Medical Office Getting More Attention From Curious Investors

Medical office was one of the few commercial real estate sectors to hold its own among investors during 2020. Throughout the recent coronavirus pandemic, more investors got a taste for these properties, which proved resilient in the face of the overall economic downturn.

“We collected about 99% of our rent last year,” Remedy Medical Properties Chief Operating Officer Krysta Bavlsik said. “So, we’re seeing many more investors turning to the sector.”  

When much of the economy began shutting down last March and April, the Chicago-based Remedy initially offered many tenants a deal on their monthly rents, she said. But rather quickly, it became apparent that doctors and other medical professionals were still able to see patients and generate income.

“Our tenants didn’t really need the help,” Bavlsik said. “That proved out our thesis that medical office is recession-resistant.”

Other owners had the same experience in 2020.

“During that period, all of our tenants paid rent,” Alliance Consolidated Group of Cos. CEO Ben Reinberg said.

His Chicago-based firm found that medical tenants providing essential services, such as dialysis, found ways to stay open and operate safely, while others were also willing to do what it took to see patients, whether that meant staggering appointments to maintain social distancing, seeing patients in parking lots or using alternative entrances.    

And as the pandemic recedes, experts say 2021 could be another big year for trades. Although there was a slowdown in medical office investment in Q1, a lot of capital piled up in 2020 that was targeted toward the sector, and with long-standing demographic trends still growing the number of older Americans, a mismatch between supply and demand should continue, keeping portfolios well-occupied and attractive to potential buyers. In addition, new trends such as telemedicine have so far largely failed to significantly dent the demand for in-person visits.

Commercial real estate investment began dropping last spring, but medical offices seemed to float above the turmoil, suffering only a slight decline. Overall U.S. sales volume fell 32% in 2020, according to Real Capital Analytics. But medical office investors spent $11.2B last year, according to healthcare data firm Revista, down from $12B in 2019.

The sector did stay relatively healthy throughout the past year, Revista data shows. Occupancy in the top 50 U.S. markets increased from 91.5% in Q4 2020 to 91.6% in Q1 2021, while tenants absorbed a total of more than 26M SF in the two quarters, the company found. And rental rates in the top 50 markets hit $22.75 per SF in Q1, a 1.9% increase over last year’s Q1.      

“If you look at the [medical office data], you see the steadiness throughout the entirety of last year and into this year,” Revista principal Hilda Martin said during a Revista webcast in April. “This is also what we saw throughout and after the Great Financial Crisis.” 

It’s also likely the market will stay tight, Martin added. Medical office inventory totals about 1.5B SF, and it typically grows by about 1.5% to 2% each year.   

“The lion’s share of that tends to be pre-leased or driven by a hospital or health system, so it’s very measured growth that we tend to see off of this base of inventory,” Martin said.

Bavlsik said Remedy, which separated from MB Real Estate Services last year, bought 4.6M SF of assets in 2020 and approximately 120 buildings and has grown its portfolio about 25% every year since 2015.

Revista said Remedy spent $1.5B on medical office properties last year, making it the sector’s largest buyer in 2020. That included a $605M purchase completed near the end of 2020 for a 29-building portfolio from Milwaukee-based Hammes Partners. 

Reinberg said Alliance bought about 12 properties in 2020, spending roughly $37M.

“That’s pretty good during a pandemic,” he said.

Institutional investors held off buying in the medical office sector until a few years ago, Bavlsik said. Unlike downtown office properties in core markets, which can absorb hundreds of millions of dollars with just one purchase, buying medical offices could mean doing due diligence on a couple of dozen buildings, which then require special expertise to manage.

“It’s always been a bit difficult for many to get their arms around medical office,” she said. “It’s an operationally intense sector, and that’s been a barrier to some people coming into it historically.”

But an increasing number of investors now understand its value, according to Reinberg. Alliance focuses on triple-net-lease properties in the medical field, and many tenants are committed to making improvements to their properties, frequently boosting resale values. Most tenants also have good credit, and securing long-term lease renewals will garner even more investor interest.   

“I’ve got tenants pulling the wagon in the same direction as Alliance,” he said. “It’s a really stable income stream with an upside.”   

And plenty of investors are piling in these days, though investment into medical offices did decline in Q1, according to Revista. Buyers spent about $1.8B on medical offices, about the same as Q1 2019, but down from $3.3B in Q1 2020.

“However, this slowdown is unlikely to continue,” Martin stated in May on Revista’s website. “Many investors have been busy raising funds over the past year and these funds must be deployed. That, in addition to continued interest from new investors, will likely drive sales up in the coming quarters.”

Bavlsik said she agrees. Like many other investors, Remedy had made a big year-end push to close transactions, and it is now gearing up for a more active summer and fall.

“The second and third quarter will be a lot better for us,” Bavlsik said.

Reinberg said the beginning of the year brought some uncertainty, but with fundamentals in the sector so strong, it shouldn’t last.

“Sometimes when there is a turnover in administration, there are nerves,” he said. “I think we will be selling a lot of assets this year.”

As sales pick up, so does pricing.

“What we’re seeing is more and more companies out there bidding up these deals,” Bavlsik said. “We’re pretty much priced out of many marketed properties because there is so much demand.”

Interest in medical offices from institutional investors was building for several years before the pandemic, she added. But the steep decline within some sectors during 2020 may cause an even larger long-term shift, drawing money usually allocated for office and retail purchases into medical. That’s even more likely if office users adopt hybrid strategies that soften office demand.

“There are plenty of companies saying things like, ‘things are working out great, so if you guys want to work from home, then work from home,’” Bavlsik said.

The great fear among medical office landlords in 2020 was that telemedicine would impact the sector in the same way Zoom and other technologies sliced into the office market. And although the use of telemedicine technology for outpatient visits soared last spring, as both patients and doctors sought to avoid contact, for the rest of the year it was a different story.

The Journal of the American Medical Association Network Open published a study in March that found telemedicine use among more than 4,000 Michigan-based surgical practices rose astronomically but then began declining after June 2020. That was when clinics were reopening and many people decided they wanted in-person consults, according to Healthcare IT News, and few new patients chose to use telemedicine technology.

That’s a huge relief for investors. Bavlsik said it now looks more likely that telemedicine will be used to supplement brick-and-mortar offices, rather than replace them.

“If ever there was a time for it to take off, it would have been last year.”