Supply in Dallas-Fort Worth’s medical office market remains on a downward slope as underwriting challenges stifle new construction.
More than two years after the onset of the pandemic, DFW’s healthcare industry continues to thrive due to an aging population and a boom in outpatient services creating strong demand for medical office development.
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But a new Transwestern report says rent growth, while above average, has struggled to keep pace with rising costs and interest rates, making it difficult to underwrite new construction. Vacancy hit 10.2% in the second quarter, its lowest level since 2018, per Transwestern’s data.
“It’s difficult for developers to underwrite new projects with higher cost basis unless you have a higher rent to offset that,” Transwestern Research Manager Andrew Matheny said. “Construction was already slowing in 2020 due to the pandemic, but it hasn’t quite recovered since then.”
The market has been on a positive streak of net absorption, with more than 847K SF added over the last 12 months and 267.5K SF added in Q2, but the construction pipeline is thinning, leaving developers scrambling to meet demand. Transwestern’s data shows that construction activity remains well below five-year averages, with 421K SF currently in the pipeline.
To solve DFW’s perpetual undersupply issue, rent growth needs to accelerate, Matheny said. Triple net rents have increased 3.5% from last year, with some properties experiencing double-digit increases, which is a positive sign for the future of the market.
“We’re starting to see the first signs of rent pricing catching up,” he said. “It just hasn’t quite baked into the entire market.”
Developers may not have to lean entirely on rent growth to boost supply, Matheny said. Decreased interest rates and lower construction costs will likely play a role as well.
“It’s really going to be that new equilibrium where rents are a little bit higher, costs come down, and developers can meet in the middle and pencil those projects to bring new supply to market,” he said.
Disposable income is needed to pay for healthcare, so in that regard, the medical office market is not recession-proof, Matheny said. Still, the sector is poised for success due to expected population growth in DFW that will translate to long-term demand for medical services.
“Even if healthcare spending decreases for the next year or year after, long-term … We know that we will definitely need more space over the next five to 10 years,” he said.
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