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Saturday, Jul 20, 2024

Real Estate Quarterly: Medical Miracle

When it comes to medical office space, two narratives unfolded last year.

“As far as leasing goes, 2022 was a particularly active year throughout the submarkets that we cover,” said Jacob Mumper, vice president at Colliers. “In the second half of 2022, sales cooled down. A pretty direct correlation in timing with the shifting lending environment and the rising interest rates.”

Medical buildings are usually located near hospitals, as their tenants are specialists providing an ecosystem for referrals. The suites tend to have a customized build-out to accommodate water lines, technology, waiting rooms and other special features.

While the general office market throughout Los Angeles continued to see a rise in vacancies and negative net absorption in the fourth quarter, the medical sector enjoyed active leasing.

“Medical office buildings withstand economic headwinds better than most asset classes,” Mumper said. “Medical-office sales noticeably cooled off but the market fundamentals are still very strong for medical office buildings. So there’s certainly still optimism for medical buildings.”

Bill Boyd of Kidder Mathews said it’s clear why firms and REITs such as MedProperties, Meridian, Healthcare Realty Trust, Ventas and Welltower continue to invest in medical real estate and why local companies such as Stockdale Capital Partners are planning a $250 million, 12-story medical tower in the Westwood neighborhood.

“As our boomer generation continues to age — 10,000 people a day in the U.S. turn 65 — that’s a huge, huge demographic bubble coming through our culture and the need for medical space isn’t going to diminish,” Boyd said.

Leasing thriving

Chris Isola of Jones Lang LaSalle Inc. traces the rise of medical leasing to a period of upheaval for retail.

“Five to seven years ago, the big trend was converting retail space into medical,” Isola said. “When retail was going through change and there was a lot of vacancy in retail shopping centers, every landlord was curious about leasing to medical groups.”

Yair Haimoff of the brokerage firm Spectrum Commercial Real Estate has seen a lot of activity on the leasing side.

“As far as leasing goes, we have practices that are growing; even within our buildings like the Northridge building, there’s a tenant that took additional space,” he said. “We did one deal with an outside tenant that came in, an urgent-care group that took the space. We just leased our last unit, Riverside Medical Building in Sherman Oaks. We just leased our last unit at the Northridge Medical Building at 18433 Roscoe Blvd. in Northridge.”

Haimoff points to the trend of doctors buying medical office condos, which are individually-owned units within a large multi-unit building.

“Medical offices are doing very well,” Haimoff said. “We sold another medical complex in Oxnard — a complex of four buildings that we sold to a doctor. On the purchase side of it, there’s a lot of specialists who want to buy their own unit because the cost of doing the tenant improvement work in these medical suites is very expensive. If I’m going to spend $150-$200 a square foot on the tenant improvement costs, I’d rather own it than lease it.”

Isola also sees medical office conversions happening at traditional office buildings. For example, tenant Southern California Orthopedic Institute leased space at 30870 Russell Ranch Road in Westlake Village and California Fertility Partners signed a lease at 2045 Sawtelle Blvd. in Japantown.

“Now we’re seeing a number of office landlords who are experiencing historically high vacancies in their buildings are looking to medical to say, ‘Well, can I convert a portion of my building to medical office instead,’” Isola said. “It’s tricky, because medical is a big parking user and a lot of office buildings don’t have the parking to support it.”

Fourth-quarter sales

Despite the recent cooldown in medical building sales, deals were still happening during the fourth quarter.

In October, the sale of a pair of Beverly Hills medical buildings with a surgery center closed for $8.5 million. Located near the highly trafficked intersection of La Cienega and Wilshire boulevards at 250-256 S. La Cienega Blvd., the two-story, 6,386 square-foot property came equipped with an extremely rare freestanding ground-floor ambulatory surgery center — an offering no longer available following a 2011 ordinance by the city of Beverly Hills. Commercial real estate agents Greg Engel and Oliver Ghadoushi of Compass held the listing.

“Through the pandemic, the medical office sector has proved extremely resilient among owners, users and investors,” Ghadoushi said in a statement. “The lack of supply and exceeding demand has brought values both on the lease and sale fronts to a very high level where there is no movement in the market. The properties perform very well, and investors know that, so they continue to hold on and often do not trade.”

Danny Barnes, CEO of Patina Capital, at his office in Santa Monica.
Danny Barnes, principal at Patina Capital.

There are even medical buildings being built. In October, Stockdale Capital Partners won approval from Los Angeles City Council to build its 12-story, class A medical building on L.A.’s Westside. Construction will begin later this year on a 145,000-square-foot tower at 656 S. San Vicente Blvd., adjacent to Beverly Hills and not far from Cedars-Sinai Medical Center and UCLA Medical Center.

