Demand for medical office space remains high throughout the Minneapolis-St. Paul region. And there are few signs that this demand will lessen any time soon, especially as the country’s population ages and a growing number of patients seek medical care outside of hospital campuses.
This doesn’t mean, though, that the Twin Cities’ medical office sector doesn’t face challenges.
According to the latest research from Colliers, the uncertainty surrounding interest rates combined with supply chain bottlenecks are combining to put many new medical office building projecs on hold until the second half of 2023.
At the same time, medical providers are struggling to find enough healthcare workers to staff new facilities. That is also putting expansion plans on hold for many providers throughout the Minneapolis region.
Even with these challenges, though, the medical office market in the Twin Cities remains a robust one, according to Louis Suarez, senior vice president for Colliers Minneapolis and an expert in the medical office building sector.
“There is still strong interest in healthcare investment sales throughout the Twin Cities market,” Suarez said. “Healthcare, along with industrial, remains the most stable of all the sub types and some of the strongest sectors historically. That is continuing.”
Thanks to higher interest rates, though, the number of healthcare investment sales will slow this year, despite this steady demand, Suarez said.
Larger REITS are putting transactions on hold or are no longer as aggressive as they’ve been historically, Suarez said. At the same time, not as many owners of medical office buildings are putting their properties on the market. This limits the number of medical office properties that are available for investors to purchase even.
“We are seeing a difference in expectations on what sellers thought their buildings were worth and what investors are willing to pay,” Suarez said. “I do think there is some of that delta between the expectations of buyers and sellers. That is slowing the pace of sales.”
The Twin Cities already saw this slowdown at the end of last year. As Suarez said, much of the debt that historically had been funneled into medical office sales didn’t flow as freely at the end of last year.
“Some of the largest lenders were off the table at the end of the last year,” Suarez said. “There was a halt on what they were putting out into the market. That dramatically affected the end of last year.”
When buyers were seeking medical office space in the Twin Cities market last year, they were often looking for core-plus assets, larger properties that are filled with high-quality tenants on long-term leases or properties on a hospital campus.
There are individual private investors, though, including many 1031 investors, who are looking for smaller medical office properties that might not be located on or near a hospital campus. And in good news for these investors, there are more of these medical offices opening across the Twin Cities region.
That’s because many patients today are receiving medical care, even surgeries, in outpatient facilities. Patients like the convenience of these medical spaces that are often located in retail strip centers. And because demand for these outpatient centers is on the rise, developers are building more of them while owners are more likely to accept switching a vacant office or retail space into one filled by a healthcare provider.
“There will always be clinics and smaller properties that will be available,” Suarez said. “Typically, they are not of the scale or size that larger institutional investors are willing or want to look at, the 10,000-square-foot to 20,000-square-foot buildings with one to three tenants. These might be attractive to a local or regional investor or a 1031 investor versus a 150,000-square-foot or 200,000-square-foot property that has more infrastructure and higher costs.”
But the challenge for smaller and larger investors in the Twin Cities remains the same: There just aren’t that many medical office properties for sale now.
“The people who own these properties are typically long-term holds,” Suarez said. “If they sell on the larger side, it is usually one REIT selling to another REIT or changing up a portion of their portfolio or adding to it.”
Waiting for certainty
What will inspire owners to put more medical office space on the market? And what will inspire buyers to return to the market to purchase these properties?
Suarez says that it comes down to certainty: Investors and owners are waiting to see some certainty when it comes to interest rates.
“People want clarity on what the new normal will be from an interest rate perspective,” Suarez said. “It might still take some time to get the buyers and sellers on the same page when it comes to the valuation of medical properties.”
Then there are labor issues, specifically on the medical providers’ side. Suarez said that medical groups aren’t as willing to expand today because so many of them are struggling to find enough healthcare workers.
They can’t open their new offices, treatment centers or ambulatory care centers because they can’t find enough workers to staff these new facilities. That, Suarez says, has slowed the amount of new medical office space and healthcare facilities that are opening in the Twin Cities market.
One trend that is boosting the amount of healthcare space in the Twin Cities, though, is the conversion of empty office and retail space into medical uses. Suarez said that this trend will continue, but did say that the space being converted has to meet certain requirements to work for healthcare use.
“You can’t put a neurologist next to a nail salon,” he said. “The space has to be well-positioned. There might not be enough windows. The parking might not work. You might run into infrastructure issues. A building might not have the right HVAC, electrical system, plumbing or weight load. If you try to put an MRI machine on the second floor of an office building and it’s not designed for that, you could face challenges.”
Then there is the equipment that developers and healthcare providers need in their spaces. They might need to upgrade their electrical systems. Getting the switch gear necessary for that could take up to a year today. This, too, is holding back both new medical office projects and conversions.
“The conversions are certainly happening today,” Suarez said. “But you can’t convert any space. It has to be the right space.”
