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Medical Office Sector Bucks The Cycle

While office building transactions have plummeted in recent months, one bright spot is the medical office market, where sales typically range from $10 million to $30 million.

Sales of medical office properties totaled $3.1 billion through the third quarter, a 20% drop from the same period a year earlier, reports Real Capital Analytics. That dip pales in comparison to the 75% dive in property sales for the entire office market for the same period.

“While volume is depressed everywhere, it's not impacting medical office as much,” says Lee Asher, first vice president of investment properties for CB Richard Ellis' institutional group. “What's attractive is you have long-term leases historically that have credit or personal guarantees from the doctors.”

Medical office sales accounted for 6.5% of all office sales during the first three quarters of 2008, up from 2.7% a year ago. The average sale price of medical office properties is trending upward as well, rising from $207 to $233 per sq. ft., a 13% increase during the past year.

Proponents point to the sector's strong ties to the healthcare industry, one of the few growth segments in the U.S. economy. Healthcare spending in the U.S. reached $2.3 trillion in 2007, and is projected to reach $3 trillion in 2011 and $4.2 trillion by 2016, reports the National Coalition on Health Care.

One byproduct of the flagging economy is doctors delaying retirement. Many have seen their personal portfolios drop by up to 50% in the stock market. “They are not as likely to get the price they had hoped for their practice, or they're not ready to hang up the stethoscope.”

There are two major types of medical office buildings: properties near hospitals, and off-campus buildings that may be miles away. Growth in the off-campus sector is fueled by consumer demand for more medical services to be located closer to residential neighborhoods.

“If you have an off-campus building that has a hospital as an anchor tenant or hospital sponsorship, that's a very attractive asset,” says Asher. An off-campus setting with ambulatory care and surgery centers allows physicians to conduct as many procedures as they could in hospitals. Given the cost of building a new hospital is around $1 million a bed, hospitals approve of the off-campus setting.

Medical office buyers include healthcare REITs and pension funds. “A lot of the REITs have shored up their balance sheets,” says Asher. “Most of them can navigate this market and be cash buyers without relying on the debt markets.”

On the sales side of the equation, Asher expects many hospitals seeking to monetize their assets will sell more of their non-core assets in 2009, including on-campus medical office buildings.

One major player in the medical office arena is Santa Ana, Calif.-based Grubb & Ellis Healthcare REIT, a private REIT that has purchased 116 medical office properties for $869 million since 2006. “Grubb & Ellis really wanted to ride the demographic wave,” says Danny Prosky, executive vice president for acquisitions at the REIT. “You've got the baby boomers hitting their 60s and hitting their 70s and 80s over the next couple of decades.”

Poe Corn, managing director of corporate capital markets for Jones Lang LaSalle, is bullish on 2009. “We're being told by a lot of the lenders that medical office will be the first sector they come back into. We're hoping that will be in the first quarter of next year.”

For the remainder of 2008, the sales spigot is closed tight. “I think all of the deals are baked in for this year,” says Asher, “and that's all we're going to see.”

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