REAL ESTATE NEWS

Medical office has long been considered a “safe and steady” investment choice within the financial community, thanks to its historic growth, long-term tenants, aging population and resilience in the face of events such as a pandemic. That's highlighted by the performance in San Diego, although the market isn't without its flaws.

Average asking rents in San Diego, for example, continue to grow, increasing to an average rate of $4.28 full-service gross across all submarkets, according to JLL’s San Diego Q3 Medical Office Report.

Meanwhile, according to Avison Young, the current medical office vacancy rate in California is approximately 8%, while office vacancy rates in much of the state hover between 20% and 30%.

Space Tightens, Rents Rise

JLL Vice President Ben Schiesl told GlobeSt.com that several converging factors support an acceleration of demand from both owner-users and investors in San Diego medical office buildings.

“From the owner-user perspective, vacancy for San Diego Class A medical office space continues to tighten, and as a result, rental rates continue to climb,” he said.

“Additionally, recent interest rate dynamics are creating a compelling window for owner-user acquisitions. As rates stabilize and potentially decline from recent peaks, healthcare providers who have been waiting on the sidelines are now positioned to act when the right opportunity arises.

“Owner-users typically have better access to favorable financing terms than investors, and the current rate environment makes ownership attractive when faced with perpetually increasing rent.”

These factors are all meaningful, but the most critical factor in San Diego County has historically been access to supply.

“We have seen an uptick in smaller opportunities through zoning changes, asset conversions, and similar transactions that have infused new inventory into the market – inventory that doesn't pencil for traditional investors,” Schiesl said.

With new opportunities available, Schiesl said he expects to see increased interest from owner-users. For example, Sharp's $30.7 million acquisition in Carlsbad, Calif., exemplifies this trend.

Schiesl said that from the investor's perspective, the secret is out on medical office buildings.

“What was once firmly considered an alternative or niche asset class has quickly gained investor interest, and for good reason,” he said.

“The combination of demographic tailwinds and the shift to outpatient care, among many other critical factors, signals a buy opportunity for institutional investors across the board.”

Perhaps the most significant acquisition within the sector, Schiesl said, occurred in late October when Remedy Medical Properties and Kayne Anderson Real Estate – together the nation's largest private owner of healthcare real estate – acquired 18 million square feet of outpatient assets from Welltower.

Medical Condo Conversion to Persist

By individual submarkets, Kearny Mesa/Mission Valley is outperforming others in San Diego in terms of 12-month vacancy improvement. This time last year, the submarket had a rate of approximately 7.4%, and today it has plummeted to around 4.6%.

“I expect quality built-out space to continue leasing quickly in this submarket, and I’m watching for rental rates to climb significantly over the next five years,” Schiesl said.

“What was once a haven for providers looking to relocate from higher-cost areas like UTC or Hillcrest will look very different in just a few years. If I am an investor and I am looking for a central San Diego location, I am starting here.”

JLL’s report noted that the trend of acquiring traditional office buildings or obsolete medical properties for medical condo conversion is expected to persist, with investors targeting low-basis opportunities in medically zoned properties.

Fed’s Lower Interest Rates Not Bringing Lower Lending Rates

Medical office investment sales have slowed in line with the general economy over the past three years, following several years of record-setting numbers and prices, according to Michael Dettling, principal of Avison Young's healthcare real estate group.

Lower lending rates have not taken effect just yet after two cuts by the Federal Reserve — but that's expected to change in the eyes of Dettling.

“The next six to 12 months will likely see an easing in long-term rates, encouraging more activity in this sector," he predicted.

The aforementioned blockbuster Remedy/Kayne Anderson announcement indicates there is plenty of dry powder on the sidelines, closely monitoring any signs of change in the market, Dettling highlighted.

“The high cost of medical office development in the state has slowed new product coming online,” he said. “Yet, it has spurred interest in medical office conversion from general office and retail in Orange County and other parts of the state.

“Such conversions are often seen as less expensive than ground up, and are quicker to market, helping to meet continued strong tenancy demand.”

Source: GlobeSt/ALM