Challenges and Innovations in Medical Office Financing
This episode of the Commercial Real Estate Daily podcast is brought to you by CRE Launch Pro. If you’re looking to take your investing skills to the next level with online courses, group coaching calls, and a community of other investors, head on over to www.CreLaunchPro.com
Episode Transcript:
Today we're diving headfirst into the world of medical office financing, where challenges are piling up like never before.
Our protagonist today, Jon Boyajian, Principal at Echo Real Estate Capital, recently embarked on a financial odyssey that involved making 39 phone calls to banks. Why? To secure funding for a medical office property in Indiana. This adventure underscores just how daunting the current landscape is for obtaining medical office financing.
The headwinds facing medical offices are blowing just as strongly as they are for other asset classes. While many remain optimistic about the sector's performance compared to traditional offices and other commercial real estate categories, it's undeniably becoming a tougher arena to navigate.
The limited availability of financing has taken a toll on transaction volumes, which have seen a sharp decline. As margins tighten, rents are on the rise, and developers and occupants are increasingly shifting their focus towards renovating older properties rather than taking on new ones.
Boyajian's Indiana deal ultimately found financing through a local credit union familiar with the property, but it was far from a walk in the park. He had to scratch beneath the surface to secure even three term sheets, highlighting the current challenges in the banking lending landscape.
Jesse Ostrow, Chief Investment Officer at RX Health & Science Trust, explains that acquiring debt, regardless of the asset class, has become more difficult, resulting in lower transaction volumes. Year-to-date sales volume for medical office centers has plummeted by about 62%, with the average deal size in 2023 sitting at around $9.6 million.
The problem isn't a lack of demand. With the essential nature of medical office visits and an aging population, demand remains robust. However, the scarcity of debt financing at higher price points has raised cap rates for medical office centers to an average of 7.1%, the highest in seven years.
To set themselves apart in the financing landscape, the industry is even changing its terminology. Rather than "medical office," they are now favoring the term "medical outpatient facilities" to avoid being lumped in with traditional office assets during loan evaluations.
The financing and transaction slowdown has led property owners to either raise margins through rent hikes or embark on renovation projects. Boyajian's company negotiated rent increases, as tenants are reluctant to undergo the hassle of moving, which often disrupts their operations and patients.
But despite these challenges, the outlook for healthcare development remains mixed. While some believe the medical office sector is as healthy as ever, high-interest rates are expected to temper new construction. Redevelopment of existing facilities may be on the rise, offering a cost-effective solution.
In the face of rising rates and limited lending, investor interest is unlikely to wane. Medical office buildings continue to attract institutional money due to their resilience compared to other asset types. As the debt and equity markets regain confidence, we might see a resurgence in transaction activity.
This is Tyler Cauble. Signing off