Medical Office Buildings: What You Need To Know
Introduction
Medical office real estate was once considered so highly specialized that few individual investors wanted to add it to their portfolios. It only took a global pandemic for people to reconsider. Today, the medical office has emerged as a darling among commercial real estate asset classes.
That doesn’t mean that MOB properties are any less nuanced today than they were pre-pandemic. Indeed, they have particular quirks that are important for investors to understand. For example, unlike traditional office users, medical office tenants often need highly specialized tenant fit-outs before committing to a long-term lease agreement. Moreover, leasing medical office properties can be more time-consuming and complex than leasing traditional office space.
Nevertheless, for those willing to understand the sector’s nuances, a medical office can be a tremendous addition to an investor’s portfolio.
Below is a primer on what investors need to know about medical office buildings.
What Is Medical Office Building Space?
Medical office buildings are traditional real estate buildings explicitly used for medical practices. Traditionally, they have been located on or near hospital campuses, given the referral patterns between physicians and affiliated hospitals. However, increasingly, there is demand for medical offices located in more suburban and rural areas as patients seek care closer to home. Those found in rural areas tend to be designed specifically for patient treatment.
Ownership of medical office buildings can take many forms, ranging from physician-owned properties and those owned by hospital systems to properties owned by much larger real estate investment groups, including real estate investment trusts (REITs) and other institutional investors.
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How Do I Choose the Best Medical Building?
There are many things to consider before investing in a medical office building. Of course, how (and how much) an investor wants to invest will undoubtedly guide their decision on which medical office building is best. An investor’s approach—if they wish to be more actively involved or instead be a passive investor—will also steer them to specific properties over others. Below, we look at some of the critical considerations when evaluating which medical office building to add to your real estate investment portfolio.
Type of Building
Before investing in a medical office building, buyers should be sure to understand the distinctions between Class A, Class B, and Class C medical office real estate.
Class A medical office buildings tend to be newer with modern-day layouts, systems, and amenities. These properties are built to be fully ADA compliant and will typically feature high-end finishes and aesthetics. They are generally located in prime locations with significant roadside visibility. Historically, Class A medical office buildings have been located on or near hospital campuses though Class A MOB properties can now be found further afield. Class A real estate will generally have solid and creditworthy tenants who have signed long-term leases.
At the other end of the spectrum is Class C medical office, which is older buildings (perhaps 1970s or 1980s vintage) that likely have lower ceilings, fewer windows, and more occasional patient and employee amenities. These properties are not as well located. They may need significant capital improvements to remain competitive in the marketplace.
Class B medical office real estate falls somewhere in between and may have Class A and Class C real estate characteristics depending on the property. They may need new flooring or carpet, may have functionally obsolete spaces, or cannot otherwise accommodate a broad range of physician practices.
The distinction between Class A, B, and C medical office real estate is essential to investors considering their investment strategy.
Those who have significant resources, time, and energy to invest in a property may pursue a value-add strategy at a Class B or Class C property. In other words, they have the money to elevate and stabilize these otherwise outdated properties to help bring them up to a different marketable standard.
An investor who is otherwise well capitalized may opt instead to invest in Class A, already stabilized property that costs more but requires fewer property improvements or management.
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Requirements for Space
With medical office buildings, the requirements for space generally depend on the number of providers and their associates who plan to occupy the building. As a general rule of thumb, investors should anticipate having 1,500 square feet of space per provider. However, some properties may be leased by a single tenant who opts to control the entire area (often tens of thousands of square feet).
When buying a medical office building, investors should look at the specialty healthcare services provided by the local hospital network. This will provide insight into the types of physicians looking to lease MOB space in that vicinity and the kind of healthcare practice that will dictate how much space those physicians need. The types of healthcare provided will also inform whether any specialty buildout of the area will be necessary. There are different space requirements for diagnostic imaging facilities, for example, where x-rays need to be conducted in lead-lined walls. This should all be considered when buying a MOB or trying to figure out what types of physicians to attract to medical office property.
Medical Building Location
As noted above, medical office buildings have historically been located on or near hospital campuses. People have grown accustomed to receiving treatment and other healthcare services in a hospital-like setting. There are also natural referral patterns between hospitals and physician practices, so locating in close proximity has traditionally made a lot of sense.
Yet not all patients can or want to travel to a hospital campus for care. This is especially true in rural or other tertiary markets where campuses are less common. Patients still need to receive medical care in areas like these, and medical office buildings offer tremendous value for physicians practicing in these places. Sometimes, but not always, these MOB facilities have an affiliation with a hospital in a larger metropolitan area, which allows the hospital network to provide one single continuum of care.
