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Medical Office Buildings Expected to Remain Resilient, Despite Changes in Payment Policies

That consistent decline in vacancy has insulated the MOB sector from volatility.

Transformation is the major theme driving the business of healthcare delivery in the United States, so it is not surprising that the medical office building (MOB) sector is also seeing fundamental changes. In one foundational shift, the Centers for Medicare and Medicaid Services (CMS) reduced physician reimbursements for certain outpatient services delivered in off-campus hospital facilities.

In a November 2 announcement, the CMS explained, medical practices that perform certain outpatient services in off-campus hospital settings will receive 20 percent less in reimbursements. The move was part of an ongoing shift in the way reimbursements for such services are funded under Section 603 of the Bipartisan Budget Act of 2015.

“CMS believes that this adjustment will provide a more level playing field for competition between hospitals and physician practices by promoting greater payment alignment,” according to a statement from the agency.

That decision is not likely to impact demand for MOBs, experts say. Health care providers are still looking to provide patient services in outpatient facilities as one strategy to stabilize their margins, says Chris Bodnar, executive vice president of the investment properties division at real estate services firm CBRE and a co-lead of the CBRE healthcare capital markets group.

“Either way, health care systems will continue to drive outpatient services,” Bodnar says. “It is a more cost-effective way to deliver services for the hospital and the patient.”

The vacancy rate at MOBs decreased by a modest 10 basis points per quarter between the first quarter of 2010 and the first quarter of 2017, according to the 2017 U.S. Medical Office and Health Care Report from CBRE. Overall, the vacancy rate averaged 8.0 percent in the first quarter of this year, a nearly 300 basis points decline from the first quarter of 2010. Also, in 22 of the 29 quarters before CBRE issued its report, the research firm found that absorption had exceeded the addition of new space.

That consistent decline in vacancy is characteristic of the MOB sector, and has insulated it from the volatility that can be so disruptive to other sectors. But that steadiness also has a flipside, which is flat rent growth. CBRE found that overall asking rents for medical properties it tracks have only moved between $22 and $23 per sq. ft.

MOB tenants tend to set down roots and remain in the same space for long periods of time, mainly to stay close to their patient bases and supporting services, according to CBRE. Also, given the amount of mergers and acquisitions among healthcare groups in recent years, smaller medical office spaces designed for individual and small practices have become obsolete. Larger medical associations require more space, according to Bodnar.

“There is rental growth being driven in newer facilities to accommodate the way healthcare is being delivered in today’s market,” he says.

Liquidity continues to flow in from newer investors, and cap rates are still falling. By the second quarter of 2017, cap rates for off-campus properties averaged 6.3 percent, barely distinguishable from the 6.1 percent cap rates on on-campus, or hospital, properties, according to data from Revista, a medical real estate research firm headquartered in Arnold, Md.

“A lot of people are looking to jump in on new opportunities. That is driving down cap rates,” says Hilda F. Martin, principal of Revista. “Investors want the deals that have not been announced.”

As motivated investors, particularly private equity firms, build the relationships that give them the inside track on attractive deals and step up efforts to make more acquisitions, they are moving into the sector with the backing of commercial banks. One lender in the sector, BMO Financial Group, is increasing its participation and doing so in a more organized way, according to Imran Javaid, managing director of BMO Harris Healthcare Real Estate Finance.

“Hospital systems realize that they cannot be at the hospitals and have the patients come to them,” says Javaid. “That is what’s driving the development of these buildings. They are going out to where people live and work.”

According to Revista, about 20.8 million sq. ft. of MOB space should be delivered to the market in 2017. The amount of completed projects has increased steadily, but incrementally, every year since 2014. Experts expect that to continue in the near term, and not just because the aging population will likely result in higher numbers of patients using the facilities in the years to come. Very little of any space in the sector is speculative, according to Javaid.

“We are not seeing speculative development,” Javaid says. “Absorption has outpaced new supply for a long time.”

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