keep up with the high cost of technology investments.
Who’s involved
The number of medical office properties sold in the Chicago region has increased by 44.4 percent over the past year, ending with the first quarter of 2020, to 78 buildings. These buildings total 1.97 million square feet, representing an increase of 8.6 percent in square footage traded during the 12 months ending in April 2020.
Private investors were the most active in Chicago’s medical office sales in the first four months of 2020, accounting for 100 percent of the sellers and 44.4 percent of the buyers. REITs and other listed companies made up the other 55.6 percent of medical office building buyers.
While medical office sale originations have slowed since the COVID-19 shutdown, transactions that were already in the pipeline have been closing in recent weeks. This is a positive sign, showing that investors view this sector as a solid long-term investment opportunity.
New sales are expected to ramp back up as the visibility to the capital markets improves. While REITs may stay on the sidelines until stock values climb, lenders are coming back into the market and private equity and fund-backed operators continue to hunt for acquisitions.
As space occupiers look ahead to a post-COVID-19 marketplace, many will begin to reevaluate their longer-term space usage. Among the questions are whether they will need more space to accommodate social/physical distancing for waiting rooms and within treatment areas or whether telemedicine consultations, which are now forced to the forefront, will gain more traction. This could decrease the need for additional space for specific specialties and cases.
This article was originally written for the June 2020 issue of Heartland Real Estate Business magazine.