Medical Office Space Sector Alive With Activity

By LOU HIRSH, San Diego Business Journal
Monday, December 19, 2011

As 2011 draws to a close, San Diego County medical office vacancy rates are falling and construction is up considerably from a year ago. But most of that coming new space is already spoken for by the region’s expanding health care providers, including Sharp HealthCare, Scripps Health and Kaiser Permanente.

“The majority of construction is pre-leased or will be owner occupied,” says Travis Ives, a senior associate in brokerage firm Cushman & Wakefield’s health care practice group in San Diego.
A recent third quarter report from Cushman noted that the county’s medical office vacancy rate is at 9.7 percent, well below the general office market’s 16.2 percent. At the end of the period, medical office direct asking rents were up 4.2 percent from a year ago, and year-to-date gross leasing activity in square feet was up 22.6 percent.

New construction activity in medical offices was at more than 523,000 square feet, more than triple the year-ago level. However, most of that will not be available to new tenants when completed.

For instance, Cushman notes that 102,000 square feet in the works at Sorrento Mesa consists of a conversion of a traditional office building to meet medical office needs at a Sharp Rees-Stealy clinic. A 71,000-square-foot medical office expansion by Kaiser Permanente in San Marcos is set to be occupied primarily by Kaiser and its providers, and won’t add new space to the county office supply.

The same goes for more than 140,000 square feet of planned medical offices at two Scripps therapy centers in San Diego.

Ives said medical office properties in the county generally are held for long periods by locally based investors, and the tenants in them tend to be “sticky” in terms of staying in place. He said he doesn’t foresee a lot of speculative construction in the near future, and much of the growth of health care providers is currently being done through the acquisition of private practices.

Cushman cited recent industry estimates that more than half of all U.S. medical practices are in some way owned by hospitals or health systems. Uncertainties about federal government funding of Medicare and other insurance reform issues will likely limit big moves by private practitioners to expand their office footprints.

Effects of Reform
“A lot of the medical practitioners are waiting to find out what happens with Medicare reform,” Ives said. “They don’t want to make long-term commitments until they know what their revenue is going to be.”

Stephen Dok, a senior vice president in the health care properties group at brokerage firm Grubb & Ellis Co. in San Diego, said rising demand for outpatient services and elective procedures, especially among aging baby boomers, is likely to keep demand for local medical office space high in coming years.

That includes providers of gastric bypass procedures for weight loss, which are increasingly being paid for by insurers, as well as cosmetic and lasik eye work, and joint replacements.

Dok said large health care providers like to have a lot of care fields represented in one complex to save time for care providers and consumers, which encourages the concentration of medical offices into relatively small areas. “Medical offices like cross-pollination — many disciplines in one center, with some duplication, but mostly complementary services,” he said.

He said the historically cheap cost of capital is attracting some investors to acquire medical office buildings, although the majority of recent transactions have been for smaller properties.

According to CoStar Group, the larger medical office building acquisitions of 2011 have included October’s $18 million purchase of Garden View Medical Plaza in Encinitas by UCSD Garden View LLC; October’s $13 million purchase of North County Medical Office Building in Escondido by Citracado Medical Plaza LLC; and March’s $8.25 million purchase of Del Norte Medical Plaza in Carlsbad by Paseo Del Norte LLC.