By Louis Suarez, Misty Bowe and Brian Bruggeman, Colliers
The Twin Cities medical real estate market has experienced many different phases over the last few years, reflecting the region’s journey toward post-pandemic recovery. Currently, this sector is experiencing a notable shift that is fueled by rising vacancy rates for on-campus hospital properties contrasted with a low vacancy rate of 4.9 percent for off-campus medical buildings.
This shift is significantly influenced by the push to outpatient surgery centers, ongoing financial pressures and consolidation trends. Additionally, experts in this region are predicting a scarcity of new medical building supply in 2024, which is expected to exert ongoing pressure on rental rates for existing medical office space, despite the stabilization of interest rates that is anticipated to come later this year.
As of the fourth quarter of 2023, the current construction pipeline consists of a mere 84,000 square feet, all of which is spoken for with no additional supply projected to come to market in the next year, which is a nearly 80 percent decrease year-over-year. The dramatic increase in interest rates, rising construction costs and capital constraints have pushed asking rents for new proposed projects to well above $30 per square foot net. This is a 30 percent increase from just a few years ago.
In response to the limited existing supply and dramatically rising new construction pricing, there’s a growing trend of repurposing existing office and retail spaces into medical facilities to address the rising demand for medical space. These market conditions are heavily shaping the way healthcare providers are forced to look at their real estate strategies, with the majority of the conversion projects focused on suburban areas where office or retail vacancy rates are higher compared with that of off-campus medical spaces.
Landlords are drawn to medical tenants due to their longer leases and high likelihood to renew or expand once they’ve established themselves in that space. Similarly, healthcare providers can take advantage of lower rental rates than that of the already scarce medical spaces within the Twin Cities.
Allina Health, a nonprofit healthcare system based in Minneapolis, is one provider that is taking advantage of this conversion trend. In January 2021, Allina originally leased approximately 22,000 square feet of space in Eden Prairie, Minnesota, in a property that was previously geared toward traditional office space. This lease served as a tipping point for the property, which has since begun conversion into a medical office property with the goal of bringing more healthcare services to the community for years to come.
Following this, Allina made the strategic decision to expand an additional 45,000 square feet within this space. This has allowed the healthcare provider to establish an even greater presence within the Eden Prairie market, as well as introduce additional service line offerings like primary care, orthopedics, women’s health and physical therapy.
Although there are numerous conversion options, not all properties are well suited to the unique requirements of medical users. Because they’re not inherently designed for medical purposes, some of these vacant spaces are not equipped to support these conversions — especially in the case of surgery centers or centers dedicated to specialty ambulatory care. Often times, converted spaces will need significant enhancements to the overall HVAC system, electrical, plumbing and parking in order to support medical operations.
Despite the challenges associated with rising vacancy rates and limited new construction projects, the Twin Cities medical office building sector remains strong and resilient. The sector looks forward to significant opportunities for growth and adaptation in response to these evolving demands and trends especially in growing suburbs as healthcare providers look to new rooftops and changing demographics.
These new opportunities, coupled with the anticipation of interest rates to stabilize and decrease throughout the year, will likely lead to a potential increase in overall transaction volume in 2024.
Louis Suarez, Misty Bowe and Brian Bruggeman are all senior vice presidents with Colliers. This article originally appeared in the March 2024 issue of Heartland Real Estate Business magazine.