Also in October, Calabasas-based Agora Realty & Management announced the acquisition of a 75,000-square-foot medical office building, the Tarzana Medical Plaza, located at 5525 Etiwanda Ave. in Tarzana. The three-story building came 90% occupied, with tenants that include Providence Healthcare Systems, Cedars-Sinai Medical Care and Unilab Corp.

Agora acquired the building for $30 million in an off-market deal. The acquisition is a value-add opportunity wherein Agora will complete an interior and exterior renovation.

Cary Lefton, chief executive officer of Agora Realty, said Agora entered the medical office space organically.

“We’re in the grocery-anchored shopping center business, and over time we started seeing more health care tenants in those shopping centers because a lot of the health care systems are now looking at the same metrics that the retailers used to look at in terms of density, income levels, area amenities,” Lefton said.

Agora is also planning on creating three ground-up medical buildings in North Las Vegas and a medical project in Orange County involving a repurposed building.

In October, Santa Monica-based Patina Capital purchased the 37,759-square-foot Santa Clarita Medical Center, a medical/dental building in Santa Clarita, for $11.3 million in a deal transacted by Haimoff at Spectrum Commercial Real Estate. Located at 23206 Lyons Ave., the medical property stands 1.5 miles from the Henry Mayo Memorial Hospital.

“We acquired this project with the intent to place a condo map on the property and selling the condos back to the doctors,” Patina Capital principal Danny Barnes said.

“The majority of the people seem intrigued with the idea of owning a space versus renting one,” he added.

By virtue of the medical professionals involved, such a building makes for a good investment.

“The banks themselves view physicians as preferred borrowers,” Barnes said. “They’re looked at as a higher-end threshold. That status allows them to take out bigger loans.”

Patina is in the process of upgrading the building.

Even though his company mainly acquires multifamily properties, Patina will continue to seek out medical buildings.

“We’re looking at a handful of assets of the similar ilk,” Barnes said. “Overall, we’re excited to hopefully build a pipeline of these opportunities moving forward.”

A Glendale property at 1510 S. Central Ave., a multitenant medical building with 20 tenants, sold for $25 million to Dallas-based MedProperties in 2021.

Boyd, who transacted the deal, said, “MedProperties were very bullish. Even though the return is lower on this Glendale asset, the long-term potential and the growth and the strength of the market is why they would pursue this asset versus some more affordable building around the country.”

John Foulger, MedProperties senior director of acquisitions, said ownership of the Glendale tower has been going well.

“We’ve been able to bring in some new tenants and renew tenants,” he said. “We’ve spent a little bit of capital on some of the common areas. We’re, generally speaking, content with the performance.”

Foulger characterizes medical office as a long-term play.

“Notwithstanding the capital markets and broader economic potential issues that we have, the fundamentals of the health care real estate market are sound,” Foulger said. “There’s still consistent demand. You and I are going to continue to get sick and seek out physicians. There is some telemedicine that’s gone on, but for the most part people want to see their physician in person.”

Medical over general

In stark contrast to medical office, general office vacancies and negative net absorption escalated in the fourth quarter.

“It’s not a pretty picture for landlords,” Boyd said. “Glendale has had 10 straight quarters of increased vacancy. It’s unprecedented.”

Currently, there is a tremendous amount of confusion in the tenant population.

“The tenants can’t give their current landlords very accurate answers as to what their future space needs are,” Boyd said. “Most companies just don’t know.”

That has made medical office a more sound investment because their tenants are usually long-term and the rents are higher.

“Medical buildings are trading a little higher, meaning a lower cap rate, so that’s why medical is outperforming office,” Boyd said.

So for now, while the leasing of general office continues to stumble, medical office has emerged as a winning asset class. As Boyd put it, “medical is a healthier market than office right now.”

Meanwhile, the cooling of medical-office sales in the second half of last year came about with the ongoing interest rate hikes.

“The Fed’s first 50 basis point increase in May, and then the 75 basis point increase in June, it really froze the lending markets across the board,” JLL’s Isola said. “Medical office was a victim of that, too.”

According to Isola, there has been a real inability to access leverage and debt that was much more prevalent over the last three to five years, and subsequently the capital market activity slowed down to a halt.

One notable event on the national stage in July was the $18 billion merger of two health care REITS when Healthcare Trust of America was acquired by Healthcare Realty Trust.

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Michael Aushenker Author