It’s no secret that the COVID-19 pandemic has had a major impact on many aspects of healthcare. While plenty of devastating outcomes resulted from the pandemic, the healthcare industry is full of investment opportunities because of the resilience and variety of its real estate properties. While many retail properties and other real estate types have struggled through economic adversity, healthcare properties — including medical office buildings (MOBs) — continue to remain stable.
If you’re looking to expand your portfolio and enhance your diversification, MOBs might be the ideal choice for you. However, before you decide, you need to know the potential benefits and risks you may face with this type of real estate investment. This article will review medical office building investment pros and cons so you can make an informed decision about your portfolio.
What Are Medical Office Buildings?
Medical office buildings or medical office spaces are real estate assets dedicated to the medical field and used for medical purposes. This includes healthcare practices for various providers, such as dentists, doctors, and other clinicians. Medical office buildings are considered part of the office sector, but they are different from traditional office spaces in many ways. These buildings can range from very small square footage to the size of a modern hospital complex.
Generally, MOBs contain exam rooms, waiting areas, and specialized building systems and materials. For example, these buildings tend to have specialized heating, ventilation, and air conditioning (HVAC) systems to maintain proper air ventilation, minimize the spread of contaminants and infection, and support various medical devices. Additionally, to help uphold patient privacy and confidentiality, many MOB spaces will have high-quality soundproofing.
Most MOB spaces are located near hospitals, nursing homes, or other medical centers. These offices are often characterized as on-campus or off-campus. On-campus MOBs tend to be close to a large hospital and may even have an affiliation with the hospital, such as a referral network. Off-campus spaces are usually located in more suburban and rural areas further away from hospitals.
These MOBs may sometimes be called ambulatory care facilities. While many providers, including physicians, often own and operate their own off-campus MOBs, many investors have gained interest in these facilities. As such, some physicians will sell their real estate and turn the day-to-day property management over to real estate groups.
Types of Medical Office Buildings
You will come across three main types of MOBs when searching for the ideal healthcare investment for your real estate portfolio. Let’s look at the characteristics of each category.
Similar to other Class A real estate properties, such as industrial spaces, a Class A MOB tends to be newly or recently constructed and is often made with the highest quality building materials. These buildings are generally located right next to a major medical clinic or hospital. Class A MOBs are sometimes developed for the hospital itself or leased from a healthcare real estate investment trust (REIT) or parent corporation.
These buildings may support shared facilities, which means physicians and other care providers can offer several services to patients in one location, such as radiology, lab work, and pharmacy access. Compared to stand-alone medical office spaces, Class A MOBs generally offer more amenities and convenience to patients.
Next up is Class B MOBs, which tend to be well-appointed, well-managed buildings that range from low- to mid-rise. These spaces are often relatively close to a medical center or hospital or located on the same campus. Owners of a Class B MOB include individual investors, physician groups, or hospitals themselves.
Class B offices are ideal for medical tenants and providers seeking a smaller medical center that aligns more with a stand-alone building. These spaces tend to offer more independence for practitioners. Class B MOBs generally provide extensive outpatient services, making them valuable assets for many companies.
Stand-alone MOBs are usually the smallest buildings out of the three categories and will often accommodate a single practice or smaller group practice. Certain general practitioners or specialists who do not require extensive services may prefer a stand-alone MOB, and physicians most often own the building.
The Tax Reform Act of 1986 requires real estate investors to depreciate their real estate investments over longer periods. Due to this act, some practitioners do not see much incentive for individual ownership, which is why many healthcare property investors may decide to step in. Today, dialysis and urgent care centers are potential stand-alone options for investors.
Medical Office Buildings Real Estate Market
Due to record high sales volumes and pricing in 2021 that resulted in over $15 billion in transactions, many investors are still picking up quality medical properties while the market is strong in 2022.
MOBs, specifically, also offer investors asset class diversification and a risk-mitigation strategy as they continue to perform well and are expected to maintain this stability well into 2023. Medical offices can range from single-tenant spaces to complex multi-tenant properties.
Generally, the healthcare sector is known for its high resilience and stability during recessions. MOBs have been a particularly strong-performing subsector in this industry, making them an attractive option recently for institutional investors and REITs looking to expand their portfolios. Despite many fears and uncertainties due to the impact of telemedicine since the start of the COVID-19 pandemic, medical office inventory has continued to grow at an increasing pace, with more than 16 million square feet under construction.
