Deals On Hold And Costs Spiraling, Healthcare Real Estate Recalibrates For Post-Covid World

Healthcare assets are being hit by the same blows as the rest of the real estate industry, but fundamental demand means the outlook is positive — even if industry leaders predict a few difficult years ahead.

“It's hard to make deals or to pencil out and make any financial sense, but in terms of the Tri-State area market ... we're pretty confident in the long-term medical prospects," Cory Atkins, the director of acquisitions at Atkins Cos., said at Bisnow’s New York Healthcare Real Estate conference on Thursday. "Health systems are getting larger, they're very sticky in their spaces, they are consolidating, they just keep continually growing. It's a better market than the general office market.”

Certainly, the market is not on fire. Deal volume in the Tri-State medical office market dropped to $550M last year, per CBRE — a 30% contraction from the year before. The drop was driven largely by a pullback in the outer boroughs and the suburbs, but values have held firm, according to the brokerage.

In fact, medical office buildings traded 6.7% higher on a per SF basis than in 2018 and 2019. Office buildings, by comparison, were down nearly 10% in the same time period, according to CBRE.

Buildings with medical and healthcare tenants are far less threatened by remote and hybrid work. There is also a growing societal focus on health and wellness, not to mention pressure to expand into retail real estate for branding and market share to reach a wider array of customers. But there are several major challenges, panelists said, that will mean a muted few years in the industry.

Costs are biting hard, just like in any other sector of the industry, for example.

“Cost of construction right now is the highest it's ever been in our lifetime,” said Peter Mulcahey, the vice president of healthcare and life sciences at JRM Construction. “We're looking at trying to get MOBs to market quickly. We can't get new switchgear, we can't get air handlers for 40 to 60 weeks … Expenditure over that period of time is a tremendously long time to wait for a medical office building to come up.”

He said requests for proposals are slowing, and conversations about development are becoming more difficult as budgets blow out and people consider whether it is better to wait out the market — or assume it is only set to become more expensive, not less.

Similarly, the cost of debt is throwing cold water on the market, Atkins pointed out. His firm owns and manages some 1M SF of medical offices in the Northeast and mid-Atlantic regions.

The Federal Reserve paused its yearlong interest rate-hiking campaign at its meeting earlier this month, but Chairman Jerome Powell signaled that the central bank is likely to usher in more raises this year in order to tame inflation.

“The cap rate trend has not gone hand in hand with the interest rate rise,” Atkins said. “The deal flow has somewhat come to a halt.”

Development and renovation is on hold, too, Cube 3 principal Matt Bluette said, adding that it has been swift slowdown over the last eight months or so.

“Last fall, we had a ton of projects that were just starting up,” he said. "Come January, February, and most of that was put on hold. Most of our clients, larger medical centers, that would have 100 projects by now have 10."

Bluette said healthcare providers, unlike developers of other commercial real estate asset types, can be more patient and wait to develop until economic conditions improve.

"We have some clients that have the cash, but they're just not going to build the building," he said. "Healthcare providers can take the long view, they can put things on pause for a while and still keep building, they don't have to worry about speed to market, things like that. They take a longer approach to it."

The slowdown isn't simply due to the cost of debt and construction, but also budget and labor shortages that are playing out in how these healthcare providers plan their real estate.

Nurses, for example, are in short supply and expected to become even scarcer. Some 31% of nurses say they are considering leaving their positions in the next 12 months, according to McKinsey’s most recent survey.

“Hospitals are concerned about that and have to take that into account when they're looking at expansion,” Simone Development Senior Vice President Megan Guy said.

She said budgets are tight now that the Covid public health emergency is over, and some hospitals are having trouble staffing facilities. But she added that she has a long-term positive outlook on the sector.

“[Providers] are still making deals. We are still active or very busy right now," she said. "But I think it will be slower than it was over the last five years over the next couple of years.”

National demographics are in favor of healthcare. In the U.S. the median age was 38.8 in 2020, up from 35.2 20 years earlier. In the Tri-State area, 20% of the population is set to be over the age of 65 by 2030, per CBRE. One in four people on Long Island, for example, are expected to be older than 65.

The way people are using healthcare is changing rapidly, and technological advances means there is going to be significant work in the sector for developers, investors, builders and architects.

“Accessibility to population, that's where the health systems want to be, and we're seeing that today from both the hospitals and health systems and the private physician groups,” Guy added. “The convenience of having a Starbucks next to healthcare is great.”

The pandemic pushed people away from going to hospitals when it wasn’t necessary, meaning providers are looking to expand their offerings closer to homes. Healthcare systems, too, will need to expand to be more accessible to those outside Manhattan, panelists said.

The ability to brand and advertise providers with strong, retail locations is also becoming a big part of the business plan, they said. “It's really a different time than 20 years ago when [a doctor's office] was a Class-B office building, tucked away,” Atkins said. “It's really kind of out front and center on highways and wherever the density of traffic is … They're fighting for market share.”