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Medical Office Deals Slow Down as Rising Rates Reset Price Expectations

“We know firsthand from deals we’ve been working on that buyers have pulled back and lenders are more conservative,” says one broker. Nevertheless, the medical office sector is still considered a favored asset class among investors.

Rising interest rates and the threat of an economic downturn have slowed real estate investment sales across the board, including in the medical office sector. But the decline in sales of medical office assets is not as deep as it has been in other sectors and the market is well-positioned to weather the latest down cycle, according to brokers.

Third quarter sales volumes for medical office from data firm MSCI Real Assets aren’t available yet, but the numbers are expected to be down from the $7.3 billion recorded in the first half of 2022. That total was up from the $5.6 billion in the first half of 2021, and higher than the $6.8 billion average recorded between 2017 and 2019.

The medical office sector “isn’t immune” to what’s happening in the broader market, according to Shawn Janus, national director, healthcare services, at real estate services firm Colliers. But healthcare is considered recession-resistant and as such isn’t impacted to the same extent as other sectors, he adds.

“We've begun to hear about some deals being delayed, as well as some re-trades,” Janus says. “The healthcare sector is still seeing capital formation seeking investment in the asset class. The belief is that healthcare will be less impacted than other asset classes and will stabilize sooner as well.”

Buyers of healthcare-related properties are adjusting to the same rising interest rates as buyers of other asset types, says Toby Scrivner, a partner and healthcare specialist at the brokerage firm Stan Johnson Company which will soon be a part of Northmarq. Because of the increased cost of debt, many buyers are sitting on the sidelines for now, looking for yields and sale prices that are more reflective of this new paradigm in the marketplace. That has slowed down the sale process, he notes.

“That said, healthcare real estate is not experiencing the same slowdown as other product types,” Scrivner says. “This is largely attributed to the limited amount of healthcare products coming to the market annually and the ever-increasing number of investors who want to invest in this sector. There is still supply and demand inequality in the market. While there have been cap rate adjustments for some assets coming to the market, there are still assets going under contract at pre-rate hike cap rates.”

Medical office is going to be more insulated than traditional office buildings from the trends in the larger marketplace because of its “recession-resistant nature,” says Travis Ives, co-leader of Cushman & Wakefield’s U.S. healthcare capital markets team. The sector has historically had higher tenant retention and rent collection. The one drawback is it can’t quickly recoup the costs of inflation, like multifamily, for example, which typically has annual lease renewals, Ives notes.

Cushman & Wakefield’s healthcare team has been hearing from its colleagues across the firm network for two or three months about the challenges they were facing in the office sector, and “we wondered when that was going to filter through to our product type, because we were not feeling it at the time,” he says. By now, however, it has become clear the increase in capital costs has hit demand for medical office sales and impacted property values. But the impact has been muted compared to the office sector.

Data on where the market is at right now is lagging because deals closing over the last few months were likely marketed and closed in the first half of the year, prior to conditions getting more challenging, Ives notes. That’s when investors pulled back and prices started to adjust.

“We’re not seeing in the stats yet a significant increase in cap rates, but we think there’s an adjustment coming,” he says. “We know firsthand from deals we’ve been working on that buyers have pulled back and lenders are more conservative.”

Nevertheless, the medical office sector is still considered a favored asset class among investors, according to Al Pontius, a senior vice president and national director for office, industrial and healthcare for real estate services firm Marcus & Millichap. Investors are attracted to the stability of medical office tenants, supply and demand fundamentals and demographic pressure on increasing medical services, he says, echoing other specialists.

“That being said, though, interest rates are up, borrowing costs are up 250 basis points from where they were only nine months ago,” Pontius notes. “You will not in a condition like that maintain the same kind of pricing. Cap rates are up across the product spectrum. They are up 50 to as much as 150 points—depending on the composition of the deal. That’s less of a rise in cap rates than a corresponding rise in borrowing costs.”

All of that has slowed sales activity in the short terms as buyers and sellers adjust to a new market, Pontius says. When conditions change as fast as they did this year, the bid/ask gaps that opens rapidly means prospective sellers aren’t as prepared to adjust to lower pricing than they would be under different conditions. Buyers, meanwhile, are waiting for price adjustments.

Marcus & Millichap is still working on a number of medical office transactions that are in motions right now and new investors continue to enter the sector, according to Pontius, “but there’s a number of considerations to making a deal right this minute.”

“It takes a level of seller understanding of the impact on pricing, and it takes buyers who are continuing to execute on their strategy for being involved in the medical office sector.”

Pricing expectations

Generally, cap rates on medical office transactions have risen in the range of 50 basis points, but the increases are market-, sponsorship- and location-specific, according to Janus. Assets that are located on-campus of larger medical office complexes have held up better and have seen only modest cap rate increases. For a while, there was a mismatch between sellers lamenting that they may have missed selling at market highs and what buyers were willing to pay, but that gap appears to have narrowed recently, he adds.

Scrivner says Stan Johnson is compiling sales transaction data that will show an “on average’ increase in cap rates of 30 to 40 basis points over the first and second quarter of the year. It’s difficult to set appropriate sale price expectations for a seller when the potential for a motivated 1031 buyer to enter the market and buy a property at yesterday’s pricing is a real possibility, he notes.