There are also benefits associated with being located farther from the hospital campus. Some of these benefits are simple, like the sheer fact that parking is more robust (and more likely to be free of charge) in suburban and rural areas. MOB facilities may also co-locate alongside retail, pharmacies, or other neighborhood amenities, providing easy access for individuals looking to simplify their errands, appointments, and different daily needs.
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Population Demographics
When considering a MOB investment, one of the first things to look at is population density. Ideally, a medical office building will be located in an area that already receives significant car and foot traffic.
During an investor’s due diligence process, they’ll also want to consider a feasibility study. A MOB feasibility study will include a look at the health and wellness of the population, including the age ranges of residents. Areas with a growing elderly population, for instance, are often considered strong candidates for MOB facilities as demand for healthcare services among this demographic tends to increase after the age of 65.
It is also common for medical office investors to pull specialized reports that outline the types of health issues the population faces in a specific city, region, or state. These reports can be especially telling as they indicate the types of healthcare the local population is most likely to need and will influence the types of tenants a MOB investor tries to attract to a building.
Competitors
Competition is evaluated using a few different metrics in the medical office space. As described above, the first is property “class,” – Class A, B, or C. A prospective investor needs to have a solid understanding of their competition, including the extent of that competition and the quality of that competition—including both quality of the physical building(s) as well as the quality of both management and physician tenants.
Another way to evaluate MOB competition is by looking at rental rates in the market. Anyone looking to develop or otherwise significantly invest in their medical office building will survey the need to ensure that the money they plan to spend on the project can be supported by current market rents. The rents that other MOB landlords receive should be put in the context of their building and tenant quality, including but not limited to the age of the building and the extent of the tenant fit-outs. Prospective investors will want to ensure that their projects will deliver at least the same quality if they expect to receive the same rental rates.
In the medical office space, competition is not inherently harmful. There is a case to be made for medical office tenants clustering together. This allows physician practices to refer patients to one another (e.g., a primary care doctor referring a patient to a specialist), which has become increasingly common as healthcare becomes more technical and specialized. These referral patterns dictate multiple practices located near each other.
Costs
The costs associated with purchasing a MOB facility can vary widely and are influenced by many factors, such as whether the property is affiliated with a hospital or not. For example, hospital real estate expansion efforts tend to be heavily regulated (from a compliance standpoint). Therefore, hospitals must use carefully created appraisals when bidding on a property because they are generally not allowed to pay over fair market value (or a price otherwise deemed “commercially reasonable”) for real estate.
An individual investor or real estate investment trust, for example, may not be subject to the same regulatory oversight. Therefore, their willingness to pay a premium for MOB facilities is ultimately grounded in whether they can still generate a sufficient return on their revenue.
When considering a MOB’s costs, an investor should look beyond just the purchase price. They should be sure to consider the cost of any potential building renovations and/or costly tenant buildouts, as well as any necessary operational improvements. There are also costs, like ongoing property management, that should be factored into a prospective investor’s budget before moving forward with a deal. A comprehensive cost assessment may also factor in any potential tax implications (though MOB is heavily tax-advantaged, as properties can usually be depreciated to offset an investor’s taxable revenue).
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Are Medical Buildings a Good Investment?
Medical office buildings can be a tremendous investment. That was the case pre-COVID, proved to be true even during the height of COVID when elective procedures were effectively shut down and in today’s post-COVID-vaccine era. The rise of telehealth initially created some concern that physicians would exit the medical office space instead of greater telehealth accessibility, but that has not proven the case. Trends indicate that doctors and patients alike prefer a multi-sensory, face-to-face examination that simply cannot be achieved via video conferencing. As such, demand for physical medical office space is expected to remain high in the year to come, especially as the Baby Boomer generation ages and seeks out increasingly specialized health care services.
Conclusion
Medical office space is as diverse as the healthcare industry itself. Properties can range in size, quality and scale. They can be successfully located in urban, suburban, and rural locations and may or may not be affiliated with a hospital. They can feature extensive amenities and full tenant fit-outs, or they might be simple properties geared toward single tenants, like a primary care physician or dental office.
The sheer variety of medical office properties is what makes the space so compelling from an investment standpoint. There’s no “one-size-fits-all” property but rather a range of properties that investors can consider based on their investment risk tolerances, goals, and objectives.
Learn more about investing in MOB properties today.
POSTED BY
Emily Johnson Moghadam
Vice President | Lincoln Harris CSG
Emily is a healthcare real estate and compliance professional specializing in hospital system lease negotiations, Stark Law and Anti-Kickback Statute compliance, on-boarding and transitioning of new lease administration and compliance oriented accounts, client support, and conflict resolution. Seasoned in a wide range of real estate transactions, including hospital and physician acquisitions, divestitures, and basic medical and commercial leases.
