Rising construction costs and mounting regulations are causing trouble for Southern California's healthcare property development community as the region's population ages, increasing the need for care.

In some instances, these two challenges converge, according to panelists at Bisnow's Southern California Healthcare Real Estate Summit held Oct. 16. Navigating this environment is guiding decisions made by healthcare systems and the developers that build their properties.

Construction costs are an issue whether you are building new facilities or updating existing ones, Manatt, Phelps & Phillips Partner Fernando Villa said. A statewide rule mandating seismic resilience of hospitals is a big contributor this year.

By 2030, all California hospitals and all acute care facilities have to be able to be fully operational following a major earthquake. The cost of compliance is high, as is often the case with seismic retrofits, and many hospitals are struggling to meet the deadline. As of early 2023, roughly 62% of hospitals had at least one building that didn’t meet the 2030 structural standards, CalMatters reported.

These costs are forcing healthcare providers “to make difficult choices of whether to upgrade, reposition or sell or otherwise just close facilities down,” Villa said.

The California legislature passed a bill that would have allowed hospitals to apply for extensions, but it was vetoed by Gov. Gavin Newsom in September.

Those owners and providers that operate more in the development space are also still seeing high costs crunch their plans.

Adventist Health Regional Director of Clinic and Ancillary Development and Business Development Steven Stubbs said that while there will always be a need for new medical office buildings, he observed that capital for those projects is a struggle.

His organization has, for the most part, been expanding acquiring existing properties rather than trying to build new facilities.

They’re not the only ones. UCI Health – the University of California, Irvine’s health system – purchased four Orange County hospitals from Texas-based Tenet Health earlier this year, the Los Angeles Times reported.

“Obviously everyone acknowledges it’s not the best time to sell if you have a choice, but there have been certain groups out there that have been looking to shift away from health care, whether they feel it's too management intensive or they don't like negotiating leases with doctors – whatever the case may be,” Remedy Medical Properties Executive Vice President of Investments Jack Gavin said during the event at the Hilton Los Angeles Culver City.

A few panelists mentioned that private equity’s involvement in healthcare was in the crosshairs in the last legislative session, when a bill was passed in the legislature but ultimately vetoed by Newsom that sought to add additional regulations to healthcare transactions involving private equity buyers.

Private equity has been a big spender in the healthcare industry nationally and locally, spending $20B a year on the sector in California alone, KQED reported.

Although the most recent effort was not successful, some in the healthcare real estate space have backed away from the parts of the market that the legislation targeted, especially the inpatient space, fearing that future legislation might be successful.

"From an investment thesis, I don't like the risk of legislation, so we've shied away from it," Stockade Capital Partners Managing Director Andrew Saba said.