Kurt Rosene is Senior Vice President of The Alter Group’s Western region.  Reach Kurt at krosene@altergroup.com.

By Kurt W. Rosene

There is no question that medical is one of the leading sectors of real estate. Just take a look at the numbers: the national vacancy rate for medical office buildings is currently 10.9%, much lower than the 12.5 rate for the office sector as a whole; approximately $5 billion of healthcare property traded in 2012, and that figure should rise by 10% in 2013; and healthcare REITs specializing in medical office buildings now typically see twice the yield as companies focusing on other property types.

The reasons are clear: As the largest generation in history–the 78 million Baby Boomers–retires, they are consuming complex medical services at an unprecedented rate. The biggest users of healthcare are older people with chronic conditions (about 145m people and projected to grow to 171m by 2030).  This flood of patients comes at a time when health systems have seen their reimbursements, charitable contributions and investment portfolios take a hit due to the recession. So, you have higher costs and less revenue.

To remain profitable in this environment, hospitals are doing a number of things – cutting expenses by about 18%; selling non-core real estate assets to the investment community; and moving services from the hospital to lower cost, more efficient outpatient medical office buildings. And that’s why the medical real estate market is on fire.

The Prospects for Real Estate

So, what should we expect? Here are just a few trends to take note of:

• With the exception of multifamily, healthcare will lead the recovery because it has stable demand, unlike the rest of the real estate market which is a lagging indicator of employment. During the worst of the recession from December 2007 to June 2009, healthcare added 428,000 jobs while total nonfarm employment was down by more than 7.5 million. Plus healthcare building proformas are based on long-term triple net leases.
• The real estate investment community, including the REITs, pension funds and private equity groups, will continue to hold medical real estate as a favored product class, along with multifamily and industrial. More than $22 billion has been raised for MOB acquisitions, mostly of portfolios. Large portfolio sales volume increased from the previous record of $1 billion set in 2007 to $2 billion in 2012.
• In light of consolidation, standard leases within medical office buildings will be larger (from 1,000-3,000 square feet to 5,000-8,000 square feet for larger physician practices). We are seeing 15-year triple net leases and a lot of 7-year leases with TI that is higher and annual rent increases of 2-3%.
• We will see the adaptive reuse of former big-box retail locations, such as Borders and Circuit City, into medical uses. Medical retail will be an important driver for demand with ambulatory centers being located within lifestyle centers and retail malls. It started with eye care, but now we are seeing urgent care, sleep centers, physical therapy, primary care and imaging within retail environments. 
• An emerging market will be building data centers for healthcare providers. American healthcare providers currently have $300 billion invested in data, including GPS and mobile apps. With the adoption of Electronic Heath Records (EHR), it is estimated that data centers could save providers between $300 billion and $450 billion annually (we spend about $2.6 trillion overall) so we are sure to see demand surge in the next cycle.