San Diego Outpaces US in Leasing Health Care Space

By THOR KAMBAN BIBERMAN, The Daily Transcript
Wednesday, March 28, 2012

Reports by Cushman & Wakefield and Marcus & Millichap bode well for medical office space here and across the country.

M&M reported in its first half 2012 national medical office report that “a near shutdown in speculative medical office development, coupled with rising space demand, will drive occupancy gains in 2012.”

M&M added that rent growth should persist across the country over the next several quarters.

Cushman & Wakefield’s newly published fourth quarter 2011 medical office report for San Diego County, prepared by medical office specialist, Travis Ives, tells a somewhat different story but with similar overtones.

The C&W report said in order to prepare for an expected onslaught of thousands of new patients, San Diego-area healthcare providers fueled a construction boom that saw 621,416 square feet begin construction last year.

That translated to a year-over-year increase of nearly 300 percent.

“Even speculative development made a comeback in 2011 with various projects breaking ground, including one off-campus (stand-alone) project that was only 34 percent pre-leased,” the C&W report stated.

The report said the project is a 40,398-square-foot medical office building known as 4S Ranch Plaza that has become 75 percent pre-leased since the beginning of this year. The building is slated for completion in June.

Most of the projects are build-to-suits.

Larger San Diego area properties under construction as of the end of 2011included the new 102,875-square-foot Sharp-Rees Stealy clinic in Sorrento Mesa; the 102,000-square-foot Scripps Proton Therapy Center in the Carroll Canyon area; a 71,000-square-foot Kaiser Permanente medical office building in San Marcos; a 63,500-square-foot expansion for Sharp Rees Stealy’s medical office building in the Bankers Hill area; and the 57,476-square-foot Tri-City Medical Office Building in Oceanside.

Other smaller medical office buildings are planned in locations as geographically diverse as Chula Vista, Escondido and the Flower Hill Promenade shopping center in Del Mar.

While the overall medical office space net absorption was a fairly anemic 67,621 square feet in the fourth quarter of 2011 in San Diego County, C&W reported the 140,450 square feet of net absorption for 2011 was enough to push the vacancy down to 9.2 percent — a 60-basis-point drop from year-end 2010.

Nationally, Marcus & Millichap reported medical office vacancy will slip below 11 percent this year for the first time since 2008, as rising health care needs once again support outsized job creation in related industries.

When asked why San Diego is generally faring better than the rest of the county, Ives cited the limited availability of land and challenging processing here.

“San Diego County has high barriers to entry,” he added.

Well-placed medical office buildings continue to be sought out by investors.

In February a 146,156-square-foot medical office building plus a 600-vehicle parking garage at 15004 Innovation Drive in Carmel Mountain Ranch was sold to a partnership of Venable LLP, of Baltimore, for $110 million. A unit of Los Angeles-based Kilroy Realty Corp. (NYSE: KRC) was the seller.

Sizable medical office building sales in 2011 included Divco West Properties’ October $46.8 million purchase of the two-building, 160,000-square-foot Genesee Executive Plaza complex in UTC.

The buildings of approximately 80,000 square feet each were 39.1 percent and 19.2 percent vacant, respectively, according to a survey conducted by The CoStar Group (Nasdaq: CSGP) earlier this year.

A Cole Real Estate Investment partnership paid $54.5 million for the fully-leased VA Oceanside Clinic building, in Oceanside’s Rancho del Oro area, in late December.

UC San Diego paid $18 million for the 40,375-square-foot Garden View Medical Center in Encinitas in October; that is also 100 percent leased to the San Diego Cancer Center and several physicians.

C&W projected vacancy rates for both on-campus and off-campus properties will generally continue to decline throughout 2012, as most of the new space has already been committed.

Save for the North County, which is experiencing some softness, rental rates are expected to continue to modestly increase through most if not the entire year.

“It has become evident we have reached a bottom in the medical office market with decreasing vacancies and stabilized rental rates,” C&W wrote. “Tenants should be addressing renewals, expansions and relocations sooner rather than later to lock in lower rents.”

Nationally, M&M noted there is uncertainty over the fate of President Obama’s health care law and how it withstands its constitutional challenge at the U.S. Supreme Court.

That could impact space demand when the Patient Protection and Affordable Care Act is scheduled to go into effect in 2014.

C&W’s Ives said if the law survives with or without the individual mandate to purchase insurance, more people who may have postponed health care will flood into the system. In turn, that would create a greater demand for space.