Essentially, though telehealth services have become more common as a result of the pandemic, they haven’t significantly impacted the profitability or longevity of MOBs. This means they remain a suitable real estate option for many investors.
As more investors become educated on the medical office sector’s resiliency, long-term prospects, and robust underlying fundamentals, competition in the real estate market will likely continue to rise steadily. While increased demand means investors should expect to see higher prices, these costs may be offset by higher rents due to limitations on new construction.
Benefits of Investing in a Medical Office Building
You may experience several benefits if you decide to invest in an MOB property. Here are some of the potential advantages:
Strong Historical Performance
Compared to some other asset classes, like retail, healthcare real estate generally performs well with steady long-term occupancy rates. Compared to the overall office sector, medical office vacancy rates have been historically low for the past decade or so. In 2010, MOB vacancy rates were 11.1%, dropping to 8.4% by 2018.
By 2020 and 2021, a combined 90% of firms stated their occupancy rates were either stable or increased from the previous year. Even with the impact of the pandemic, 80% of respondents believe the healthcare real estate industry is recession-resistant. The strength of MOB occupancy rates also signifies long-term leases due to the highly specialized features of many medical buildings. The healthcare sector is constantly growing as demand for healthcare services and workers steadily rises, making this investment more resilient.
Potential for Stability and Resilience
Many factors could potentially lead to faster, continuous demand for quality healthcare services and providers outside a hospital setting. Some of these factors include a growing emphasis on preventive care and wellness and a larger aging population. MOBs that provide a diverse tenant mix with various services may be more resilient.
For instance, while telemedicine and virtual visits are convenient for some patients, they are no substitute for in-person appointments or essential visits for treatment, including procedures, lab work, and surgeries. The necessity of healthcare alone makes it more valuable and resilient during economic downturns, while other industries like entertainment and retail may suffer. As more and more people return to in-person healthcare visits since the pandemic, investors may see a more competitive demand for healthcare real estate.
People are always going to need access to healthcare. Because many people held off on doctor’s visits due to the pandemic, there is also a pent-up demand for regular procedures and visits, which means MOBs can serve as a low-risk asset for investors. Because of this reason and those stated above, MOBs can be a lower-risk investment, potentially even during a recession.
Compared to the office sector as a whole, MOBs are more robust and resilient during fluctuating economic conditions due to the overwhelming need to provide most healthcare services in person at a physical site. This factor could be why investors are flocking to this sector as a more stable alternative to suburban office holdings, with some calling it a “safe haven” investment.
Potential Tax Benefits
Due to provisions in the Tax Cuts and Job Act of 2017, some owners of medical office assets may qualify to take accelerated or bonus depreciation. Those who qualify could take a larger tax deduction for bonus depreciation. This benefit can help investors offset gains elsewhere in their portfolio.
Though all investment situations and properties are different, this tax subsidy may essentially allow investors to take bigger deductions and pay fewer taxes on their investments in the early years. If an investor wishes to invest in more than one real estate property, this benefit can help them do so if they qualify.
High Credit, Long-Term Tenants
Though every tenant is unique and there are no guarantees in any investment, many MOB tenants tend to have strong credit. Additionally, many of these tenants prefer to be located near hospitals, medical offices, and other complementary services, so they may even help attract more tenants who also prioritize proximity to other healthcare facilities. Once these tenants have built a physical network and community of healthcare services, they will likely sign long-term leases or continue to renew for years to come.
Since many MOBs are designed and built for various healthcare needs, it can be difficult for providers to move frequently and lose their clientele. By investing in an MOB, investors can likely benefit from the longevity many practitioners seek.
One of the most common phrases you’ve likely heard as an investor is portfolio diversification. The diverse nature of real estate as a whole provides many benefits to investors, particularly during economic downturns. For example, if your portfolio is diverse, instead of just the same type of asset, it is more likely you will always have an investment that is doing well in the market.
However, it’s important to note that even if your portfolio is diversified within real estate, the same potential market risks, such as interest rate hikes, can affect all industries and subsectors within real estate.
When one industry isn’t performing well, another may keep you above water. A medical office building investment can provide this advantage for investors because these office spaces can house many types of tenants, such as:
- Dialysis centers
- Plastic surgeons
- Digital imaging services
Adding MOBs to your investment portfolio can make it easier to access successful tenants.
