Twin Cities, MN
Medical Building
Building
Key Takeaways
• High interest rates continue to affect real estate decisions.
• Overall market activity was slower in the first half of 2024.
• Aging facilities and limited options are forcing groups to look to alternative options.
• Projects under construction have increased since the last half of the year; however, they consist of single-tenant projects and will not add significant space to the market.
Changing Dynamics
The healthcare market in the first half of 2024 has been significantly impacted by high interest rates and economic uncertainty, which continue to influence decision-making processes. This period has also seen a slowdown in overall market activity, with a negative absorption of just under 42,000 SF. Additionally, challenges posed by aging facilities and a scarcity of available options are pushing practices to explore alternative solutions to meet their real estate needs.
Economic Indicators
Historic Comparison
Historic Absorption, Deliveries and Vacancy Rates
Source: Colliers, CoStar
Photo Source: LoopNet
Market Pulse
Over the past two decades, we have seen a consistent delivery of new healthcare buildings, but the vast majority of healthcare properties were built before 2000. As a building approaches twenty years old, significant capital costs such as a new roof, parking lot, infrastructure replacements, and shifting demographics become necessary, prompting ownership decisions. From a clinical operations standpoint, this timeline also presents an opportunity for healthcare providers to reevaluate their healthcare delivery strategy for the site. These aging facilities represent several challenges for modern healthcare delivery models. Alanna Carter, South Central Healthcare Leader at Gensler, highlights the issues healthcare providers consider when deciding whether to remodel, replace, reduce, or relocate their clinic.
• Clinical Strategy: Evaluate whether clinical services are effectively located for accessibility and efficiency, assess changes in demographics and market trends, and determine if the operational model aligns with strategic goals and facility maintenance costs.
• Patient & Staff Experience: Focus on ease of access, enhancing patient experiences from their departure from home, ensuring brand alignment in the patient environment, and facilitating frictionless care delivery.
• Facility Physical Assessment: Conduct facility assessments to gauge current conditions and future maintenance needs, analyze building efficiency, consider adaptability for future expansion, and evaluate energy usage and legal restrictions affecting potential renovations.
Age of MSP Medical Inventory
Source: Colliers, CoStar
Age of US Medical Inventory
Source: RevistaMed
Vacancy
Vacancy rates for medical office space, both on-campus and offcampus, remain strong compared to other real estate sectors at 5.8%, but that is only part of the overall story. We have seen a steady increase in vacancy rates over the past several quarters, with a larger jump for on-campus properties, with some hospital campuses seeing vacancy rates approaching 20%. This is primarily attributed to factors such as the aging infrastructure of on-campus buildings, patient convenience, and the push toward more suburban ambulatory points of care.
Vacancy rates in suburban off-campus medical properties remain very low, as clinics continue to focus on high-traffic, rapidly growing demographics. While vacancy rates remain low and new construction prices skyrocket, we are seeing clinical groups continue the trend of looking at general office and retail options instead of traditional medical office buildings.
Absorption and Leasing
The first half of 2024 saw a slowdown in activity and leasing of medical office space, which is consistent with the broader market trends. Many larger clinical groups and healthcare systems have focused on renewals and short-term stability rather than the significant expansions seen in previous years. Leasing absorption was negative for the first time in three years at -41,600 square feet, driven by groups moving off hospital campuses or opting for general office or retail spaces. Economic and political uncertainty has caused many medical groups to pause long-term decisions. If interest rates decrease later this fall, we could see an uptick in leasing activity in the fourth quarter.
Local Investment Trends
The first half of 2024 saw sales volume of over 280,000 square feet valued at over $108,000,000, with the vast majority of transactions occurring in the first quarter of the year. This activity was led by the sale of the Hudson Physicians building and the Associated Eye Care portfolio, both of which were long-term, 100% leased assets.
Inflationary concerns remain strong, and the Federal Reserve’s reduction of their guidance for interest rate cuts in 2024 has put pressure on several transactions that were either renegotiated or canceled. Currently, over 350,000 square feet with an estimated value of $110,000,000 is being actively marketed for sale. All but one of these properties is likely to trade at well over a 7% cap rate, with some pushing 8% or higher.
Vacancy Rate by Category
Absorption and Vacancy Rate
Sales Volume
Source: Colliers, CoStar
Source: Colliers, CoStar
Source: Colliers, CoStar
Rental Rates
Overall rental rates for second-generation medical office space continue to climb, led by the suburban off-campus market. Secondgeneration off-campus space has seen an average rental increase of over 20% from just two years ago. These rates can vary dramatically depending on the location, quality, and age of the property, but we anticipate this trend will continue as new construction pricing ranges between $35-$40 per square foot net, equating to a 75% rental premium for new construction.
The on-campus hospital market has seen a very different outlook. Each hospital campus is its own universe for occupancy and asking rents, but overall, we have seen a 4% rental rate decrease over the same two-year period. Several factors are driving the push to off-campus facilities, including the age of properties, inconvenience for patient access, and a shift toward more ambulatory outpatient services off-campus.
Overall Rents (N) for New and Old Buildings
Source: Colliers, CoStar
Source: Colliers, CoStar
Construction
The first half of 2024 saw the lowest level of new construction medical facilities delivered in several years. The current pipeline of medical facilities under construction is led by orthopedic specialty and outpatient surgery centers. Large projects have been put on hold due to high interest rates and tight debt markets. However, with construction costs starting to decrease and the hope for interest rate cuts in the second half of 2024, many of these projects are expected to commence within the next six months.
There are numerous new medical projects under consideration, but with asking rental rates pushing $35 per square foot and 60% pre-leasing required, it may take some time before additional new speculative space is delivered. We anticipate more users and developers will look to reposition existing office and retail buildings for medical use.
Medical Office Building Construction Sites
Source: Colliers, CoStar
New Supply Delivered and Under Construction (UC)
