Investment Perspectives

The Future of Medical Office: A Resilient Investment in Healthcare's Future

November 21, 2023 10 Minute Read Time

Interior of a medical office reception area

The Case for Life Sciences

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The Case for Medical Office

Illness, chronic underlying medical conditions, injuries and other human health issues don’t take a backseat during economic downturns. Patients require treatment no matter the economic environment. Demand for medical services is, therefore, relatively resilient. This resilience lies behind the medical office sector’s track record of generating high-income returns with low volatility regardless of the cycle (e.g., demand for medical office space stayed positive throughout the pandemic with vacancy rates remaining at pre-COVID-19 levels). Because of this, medical offices have the best long-term risk-adjusted return profile compared with the four major property types.

Medical office sector investment is more than just a defensive play, however; we anticipate growth in the sector as well. Demand for medical services continues to grow as the U.S. population ages and as more people gain access to health insurance. The subsector also has strong fundamentals with no impact from the working-from-home phenomenon and subsector supply struggling to meet demand.

In this Part 2 of our series on the Future of Office, we’ll take a deep dive into factors that have made medical office one of the most resilient property subsectors and look at why performance may be even stronger in the future.

Medical Office: long-term themes

Aging population: The 65+ population in the U.S. grew at an average rate of 3% per annum over the past decade—nearly 15 million people.

65+ Population in U.S. (millions)

65+ Population in U.S. (millions)

Source: U.S. Census Bureau, Oxford Economics. As of October 2023

The older the population, the higher the number of medical events requiring treatment. Older adults use medical services at nearly three times the rate of younger people, averaging nearly 40 medical visits per year including routine wellness visits, dental cleanings and appointments with specialists. A growing share of these visits occur in medical offices rather than in hospitals.

Average Number of Healthcare Events per Person

Average Number of Healthcare Events per Person

Source: Agency for Healthcare Research and Quality Medical Expenditure Panel Survey. As of November 2023; last historical data as of 2019.

Higher underlying demand for medical services supports higher demand for medical office space.

Expanded access to healthcare: Since the 2010 enactment of the Affordable Care Act, the total number of Americans with health insurance rose to 300 million. By 2020, 92% of Americans had insurance coverage, up from 85% in 2009. More medical events are, therefore, being treated and this trend is set to continue as more Americans upon turning 65 become eligible for Medicare.

The expansion of insurance coverage will continue to drive further growth in demand for medical services.

In-office work: The nature of most work done by healthcare professionals, including x-rays, blood draws, minor surgery and dental work, requires special equipment and facilities as well as patient in-person visits. While more than 40% of information, tech, professional and business services employees now work from home, the vast majority of healthcare workers either work in a medical office or a hospital. According to the 2021 American Community Survey, just 10% of healthcare workers reported that they worked primarily from home. Medical office, therefore, has not faced the structural change occurring in the traditional office sector.

Percent “working primarily from home” by occupation category, 2021 ACS

Percent “working primarily from home” by occupation category, 2021 ACS

Source: 2021 American Community Survey from U.S. Census Bureau. Created January 26, 2023. See Appendix 1 for list of occupations in each category.

Long-term structural growth from demographic trends and a high propensity for in-office work support reliable demand for medical office space.

Medical Office: fundamentals and performance

We believe the sustained growth in demand for medical office space in the U.S. will continue.

Medical office properties have maintained higher and more stable occupancy levels than the traditional office sector. Even throughout the pandemic, demand for medical office space remained positive, resulting in relatively stable vacancies in the subsector. This compares with the traditional office sector which shed more than 100 million sq. ft. of occupancy and saw vacancy rates rise 6% since the outbreak of COVID-19. The vacancy gap between traditional office properties and medical office properties has never been wider.

Office Vacancy by Subtype and Vintage

Office Vacancy by Subtype and Vintage

Source: CoStar, as of November 10, 2023. Medical office includes office properties of at least 20,000 sf with subtype “Medical.” Life science includes office and flex properties across seven major life science markets with “bio-tech / lab space” listed as an amenity that have housed a life science tenant in the past five years (or are otherwise deemed to be life science properties by CBRE IM U.S. research. Office vintages include buildings of at least 20,000 sf which are not medical office and are not owner-occupied.

In addition to healthy fundamentals, since 2006, the medical office subsector has delivered on average the highest income returns compared with the four major property types.

Income Return, Medical Office v. Other Property Types

Income Return, Medical Office v. Other Property Types

Source: NCREIF. Medical office references the “Healthcare” classification, per guidance from NCREIF that it only includes medical office assets. Sample sizes for Medical Office are < 30 prior to 2013.

Investors have achieved high income returns in part due to the prevalence of medical offices in secondary markets and locations.

While Medical Office has a reputation for “slow but steady” rent growth, the sector has actually delivered higher asking rent growth than traditional offices since 2000, averaging 1.8% on average compared with 1.4% average growth for traditional office space. While traditional office rent growth does outpace medical office during periods of growth, medical office rents have held up much better during downturns.

Medical Office v. Traditional Office Rent Growth and Outlook

Medical Office v. Traditional Office Rent Growth and Outlook

Source: CoStar. Includes office properties of at least 20,000 sf classified as Medical Office subtype. Rent growth is per CoStar’s Market Rent, a constant-sample series that controls for changes in the set of properties and spaces on the market period-to-period. As of September 2023. For illustrative purposes only. Current market conditions differ from prior market conditions, including during prior periods of stress and dislocation. There can be no assurance any prior trends will continue.

Stronger rent growth, low and stable vacancies and higher income returns have in turn produced higher total returns. Since 2005 (the advent of NCREIF’s coverage of medical office), medical office total returns averaged 9.1% or 200 basis points higher than traditional office.

Total Returns, Medical Office v. Traditional Office

Total Returns, Medical Office v. Traditional Office

Source: NCREIF. Medical office references the “Healthcare” classification, per guidance from NCREIF that it only includes medical office assets. Sample sizes for Medical Office are < 30 prior to 2013. As of 3Q 2022.

Medical office space not only delivered higher returns than the traditional office sector, but also higher returns than three of the four major property types (only outpaced by industrial) over the last three, five, ten and fifteen-year time periods up to and including 2022. Because of the subsector’s high-income returns and resiliency in downturns, medical office total returns are the least volatile of any property type—medical office delivered the highest total return per unit of risk (as measured by standard deviations of returns).

Total Returns by Property Type

Total Returns by Property Type

Source: NCREIF. Medical office references the “Healthcare” classification, per guidance from NCREIF that it only includes medical office assets. Sample sizes for Medical Office are < 30 prior to 2013. As of 4Q 2022; all time periods extend to 2022 the last full year of returns at the time of writing.

Medical Office: resilience and growth

Medical office assets quietly generated superior returns for investors over the past two decades with lower risk. That’s because healthcare services are needed despite the economic environment.

Meanwhile, medical offices’ long-term growth drivers, such as favorable demographic trends and increased insurance coverage, are fueling demand now and into the foreseeable future.

And against the backdrop of growing demand, the supply of new medical office space will likely struggle to keep pace given the state of credit markets and limitations placed on funding office space in general. These same challenging market conditions, however, will create opportunities to acquire irreplaceable medical office assets at attractive bases that can deliver superior returns, provide stability to portfolios and diversify real estate exposure during all economic cycles.