Medical Office Building Investment – What You Need to Know
Some asset classes commercial real estate industry have been on an upward trajectory for several years now, in large part, due to investors looking to diversify their portfolios. In turn, the yields for certain asset classes have become increasingly compressed. Investors looking for greater value are starting to look at niche products as a way of earning more substantial returns.
Medical office buildings are one such “niche” product that investors have begun swooning over.
There are many reasons to be drawn to medical office building investments. For example, an aging population is driving demand for medical office buildings in more communities, with services provided closer to home. Moreover, the pandemic has highlighted the resiliency of the sector. Regardless of economic and global health considerations, people continued to seek out routine and necessary medical care, which allowed the sector to continue thriving.
In this article, we provide a more detailed look at medical office as an asset class including the most pressing things investors need to know about the sector.
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What are medical office buildings?
Medical office buildings are a subset of the “office” sector but are distinct from traditional office in many ways.
Medical office buildings, often referred to as “MOBs”, are properties that have been designed specifically for health care providers such as doctors, dentists and other clinicians. These buildings are typically structured with patient waiting areas, exam rooms, and specialized building systems and materials. For example, given concerns about doctor-patient confidentiality, MOB offices will usually have especially high-end soundproofing. The buildings may also have specialized HVAC systems to ensure proper air ventilation needed to accommodate various medical devices.
Medical office properties are usually characterized as either “on-campus” or “off-campus”. On-campus buildings are usually located on a hospital campus or immediately adjacent thereto. These MOB facilities will usually have some sort of affiliation with the hospital, even if that affiliation only pertains to the doctors’ referral networks.
Off-campus MOB properties are usually located further from hospitals and are more likely to be found in suburban and rural areas. These properties, sometimes referred to as “ambulatory care” facilities, bring health care services closer to the areas where patients live and work.
Historically, many physicians would own and operate their own off-campus MOB buildings. However, as more real estate investors look to buy MOB facilities, many physicians are selling their real estate (often leasing back) and turning over day-to-day property management to more professional and specialized real estate groups.
Are medical office buildings a good investment?
Medical office buildings are certainly a good investment, especially for those looking to invest in a lower-risk asset class given the resiliency of the sector. Investors are quick to note the strong underlying fundamentals supporting MOB’s long-term prospects. For example, nearly 10,000 Americans are turning 65 years old each day, according to AARP. As people age, their need for health care increases. Someone who may have only visited the doctor once or twice a year when they were younger will often find themselves seeing the doctor 10+ times as they approach retirement age.
Moreover, health care is a fundamental human need and therefore, people do not hold off on seeking health care regardless of economic conditions. While some people may temporarily delay elective procedures, those who are sick and need medical treatment will continue doing so whether the stock market is up or down. This is evidenced by the sector’s strong rent collections that have exceeded 95 percent even during the depths of the pandemic. With patients continuing to seek care, despite economic uncertainties, the majority of MOB tenants were able to make on-time rent payments.
Lastly, the number of Americans with either public or private health insurance is higher than ever. This creates a source of sustained demand for health care services that has caused unprecedented strain on the nation’s health care infrastructure. Medical office buildings are already in short supply and as demand for services increases, this supply-demand imbalance is expected to grow. Investors who enter the sector now are well-positioned to reap the benefits of the sector’s ongoing success.
Medical office building real estate - an overview
Medical office building real estate comes in all shapes and sizes. Buildings can be as small as 1,500 square foot standalone properties leased to an individual practice (i.e., a primary care physician or dental practice). At the other end of the spectrum, MOB properties can be tens of thousands of square feet, hospital-affiliated properties that are subdivided and leased to dozens of tenants. The latter was commonly built in the 1970s and 1980s with the rise of the suburban “medical office complex” – properties that still hold their value today, especially if well-located with strong visibility and access.
How to invest in medical office buildings
Medical office buildings have historically had very high barriers to entry. This can be explained, at least in part, due to the average investor’s inexperience and discomfort with the niche sector. Typically, smaller properties would be owned by physicians’ groups and larger buildings would be owned by hospital systems, real estate investment trusts (REITs) and a handful of other institutional investors. “Retail” investors have rarely invested in medical office buildings—until now.
As cap rates and yields among other commercial real estate asset classes (e.g., multifamily, traditional office, industrial) have compressed, more individual investors are turning to medical office as a way of earning higher returns. Many will do so by investing in a REIT that specializes in medical office buildings. Others will opt to invest alongside a sponsor in a syndicate or fund that plans to invest in MOB real estate. A smaller number of investors may decide to partner with a physicians’ group to purchase and lease the space back to the clinicians currently operating out of the space.
