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Posted: Monday, April 27, 2009

Medical is Real Estate Bright Spot

Business is moving along at a steady clip for David Kim of the commercial real estate firm Lee & Associates. He recently closed a 6-year lease on 2,300 square feet of office space in Moorpark, a 7-year-lease on a 1,800 square foot property in Moorpark, and a 5-year lease on a 1,000 square foot office space in Camarillo.

All of these properties are medical offices, a segment of the commercial real estate market he says seems to be holding relatively stable compared to conventional office and industrial where vacancy rates are rising and rents decreasing.

“As far as medical office goes, I have personally not seen any slowdown,” says Kim. “When these guys need an office they need an office.”

Unlike other asset types, medical offices nationwide continue to garner investor demand and show resistance to the economic downturn. The trend is fueled by the positive state of the healthcare industry, says a report for the first half of 2009 by Marcus & Millichap.

Healthcare spending is expected to exceed $3 trillion by 2013. Medical is shifting from an impatient to outpatient focus. And people are seeking medical care for illness and preventive reasons, despite a slowdown in costly elective procedures, says the report. However, there are still locales where medical assets are underperforming.

Local brokers and developers say the medical office market is more resilient in the bad economy because: supply is low in some areas; physicians typically sign long-term leases; they do significant build-outs; and they tend to default less.

“Medical tenants typically sign 5-10 year leases and don’t want to re-locate,” says Jeremy Barbakow, senior VP with NAI Capital. “It’s not like you can just pick up a whole medical practice and move from Encino to Pasadena.”

Parking crucial

The difference between medical and conventional office space largely boils down to parking. Every city has a minimum number of parking spots per 1,000 square feet of office space. In Palmdale it’s 5 per 1,000 square feet for medical and 4 per 1,000 square feet for conventional. Visibility and proximity to a major hospital also come into play.

Another difference is that individual doctors and larger organizations typically do major tenant improvements, to accommodate equipment and increase the functionality of the space. Landlords, therefore, require longer lease terms to justify the improvements.

Medical tenants are some of the best payers, says Rickey Gelb of Gelb Enterprises, a property management and real estate development firm. The average lease rate is $2.20 per square foot for his properties in Encino, Van Nuys and Granada Hills. And Gelb says he has not had to come down much other than offering half-month free deals.

“If a person is not working they still need to get medical help (e.g. dialysis),” says Gelb. “We’d love to get more of it, but the hard part is people don’t move very often.” Most deals are for properties from 1,500-2,000 square feet, he adds, and leases are 10-20 years. Occupancy rates for all of his properties average 95 percent.

There’s quite a bit of medical office activity happening in the Antelope Valley, because of the soon-to-be-completed Palmdale Regional Medical Center.

The Meridian Professional Center, which includes eight buildings and 73,000 square feet of medical office space and condos located near the new medical center, is just coming to market, says John Erickson, senior VP with Colliers International. And activity has been steady.

“We have one signed five-year lease for a 3,000 square foot office, a lease out on another 3,000 square foot space, and we are negotiating for four of the buildings,” says Erickson. “Most of the activity is from the medical community, local doctors looking to relocate to a modern facility and some larger organizations.”

Interest in buying

Leases at Meridian are 5-10 years, says Erickson, and many doctors are interested in purchasing. They generally view the move as a long-term investment, and financially speaking, only bite off what they need, he adds.

But the medical office picture is not all roses.

Nationally, construction completions are expected to only increase 2.6 percent this year; vacancy rates will increase to 12.4 percent; and asking rents are expected to dip 2.7 percent by year’s end, says the Marcus & Millichap report.
Vacancy rates in the West/Pacific Northwest, which includes California, are expected to increase in 2009 and dampen some of the investment activity. However, median sales price in the region rose 12 percent last year to $300 per square foot. Cap rates remained in the low 7 percent range.

Barbakow, with NAI Capital, says vacancy rates in the San Fernando Valley properties he works with have not changed much. Most hover in the 3-5 percent range. But lease activity has decreased and rates at some properties have dropped 10-15 percent over the past year.

The average price per square foot is $2.50-$3 full service gross with paid parking, and most deals are for 2,000 square feet spaces.

“It depends on the specific product,” says Barbakow. “And there are a few landlords out there that are holding tight to the numbers and closing deals.”

Article By: Eric Billingsley of San Fernando Valley Business Journal


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