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Medical Office Space in High Demand, Low Supply

Medical office buildings were a hot real estate investment in 2021 and are likely to be even more so in 2022, according to a new report from the commercial real estate brokerage JLL.

There’s plenty of demand for property but not enough property available to keep up and not enough new medical office projects being built.

“It’s getting tighter,” said Kelly Moriarty, co-director of JLL San Diego’s Healthcare Practice Group.

“In San Diego especially there’s a lot of different buyers that would like to get into this market but not a lot of buildings that trade on a year-to-year basis,” Moriarty said. “There was a lot of interest in money chasing medical office leading up to the pandemic and the pandemic just intensified the interest given the stability of medical office and how it can perform relative to other classes during a recession and economic dips.”

Hard to Find

Just as with conventional office space, the medical office market is being squeezed by San Diego County’s voracious demand for life science space and building owners are rushing to convert their property to lab and office space for life science.

“We have to compete with that in addition to the zoning restrictions that healthcare providers have to comply with,” Moriarty said. “In terms of the existing zoning, there’s only certain pockets that have medical projects. To find those opportunities is difficult and the process of trying to change the entitlements or zoning for a parcel are even more challenging.”

In 2021, 280,000 square feet of medical office space was absorbed – a 77% increase from 2020, according to JLL, but the firm attributed the increase to “a short-lived spike in new deliveries,” reporting that the vacancy rate countywide was 5.8% at year’s end – the lowest it’s been since 2006.

Medical office space under construction at the end of 2021 was 97,177 square feet, rivaling levels seen during the Great Recession, JLL reported.

 “Health care obviously is a necessary service for everyone and with the continued growth of the aging population, it’s just those two forces working together that brought us to today,” Moriarty said.

Conversions

Among the few projects under construction are three medical office buildings that Palomar Health is building adjacent to its Escondido hospital.

“It remains to be seen what portions Palomar will secure for itself and affiliated groups and what might be left for third party medical groups,” Moriarty said.

As with life science, some developers are looking to renovate older office and even retail buildings to meet the demand for medical office space, Moriarty said.

For example, NextMed in April 2021 bought a Kearny Mesa office building for $9 million with plans to renovate it into a surgical center and medical offices.

Long term, JLL forecast that the situation should improve as rising rents and an expected dip or flattening of construction costs make it more attractive to build medical office product on speculation.

Medical office rents rose 5.5% in 2021, nearing $4 per square foot, according to JLL.

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