How to source medical office buildings to invest in
Those looking to invest in medical office buildings will want to pay close attention to the property’s location. Location is one of the most critical aspects of an MOB property’s success. Investors will want to consider first, for example, whether they want to invest in an on- or off-campus medical office building. There are certain advantages associated with investing in an on-campus, hospital-affiliated property. Practitioners operating in on-campus MOB facilities are usually eligible for higher health insurance reimbursements compared to off-campus properties, and therefore, tenants are usually willing to pay a premium for the space. However, as a result, on-campus properties usually trade for higher prices and at lower cap rates than their off-campus counterparts.
There are also advantages to sourcing off-campus MOB deals. Off-campus facilities, ranging from single-tenant, standalone buildings to more intricate “MedTail” (e.g., medical office buildings that have been integrated into retail and other mixed-use development projects) tend to have strong appeal among local residents in search of care closer to home. Physicians looking to expand their geographic footprint will often do so in these off-campus facilities.
A qualified medical office broker or MOB real estate developer will be able to walk investors through the pros and cons of each unique opportunity as they evaluate various medical office opportunities.
Medical office building requirements
Medical office buildings have a few unique requirements that investors should understand prior to investing in any specific deal. First, medical office buildings generally have specific requirements around parking and ADA accessibility. Parking is especially important given the number of patients who visit MOB properties each day. Parking ratios are generally higher (at least 5 spaces per 1,000 SF of medical office space) than required by other commercial real estate uses. Parking lots need to be level in order to meet the needs of patients with limited mobility. MOB parking often features a disproportionately high number of handicapped-accessible spaces compared to other real estate uses, as well.
To that end, ADA accessibility is critically important to all medical office buildings. This is especially true in ambulatory care settings where patients may be visiting for day surgeries and other intensive clinical care. Older MOB properties will often need to be upgraded to comply with city, state and federal regulations to ensure accessibility. This may require the addition of building ramps, improvements to bathrooms, hallways and corridors, or the installation and/or upgrading of elevators to meet the needs of those who are mobility impaired.
Building materials are also something to consider. While not as prescriptive as building codes or ADA requirements, building materials will influence the type of tenants an MOB investor can expect to attract. Properties with newer finishes, better lighting, more efficient HVAC systems and various sustainability elements will attract higher-paying, more creditworthy tenants than older, more outdated MOB properties. In some cases – for instance, health care providers who cater to private payer clientele seeking specialized services like plastic surgery – the design of an MOB property may need to feel more like luxury retail or high-end hospitality setting than a traditional doctor’s office.
Medical office building REITs and portfolios
Those who are considering investing in medical office may want to dip their toes into the water by investing with a medical office building REIT and/or private equity real estate investment firm with a large medical office portfolio. The benefit to investing in either an MOB REIT or other portfolio deal is that it provides the investor with exposure to various medical office assets, including but not limited to on-campus MOB facilities, off-campus ambulatory care facilities, senior living facilities (that feature assisted living, memory care and other healthcare services), and skilled nursing facilities. This approach provides investors with the greatest portfolio diversity as they broaden their commercial real estate investments.
Medical office real estate brokers
Medical office real estate brokers are uniquely positioned to assist investors in identifying the most appropriate MOB deal based on their specific investment goals, objectives and risk tolerance. They understand the sector’s intricacies, which are often very different than traditional office.
Medical office real estate brokers can be helpful in ways well beyond the purchase and sale of any single asset. They can also provide investors with valuable guidance around tenant leasing, construction management, property management, capital markets, investment sales and more.
While medical office real estate brokers tend to provide the most value to general partners (owners) and tenants, they can also help guide individual investors looking to partner or invest in medical office real estate alongside others.
Medical office building management
Owning and operating a medical office building can be challenging, even for the most adept commercial real estate experts. Medical office buildings have specific characteristics, tenant profiles, and more that require certain skills and knowledge to operate a building efficiently. Prospective investors will certainly want to consider who (and how) the property will be managed long-term.
A few things to note about medical office building management.
First, large, multi-tenant buildings tend to require more intensive management than properties leased to a single or very few tenants.
Second, older MOB properties tend to be more management intensive than newly-constructed properties. What’s more, although the cost of new MOB construction is at all-time highs, the delta between upgrading an existing facility to modern-day standards and building new has narrowed in recent years as labor and material costs have risen. Therefore, an investor considering an older MOB property with the intention of executing a value-add strategy that would eventually require less intensive management will want to carefully consider whether they are better off simply buying a newly built property that has been optimized for today’s medical office users.
Conclusion
Medical office buildings are an increasingly attractive asset class for commercial real estate investors to consider. The healthcare sector is one of the nation’s fastest growing industries, in terms of both demand for services and need for health care workers. The nation’s existing MOB inventory cannot keep pace with this growth or demand, which has pushed MOB rents to all-time highs. Absent significant new construction (and with limited new development planned or in the pipeline), medical office investors can feel confident about the projected stability of these properties—not just today, but well into the future.
POSTED BY
CASEY HURSH
Casey leads the investor relations team at Rising Realty Partners and is responsible for growing the community of accredited investors, fostering investor engagement, and raising capital.
