Since the onset of the COVID-19 pandemic, the General Office Building sector of U.S. commercial real estate has faced substantial challenges. The new, hybrid work environment has led to decreased demand, a surplus of available sublease space and higher vacancy rates in general office buildings nationwide. Valuations have continued to fall, uncertainty abounds, and a near term recovery to where the office market was prior to COVID-19 is unlikely.
In contrast, Medical Outpatient Buildings (MOB), have historically outperformed general office in key metrics, delivering higher income returns on average for decades. The challenges and uncertainty plaguing the general office market of late are not reflected in the medical outpatient market. Industry and demographic trends support continued future growth in the medical outpatient facilities market.
MOB fundamentals have historically been – and remain – stronger than the general office sector as illustrated in the following metrics for the year ending 2023.
AVERAGE INITIAL LEASE TERM
Tenants in Medical Outpatient Buildings sign longer-term leases compared to General Office Buildings, typically ranging from 7-15 years. Healthcare tenants typically invest more significant improvements into customizing their space for medical use than general office users, and are less likely to relocate frequently due to the specialized nature of their facilities and the importance of maintaining a consistent patient base. This stability contrasts with the higher turnover rates seen in general office buildings.
VACANCY RATE
Medical Outpatient Buildings command strong and stable occupancy. Even in the wake of the financial crisis of 2008–2009, healthcare real estate vacancy rates never exceeded 10%. MOB vacancy rates have held stable over the last five years, varying only 140 basis points between 7.9% in 2019 and 9.3% in 2023.
In stark contrast, General Office Building vacancy has hit a 30-year high, surpassing the prior peak of 16.3% seen at the height of the financial crisis of 2008–2009. Over the last five years, General Office Building vacancy rates have steadily increased by 690 basis points from 11.4% in 2019 to 18.6% in 2023, with further upward pressure expected.
DEMAND (COMPLETIONS AND ABSORPTIONS)
The demand for Medical Outpatient Buildings (MOB) space is outpacing supply in most regions as MOB occupancy continues to climb amid record low completions. This trend is projected to continue, likely resulting in further growth in occupancy levels and the ability for owners to increase rents.
Conversely, General Office Buildings finished the year ending 2023 with a fifth consecutive quarter of negative absorption. Tenant downsizing has become the norm, with large occupiers reducing space by an average of 20% on new leases and renewals.
RENEWAL/RETENTION RATE
Medical Outpatient Building renewal rates are typically 80% or more. Following the pandemic-related shutdowns in 2020, physician employment recovered quickly and, despite the sudden but temporary halt of many services, renewal rates increased.
By comparison, General Office Building renewal rates accounted for less than a quarter of all leasing activity in 2023. Of the largest 100 U.S. office leases, 58% were renewals of expiring leases, but for 12% less space.
RENT GROWTH YEAR-OVER-YEAR
Year-over-year rent growth for Medical Outpatient Buildings has increased steadily, even since the COVID-19 pandemic.
In contrast, year-over-year rent growth for General Office Buildings has not recovered to its pre-pandemic trend. It is currently trending downward and is projected to fall below COVID-19 pandemic levels by the end of 2024.
Due to the strength of the Medical Outpatient Buildings market fundamentals, as well as industry and demographic trends, MOBs are surpassing general office in all performance metrics. While higher interest rates and operating costs have affected both sectors, the shift to remote and hybrid work has adversely affected office space in particular. Unlike other real estate sectors, healthcare real estate’s underlying demand is driven by demographics rather than the broader economy. The minimal correlation between the economy and healthcare spending allows healthcare real estate to consistently outperform other asset types.
From September through November 2023, healthcare created 32% of the new jobs in the U.S., nearly six times more than the collective jobs added by the office, industrial, and retail sectors combined. This trend has continued into 2024 with healthcare again adding 32% of the new jobs in the U.S. in April, according to the Bureau of Labor Statistics.
Already accounting for nearly 20% of the U.S. GDP, healthcare is expected to be a substantial driver of growth in the U.S. over the next decade. As the healthcare landscape continues to evolve, medical outpatient buildings are poised to maintain their superior performance, offering investors and stakeholders a stable and lucrative opportunity in the commercial real estate market.
For more information about Flagship Healthcare Properties and its service and investment offerings, visit FlagshipHP.com.