Cap Rate and Yield Arbitrage
Many factors aside from price determine the capitalization rate, including occupancy, size, lease structure, annual escalations, and proximity to campus. Compared to some other assets, it’s not uncommon for MOBs to have higher variations in cap rates. In 2021, MOBs in the U.S. were 25 basis points higher than suburban offices and had a cap rate of 6.5%.
When comparing MOBs to other types of office buildings, MOBs tend to come out on top. For instance, another type of office or retail property may appear less risky to some investors, but the returns on these investments are often much lower. Those who invest in MOBs may be in a better position to capitalize on these strong cap rates and yield arbitrage.
Not Reliant on New Development
Since the 2007-2008 financial crisis, many investors are likely familiar with market collapse and being left with unfinished projects. Due to the ebbs and flows of any investment or market, including the real estate cycle, it’s easy to see why some investors may feel uncertain about ground-up development projects or uncharted waters, particularly after the COVID-19 pandemic. MOB investments eliminate this issue because new development is not necessary for investor success.
What to Consider Before Investing in a Medical Office Building
While there are many positive aspects of investing in MOB real estate, it’s important to know the challenges you may run into during the process. Here are the top things to consider before investing in a medical office building.
Location is one of the most critical factors in any real estate investment. When selecting a medical office property, you want to choose a prime location that will see as much business and revenue as possible. Investors can choose an MOB that is either on or off a hospital campus, which can impact the convenience for patients, the demographic, and the patient population the facility will see.
Many investors seek on-campus locations simply due to their proximity to hospitals and other complementary services, which may attract more patients and high-quality tenants than some off-campus MOBs. However, there is still a demand for off-campus MOBs as these offices tend to be closer to local communities where patients live and work.
The size of the facility is another item to consider. The building size will influence the type of tenants that want to lease the MOB. For instance, a large building that only suits one tenant may appear to be a higher risk to some investors, while others may feel more secure with a multi-tenant building.
Before deciding on a specific property, it’s important to inquire about the number of providers the building can hold, the amount of space for various technologies, the size of the patient waiting room, and the number of parking spaces for the facility. Some investors may also want to know if the property has room for expansion in the future for potential growth.
Outdated vs. Updated Building
In any investment, there are certain pros and cons to both outdated and updated buildings. For example, an outdated building in a prime location can be renovated into something entirely new and highly valuable, while a new building in a not-so-popular location may have its unique struggles.
Whether you want to invest in an outdated, affordable property and equip the building with modern-day features or go with a newer, smart building that can immediately accommodate new technologies and digital imaging, there are benefits and drawbacks to both types of properties.
Building Strength and Adaptability
Technology rapidly changes in every industry, including healthcare, so MOBs must be adaptable to help meet these changes. As modern healthcare continues to evolve, practitioners and providers require flexibility in their spaces to grow and include new types of treatments, equipment, and specialties.
Luckily, many clinical spaces are naturally adjustable and can meet the needs of various healthcare professionals. Consider whether the MOB you plan to invest in has universal waiting, exam, and procedure rooms to accommodate different needs. You may also want to inquire about incorporating new technologies and repurposing rooms to meet your scalability needs.
As with any real estate investment, looking at the tenant profile is important. Depending on what the tenant does, you may have potential barriers and risks when entering the local marketplace. For instance, look at whether the tenant is part of a physician group and review their credit profiles and history in the local market.
This information can help you understand how the tenant fits into the community and the specific MOB space you’re investing in. For instance, urgent care facilities that offer basic, general services may be more successful from the start than a highly specialized practice, such as an endodontist or orthopedic surgeon.
Learn More About Medical Office Investment Opportunities From 1031 Crowdfunding
As you can see, the healthcare industry remains one of the most dependable real estate investment options for many reasons. Taking the next step to diversify your real estate portfolio with a medical office building may help you gain the earning potential and stability you’ve been looking for. At 1031 Crowdfunding, it’s our mission to help investors like yourself know all the advantages and drawbacks of real estate assets.
We offer an extensive online marketplace of various medical and healthcare investment opportunities. Our experienced and knowledgeable professionals are ready to answer your questions and help you find the healthcare investment opportunity that meets your needs. To learn more about adding a medical office asset to your real estate portfolio, register for an account today.
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