November 21, 2017
John B. Mugford

Construction of non-health system affiliated MOB space rises in 2017

By John B. Mugford, Editor, Healthcare Real Estate Insights

Prior to the onset of the Great Recession, the medical office building (MOB) market was coming into its own as an asset class.

In garnering plenty of new attention from investors and capital sources, sales of MOBs were booming, as were new development projects.

However, during the hot streak, the development market heated up a bit too quickly, with some firms – not the long-standing developers that helped establish the sector – started moving forward on speculative projects that often did not have anchor tenants signed to leases.

Such a practice goes against the norm in the MOB development sector, where most projects have a health system or large group practice, sometimes both, as anchor tenants to get the ball rolling, make the numbers work and keep the disruption of a market’s MOB vacancy rate and rental rates to a minimum.

Whether it can be attributed to speculative projects or not, there was certainly an abundance of vacant MOB space coming out of the recession.

Is the speculative MOB market overheating once again? Data from Annapolis, Md.-based research firm Revista indicates that it could be, as the amount of speculative MOB space, or space not affiliated with health systems, has reached a four-year high point when compared to health system-affiliated space.

Revista has found that a total of 13.3 million square feet of non-health system affiliated MOB space is or has been under construction in 2017. This marks the first time in the last four years that construction of non-affiliated space has topped that of affiliated space, at 11 million square feet in 2017.

Despite these statistics, developers tell HREI and Revista that they are not seeing many projects that could be considered “speculative” in the traditional sense: starting construction without leases in place.

Perhaps the definition of a speculative MOB project has changed. Development firms say that even when they secure land and embark on planning a project without a health system or major physician group as an anchor tenant, they are not likely to start construction without at least half of the future building pre-leased and good prospects lined up for some of the remaining space.

A prime example of this type of MOB project is being planned next to a growing hospital campus in the northern part of Colorado Springs, Colo.

The project, the Pine Creek Medical Center, is being developed by a partnership of Minneapolis-based Mortenson Development and Denver-based Realty Management Group, with Denver-based National Healthcare Realty providing leasing services.

What started as a plan for a single 34,000 square foot MOB has turned into a potential for a medical office campus with up to 150,000 square feet – all because of demand for MOB space, the submarket’s population growth and expansions taking place on the adjacent hospital campus. There, UC Health Memorial Hospital North is adding 110 beds and a new $154 million Children’s Hospital of Colorado is under construction.

That original building is now likely to have about 50,000 square feet, with plans pending for another MOB with up to 100,000 square feet. So far, the hospitals next door have not signed up for space, even though the only MOB on the UC Memorial North campus is virtually full.

Jecoah Byrnes, CEO of National Healthcare Realty, the leasing firm for Pine Creek Medical Center, says that demand is “very” strong for space in the first phase and is likely to remain strong for a potential second phase.

“I guess in the traditional sense of MOB projects, this could be considered speculative because a healthcare system did not approach the developer to build them a building,” Byrnes says. “But in a practical sense, it’s not speculative based on pre-leasing activity, as the entire first floor and a portion of the second floor will be leased by the time construction starts in early 2018.”

Even more of the space in the building is likely to be leased by the time the building opens in late 2018 or early 2019.

JM Blog Chart 11.17.17 (002)

MOB Construction by Hospital Affiliation – SF Started (In Millions)