Orange County’s Medical Office Market Stays on Solid Ground

by Jeff Shaw

— By John Wadsworth and Aaron Phillip, Colliers —

The Orange County medical office building (MOB) market continues to show resilience post-pandemic despite headwinds of the new interest rate environment. The overall Orange County MOB market consists of 10 million square feet with a current vacancy of 8.5 percent, down 100 basis points from the end of 2022. The average rental rate is $3.48 per square foot, per month, full-service growth, with an increase of 9.3 percent from mid-year 2022. The lack of significant MOB construction completions, coupled with much of the existing vacancy found in older, functionally obsolete buildings, has kept supply largely in line with demand. 

The velocity of MOB leasing activity has softened compared to pre-pandemic transaction volume, with healthcare providers still digging out of the financial “COVID hole.” Among other market pressures, labor costs and retention across healthcare employment significantly contribute to continued narrow margins on provider balance sheets. From larger health systems to smaller independent practices, all have been impacted, slowing the pace of expansion projects and mandating shorter, more flexible transactions until more permanent real estate solutions can be implemented. Despite the market challenges posed by the pandemic, MOB absorption has remained positive countywide, posting a net gain of 75,200 square feet leased over the past four quarters.

Leasing concessions are more prevalent in mid-2023 as transaction volume trends downward, resulting in landlords competing harder for fewer deals. As negotiating leverage shifts from landlord to tenant, tenants are mandating higher tenant improvement allowances and asking for more upfront rental abatement. Access to capital continues to be a challenge in the new interest rate environment, with one of the biggest hurdles in lease negotiations being who will pay for tenant improvements, and how. With construction costs at historically high levels, landlords who are willing to aggressively fund improvements (often offering well north of $100 per square foot) will be at a significant advantage. In return, however, tenants must commit to longer lease terms with financial credit to securitize the landlord’s investment.

Orange County continues to see a steady flow of new MOB and hospital construction projects that will bode well for future demand and further solidify the county as a center of excellence for world-class healthcare. A few of the noteworthy projects include City of Hope’s 73-bed specialty hospital and 190,000-square-foot MOB; UCI Health’s 144-bed hospital and outpatient center; Hoag Hospital’s Irvine Campus expansion, which added 155 inpatient beds and 120,000 square feet of new outpatient space; Children’s Hospital of Orange County’s new 190,000-square-foot Southwest Tower outpatient center; and Providence Health’s Mission Hospital Campus bed tower expansion that added 100 new inpatient beds. The cumulative construction cost of the abovementioned owner-user projects total more than $5 billion.

The overall fundamentals of the Orange County MOB market remain on solid ground, with the theme for the second half of 2023 expected to be a continued improvement as healthcare provider volumes and balance sheets normalize. With the pandemic now in the rear-view mirror, all eyes remain on the ongoing impact of the new interest rate environment, inflation and other global economic pressures. However, amid another economic downcycle and a disruption in the commercial real estate markets, the medical office building sector continues to prove its resiliency.

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