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How Changes In Delivery Of Healthcare Are Impacting Medical Office Real Estate

San Diego’s overall medical office vacancy climbed to 8% in Q1 2016, up from 7.8% in Q4 2015. But Class-A medical office vacancy decreased by 50 bps to 6.1%, JLL SVP Chris Ross tells Bisnow. Over the last six years, Class-A medical office vacancy dropped a remarkable 81.7%, a recent JLL report noted.

Chris Ross

We spoke to Chris, pictured here with his children: Walker, 6; Beckett, 2; and Max, 4.

With the Affordable Care Act extending healthcare to hundreds of thousands of new patients, medical groups and hospitals are establishing convenient medical offices for routine care in communities close to the patients they serve, he explains. This is freeing up space in hospitals and campus professional buildings, allowing hospitals to expand services on medical campuses, particularly those provided by specialty physicians.

The new 150k SF Scripps Anderson Pavillion is a MOB located on Scripps La Jolla campus.

With the movement of routine healthcare to community facilities, there is high demand for quality medical office space, which is becoming increasingly harder to find, Chris tells us. "Since little new MOB product is being developed, some community healthcare facilities are going into older office buildings repositioned as MOBs."

He says most major new healthcare facilities are being developed by or for health systems. Scripps Health recently opened the John R. Anderson Outpatient Center (above) on its La Jolla campus, which is about 150k SF; University of California San Diego Medical Center is developing a 150k SF outpatient center on its La Jolla medical campus; and Sharp Healthcare is building a 100k SF MOB in Rancho Bernardo. Other than those, there are only three new MOBs in the pipeline, all between 30k and 40k SF, he says.

The new Village North mixed-use, affordable apartment project will have medical office space on the ground level.

The new Village North mixed-use, affordable apartment project, above, will have medical office space on the ground level.

While overall MOB rents were flat on a year-over-year basis, the JLL report found Class-A and B rents rose by 1.5% and 0.7%, respectively. Class-A MOB asking rent is now $3.42/SF, Chris says, just $0.03 off the previous high mark of $3.45/SF in 2007.

Tenants with long-term triple-net leases are challenged when a building trades before their lease expires, he says. Chris explains triple-net tenants generally pay $0.30 to $0.50/SF in taxes, but if a building trades at a higher value, the tenant is stuck with higher taxes until the lease expires.

On the other hand, he says many new owners are facing challenges as leases expire. "If the property's operating expenses are above average due to high property taxes, they may have to sharpen their pencil on the base rent, which will impact rental income."

Merge Carmel Valley, a new retail center at 5550 Carmel Mountain Rd, has medical office space on the second level.

Merge Carmel Valley (above), a new retail center at 5550 Carmel Mountain Road, has medical office space on the second level.

Chris says perhaps the most noteworthy condition affecting the market is that "we are well past due for new medical office development, but it is hard to find sites because MOB developers are competing with other hot sectors such as life sciences, retail, multifamily and mixed use."

MOB space recently delivered or under construction represents less than 4% of the region’s total inventory of 12M SF, Chris points out. “The current pace of new construction activity cannot keep up with the increased demand, which is putting upward pressure on rents.”

Rendering of new 565k SF 450-bed, state-of-the-art Kaiser Permanente Central Hospital at 5201 Ruffin Rd in Kearny Mesa, which is scheduled for completion in 2017.

Above is a rendering of a new 565k SF, 450-bed, state-of-the-art Kaiser Permanente Central Hospital at 5201 Ruffin Road in Kearny Mesa, scheduled for completion in 2017.

Hospitals may complain about a provision in the Bipartisan Budget Act of 2015 that changes payment policy for new outpatient surgery and imaging centers. Formerly, hospital-operated outpatient surgery and imaging facilities were paid higher reimbursements than physician-operated outpatient facilities, regardless of location. Now, new outpatient facilities must be within 250 yards of a hospital campus to receive reimbursement at the higher hospital rate.

“In some ways, this levels the playing field, with independent facilities now being paid at the same rate as hospitals,” Chris says, noting existing hospital-operated outpatient facilities were grandfathered in.