Medical Real Estate Has Caught A Bad Case Of Capital Markets Malaise
New healthcare real estate development is more necessary than ever as the sector sees high demand and low vacancy, but medical office developers are suffering from the same illness affecting all of commercial real estate: stagnant capital markets.
The projects that are getting underway are building in flexibility and foresight and prioritizing speed, several healthcare real estate pros said at Bisnow’s Mid-Atlantic Health Care Summit Wednesday.
“The more we can take a look at scoping projects early with enough information to really dig into the key costs, the escalation of money, the contingencies and really putting in realistic budgets in those early processes, is so important,” HDR Regional Health Director Sandy Tkacz said onstage at the Renaissance Arlington Capital View Hotel.
Medical offices aren't as endangered by remote work as traditional offices. Although new developments are making medical spaces more efficient, panelists said, the need for more medical development isn't shrinking. In fact, it is expected to accelerate even more in the coming years as baby boomers age.
But as lenders are extremely careful about how they allocate funds and as the cost of capital and supplies remains elevated, a slow pace of development is widening the supply-demand gap.
Nationwide medical office vacancy last year was the lowest it has been in more than a decade, falling 63 basis points from the year prior to 7%, according to Colliers’ annual healthcare marketplace report. At the same time, medical office building construction starts in 2023 were down 44.8% from 2022, according to the report, from 16.2M SF to 8.9M SF.
There are still projects getting underway. Trammell Crow is building a 125K SF medical office building in Falls Church, Virginia, at Hoffman & Associates’ 1.2M SF West Falls mixed-use development. The developer is also building out a trio of medical buildings at the McMillan Sand Filtration Plant, which is approved for up to 900K SF.
A big part of the equation is timing, Trammell Crow Managing Director Eric Fischer said.
“Time is one of our greatest enemies,” he said. “So we need time in today’s very disjointed capital market because raising capital is extremely difficult.”
Given the uncertainty of any capital markets relief ahead, Fischer said flexibility with partners is paramount for keeping plans from being stopped in their tracks.
“You can literally burn up a year and try to revise a plan,” he said. “And that year is incredibly important in today's market. So in addition to all the macro risks that keep us awake at night, I would say time is one that we have to be really mindful of — that focus on partnerships to get things done more quickly.”
Along with the cost of capital, inflation also puts timing pressure on developments. The longer they sit, the more vulnerable they become to rising costs.
Inova Health System is also in the middle of some substantial projects in the region. The system recently topped out its nearly 100K SF health center at Potomac Yard’s Oakville development, expected to open in the fall. It is also developing a 1.1M SF campus at Alexandria’s Landmark Mall redevelopment, which is expected to deliver in 2028.
Inova Health System Assistant Vice President Stacy Bell, who said the system has seen a “tremendous increase” in costs, said the ability to forecast is necessary.
“It’s the only way to get through approvals and all the way to construction and have enough money still in the budget,” she said.
Bell said that about every six months, her in-house architect calls to tell her they need to up base cost estimates.
“Over the last year and a half, we are adding $50 a foot to that estimate every six months, and it's brutal on the pro formas,” she said. “It’s required, to be realistic, and I don't see it changing.”
But amid the tough environment, the pipeline could rev up again soon, panelists said.
The Federal Reserve hasn’t raised interest rates since last summer, and economists are forecasting rates will stay the same or drop slightly through the rest of this year. And that sense of stability may start pushing developers to pick up their pencils again.
“I feel, from a capital markets perspective, that interest rates should remain relatively stable this year,” Colliers Executive Vice President Adam Schindler said. “So that's enabling capital projects to pick back up, whereas I would say basically Q3 2023, everyone just said, ‘Pencils down. We're just going to sit for the time being and see what happens.’ I feel like things are coming back.”
