3 trends impacting medical office demand

Cheryle Powell
Health care services, Colliers International, Denver

Colliers’ analysis of the health care industry and its effect on commercial real estate in the U.S. points to a soaring health care landscape with expected increases in investment and further “retailization.” Colorado follows this national trend presenting a strong performance in 2015.

Along the Front Range, medical office vacancy is 8.6 percent and absorption remains positive. In some areas vacancy is lower, which makes it challenging for practices in need of expansion to find medical office space. Vacancy rate in Midtown is 0.3 percent; North Denver is 4.2 percent; and Fort Collins/Loveland is 4.9 percent. Leasing rates increased 7.4 percent over the last four years averaging $22.81 per square foot in 2015.

This downward trajectory of available lease space will continue in 2016 as the health care industry experiences growth in both employment and the 65-years-and-older demographic. Douglas County has the sharpest increase in health care employment and is projected to have the highest 65-plus population increase over the next 10 years.

Strong performance of medical office sales continued in 2015. Sales volume reached over $290 million as capital continued to flow into the sector and drive cap rates down to 7.16 percent. The strong investor appetite is driven by higher yields compared with other asset classes, low interest rates and a stable tenant base with strong credit. Health care inherently is driven by demand for patient care. The constant nature of this demand renders the health care sector attractive to investors.

The solid fundamentals of this asset class, combined with the projected growth in aging population, are attracting investors not accustomed to investing in medical office buildings. We expect strong demand to continue into 2016, virtually unaffected by the interest rate increase. In Colorado and the U.S., these trends are driven by:

1. More patients having insurance coverage under the Affordable Care Act.

2. More “consumer-friendly” outpatient clinics, such as urgent care centers and retail clinics.

3. Mergers and acquisitions.

Expanded Health Insurance Coverage

In 2015, 140,327 Colorado consumers enrolled or were automatically re-enrolled in affordable health insurance coverage through the Marketplace. We expect health care costs will continue to rise as ACA members are actively using the coverage in which they are paying. Based on these factors, as well as growth projections, it is estimated that health care spending will nearly double in the U.S. over the next 10 years – from $3 trillion in 2014 to a projected $5.5 trillion in 2024.

Consumer-Friendly Clinics

The retail sector is expected to benefit as medical clinics, urgent care centers and other outpatient facilities lease space in vacant retail spaces in shopping centers. These properties offer favorable lease terms, great visibility and convenient locations to patients.

Additionally, improving the patient experience is the focus of health care construction, according to a survey conducted by Health Facilities Management and the American Society for Healthcare Engineering of the American Hospital Association. The survey polled a random sample of 3,125 hospital and health system executives to study trends in hospital construction. More than 86 percent of survey respondents said that patient satisfaction is “very important” in driving design changes to health facilities or services. Approximately 63 percent of respondents said now they include patients and community members in the design process.

The Advisory Board says consumers want it all – short drive times and ancillaries at every site, provider continuity and 24/7 availability. The millennial generation is driving this desire, as they are accustomed to on-demand convenience.

Merger and Acquisitions

As hospitals and health care systems are under pressure to reduce costs while increasing the quality of care, there has been a wave of merger and acquisition activity that is expected to continue into 2016. These hospitals and health care systems are seeking to improve efficiencies, reduce duplicate facilities and gain greater negotiating leverage with insurance companies.

As mergers bring together hospitals and physician practices into large, financially solid health care systems, they aggregate significant real estate portfolios. The full implications of this merger and acquisition activity on real estate demand have yet to be fully realized.

Technology Transformation

Technology transformation possibly could decrease demand for medical office space. In a study performed by InMedica, it was predicted that the number of patients with chronic illnesses who are remotely monitored will increase from 308,000 in 2012 to approximately 1.8 million by 2017. Remote monitoring can be effective in preventing highly expensive hospitalizations, re-admissions after discharge and emergency department visits through proactive early identification and response to symptoms of a worsening condition. All of this reduces the need for direct patient care and thus the need for medical real estate.

The impacts of ACA, “retailization,” mergers and acquisitions, technological advances and financial uncertainty will have an effect on health care real estate in the years to come.

Featured in CREJ’s March 2-March 15, 2016 issue.