“We advise buyers that while the possibility of achieving yesterday’s pricing exists, hoping is a luck strategy,” Scrivner says. “If there is a real motivation to sell, deals should be priced to attract the broadest pool of sophisticated healthcare investors. This business strategy will ensure a competitive bidding process and the best surety of sale execution.”

There’s also an “interesting dynamic” with sellers of better properties holding onto them or not doing a deal if they fail to get the target price, according to Ives. They would rather own it than sell it at a discount and are under no urgency to do so, he adds.

“You don’t see an adjustment in those values because those deals didn’t trade,” Ives says. “But what you will see in the stats that show up are some of the more challenging projects that had some hair on them and a seller that had some urgency where they needed to sell and were willing to adjust their value expectation to get the deal done. That’s where we are going to see the adjustment in cap rates reported, but it could be misleading because it might not be indicative of where core-plus pricing would have been.”

Many of the buyers in contract over the last couple of months had locked in rates or had secured lines of credit and weren’t exposed to the volatility in the debt market, according to Gino Lollio, co-leader of Cushman & Wakefield’s U.S. healthcare capital markets team. That has since changed, he adds.


Financing for medical office acquisitions continues to be available, but underwriting has become more stringent, brokers say.

Healthcare has always been an attractive sector for lenders who love it for the same reasons that investors do—stability, demographic trends that boosts demand and resistance to recessions, says Scrivner. Lenders still want to make loans on healthcare real estate, but the debt terms that banks are willing to make will vary based on the project, the property use, the size, or affiliation with a healthcare system, he adds.

“Rest assured though, if there is healthcare real estate involved there are lenders eager to be involved.”

However, as debt has become more expensive, lenders aren’t as willing to provide debt on large portfolios, says Ives. Many big national banks “have put their pencils down,” and that means reaching deeper into the debt pool of local or regional banks who aren’t willing or able to finance such large acquisitions.

“There were a lot of big portfolios on the market the last six months that did not transact and got pulled, and they will probably come back out eventually,” Ives says. “They certainly did not hit their values.”

In response to higher interest rates, buyers have turned to all-cash transactions or lower leverage—for example, 50 percent vs. 65 or 70 percent previously, according to Pontius. This helps structure more economically sound deals. But even the all-cash and lower-leveraged investors are cognizant that the interest rate environment has pushed cap rates upward, he adds.

Buyer groups

During the first half of 2022, private buyers made up 54 percent of investors in medical office properties, followed by institutional funds at 24 percent and REITs at 15 percent, according to MSCI Real Assets.

Private equity groups continue to acquire medical office properties, provided they get the right terms, while REITs have been less active because of dividend yield constraints, says Janus. End-users are looking closely at lease versus own strategies, given their thin operating margins and the changing macro environment that has impacted them. All-cash buyers have a leg-up on competitors who rely on leverage, given the rising interest rate environment, he adds.

Generally, private investors are more active in the sector at this time and more expansive in their criteria than institutional investors whose acquisition criteria are tighter, notes Pontius.

Meanwhile, while some sellers are opting to stay on the sidelines, others are coming to the market anticipating interest rates will continue to rise and that it might be better to sell now than in 2023, he adds.

“Then others have event-based decision making,” he adds. “If I have a loan coming due in six to nine months, and I don’t like the interest rate market from a refinance, then that’s an asset that may come to the market because of that.”

Overall, however, “it feels like a wait-and-see mentality right now,” says Ives. “We’ve been putting this in a lot of our pitches to sellers in what’s going on in real time. If you are not in desperate need to deploy capital, you’re willing to sit back and hopefully see some kind of adjustment and opportunistically come back into the market at a lower value. If you are a seller that doesn’t need to sell, you’re hanging onto it. If you’re a seller that needs to sell over 12 to 24 months, the general sentiment is you’re better off going now rather than later.”

There are still opportunities

As conditions shift and push up yields, it has allowed certain funds that have historically had higher yield thresholds and were previously priced out to enter back into the marketplace, notes Cushman & Wakefield’s Lollio.

Scrivner says that while his team has seen buyers taking a step back, they have tended to be the funds and REITs focused on the healthcare sector. For them, it’s an opportunity to let the market cool and wait for sellers to adjust pricing expectations. For private buyers dependent on bank financing a higher purchase cap rate is required to achieve positive leverage, he says. However, that’s a sound strategy until you introduce the elements of private buyers with tax avoidance motivations, a popular asset class and a very limited supply of product.

“We estimate it will be six to nine months for the market to level out and close the gap between the expectations of the focused healthcare buyers and those of sellers seeking to achieve the record pricing of sale comps that closed in the first half of 2022,” Scrivner says. “During this time, I expect to continue to see certain types of deals that will generate strong interest and will subsequently trade at aggressive cap rates on par with 2021 and the first half 2022... Other deals will not garner the same level of interest and will ultimately trade at pricing more reflective of where the broader market is willing to buy investments in today’s environment.”

If inflation starts leveling off and a recession hits, the medical office sector will likely be sought out for its stability of cash flow, says Ives. He’s hearing from some people that the debt markets might become more liquid in January. Even though the rates will be higher and that will make transactions easier to get done, there will need to be some adjustments in values for people to step back, he adds.

“It would be the right investment to hide out for a while,” Ives says. “We call it a safe harbor where capital has sold something and is looking for a place to deploy with plans to be there for three to five years. It wants to know the cash flow they are buying is going to be sustainable.”

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