Recession-Resilient Medical Office Building Assets

Medical offices house tenants providing essential services, with customers prioritizing health regardless of economic fluctuations. Experts forecast over 8.27% annual growth for healthcare real estate through 2030, fueled partly by America’s aging population, with 16.8% of adults now over 65, according to 2020 census data.

This expanding healthcare market fuels demand for specialized medical office buildings (MOBs)—properties housing everything from individual physician practices to dialysis clinics to imaging facilities. And even amidst the COVID pandemic’s economic shockwaves, MOBs demonstrated resilience.

For investors seeking stable assets, MOBs present a compelling opportunity. They enjoy reliable tenant demand, high renewal rates, and barriers to competing new development.

Why medical office buildings?

MOBs have proven resilient across economic cycles. Healthcare’s essential nature shields this real estate asset class from broader economic volatility.

Strong demand

Physician office employment has grown steadily at 3.3% annually as of Q3 2023. Yet over the same period, MOB inventory itself only expanded by 1%. With doctor and healthcare worker counts rapidly rising amid continuously expanding demand, these properties enjoy strong tenant demand compared to supply.

This durable demand persisted even when temporary shocks like COVID-19 disrupted healthcare delivery. During 2020 lockdowns, waiting rooms turned ghost towns, with a 36% reduction in patient visits. But you can only defer essential care for so long. By 2021, appointment books filled again, rebounding 5.3% to pre-pandemic levels as patients returned.

Come recession or pandemic, patients keep seeking care and physicians keep providing it. This essential nature demonstrates why MOBs remain one of the more resilient commercial real estate assets across economic cycles.

Stable tenants

On top of reliable demand, MOBs also house solid tenants consistently meeting rent obligations. These medical buildings contain healthcare giants—sprawling hospital networks, physician groups, hundreds of doctors strong, and massive regional health systems anchoring communities.

These foundational healthcare institutions demonstrated resilience even amidst the pandemic’s economic uncertainty. Despite deserted waiting rooms and plummeting patient visits, MOB tenants’ strong financial backing allowed them to uphold rent payments.

The scale and creditworthiness of hospitals and massive physician groups provide the productive, long-term occupants that enable MOBs to deliver stable returns across market cycles.

Consistent renewals

We’ve found these properties enjoy significantly higher tenant renewal rates compared to other commercial real estate. A recent investor survey in 2023 found most expect renewal rates of 85% or more in MOBs they own.

This sticking power stems from the sunk costs medical tenants invest when moving in – expensive MRIs, CAT scan machines, and customized plumbing for complex procedures. With millions already spent outfitting these specialized spaces, relocating proves complex and budget-straining. So, healthcare companies choose to renew, avoid disruption, and continue relying on the tailor-made offices that have served their patients well over the years.

In medical office buildings, the same devoted medical teams greet familiar patients year after year, facilitated by consistently renewing leases. Patients appreciate being able to continue visiting their trusted doctors in a convenient and familiar location. This patient preference provides further incentive for consistent renewals.

MOB resiliency

Tenant diversity

MOBs typically house a diverse mix of medical tenants, from primary care and pediatrics to specialties like surgery, imaging, dialysis, and more. This diversity helps mitigate risk if one sub-sector faces headwinds.

Creditworthy tenants

Many MOB tenants are large hospitals, regional health systems, and physician groups with strong financial backing and creditworthiness. For example, as of 2023 America’s Physician Groups represents approximately 360 physician groups – with over 170,000 physicians providing care to over 90 million patients across the United States. These deeply resourced healthcare institutions make productive long-term MOB tenants.

Barriers to new development

Constructing new MOB supply is a lengthy, specialized process constrained by significant zoning restrictions, construction approvals, specialty medical certifications, and rigorous compliance processes. Completing feasibility studies, site plans, permits, and licensing can take years before new properties open their doors to patients and staff.

These substantial barriers limit competitors from quickly saturating certain medical office submarkets when demand rises. It helps curb overdevelopment risk and contributes to balanced MOB ecosystem growth.

Mitigating risk

Investing in medical office, like any asset class, carries risks that can sink returns if not properly assessed. However, we take key steps when deploying capital into MOBs:

1. Understanding healthcare markets: We thoroughly analyze specialized healthcare real estate markets – working closely with hospital systems, major physician groups, and specialty providers to assess opportunities. This experience lets us navigate industry trends.
2. Tenant financial review: As a CPA, I carefully review the financial statements of potential MOB tenants. For example, an oncology practice with expensive equipment and specialty-trained staff presents a far different risk profile than a family medicine clinic. This review enhances tenant creditworthiness assessment.
3. Inspect leases: We scrutinize individual MOB leases to understand risk exposures within each agreement. Assessments include expense obligations, renewal options, and termination clauses.
4. Market factors: Conservative underwriting requires assessing key factors like submarket vacancy rates, absorption trends, market rental rates per square foot, and typical tenant improvement requirements in the area.
5. Building reserves: A reserve fund allows us to carry an underperforming asset through periods of market volatility. This cushion ensures resilient returns even in times of broader economic uncertainty.

Industry considerations

While MOBs have inherent resilience, investors must still monitor healthcare industry risk factors:

Healthcare Consolidation

A key trend to watch is the pace of healthcare consolidation. A recent survey found 60% of industry executives expect more consolidation in 2024. As organizations combine, they exit redundant spaces, causing uncertainty for nearby practices reliant on that health system.

Regulatory Changes

Shifts in healthcare regulations and reimbursement models can positively or negatively affect MOB tenant revenue. For example, changes in insurance coverage or federal programs, such as the 2022 expansion of Essential Community Providers, may significantly impact service demand. We factor this external risk into our underwriting considerations, recognizing it as an unpredictable influence on occupancy.

Key Takeaways

MOBs stand out as resilient assets in real estate portfolios, thriving even in economic downturns due to the essential nature of in-person healthcare. They offer stability with stable, creditworthy tenants and high renewal rates, backed by diverse tenant profiles that mitigate sector-specific risks.

Taking a strategic approach to monitoring healthcare trends and regulatory shifts helps support sound investment decisions in this dynamic sector.

Modified Date & Time : 31 Dec 2023, 02:57 pm

Author

Ben Reinberg

Ben Reinberg is the Chief Executive Officer of Alliance Consolidated Group of Companies, LLC. Before founding Alliance, His journey in acquiring commercial real estate assets started in the 1990s. Ben holds a B.S. from the Kelley School of Business at Indiana University and is a qualified Certified Public Accountant.

• 
•