CREJ - Healthcare Properties - September 2016
Denver’s medical office market experienced modest improvements in net absorption, investment activity and rental rates in the first half of 2016. Overall direct asking lease rates reached $27.31 per square foot full-service gross, a year-over-year increase of 25 cents per sf. Although positive net absorption of 65,793 sf was recorded in this half of 2016, direct vacancy increased to 10.3 percent, up 4.7 percent year over year due to new deliveries with available space. Year-to-date transaction volume reached $38.8 million, an increase of 21.3 percent year over year. Economic/unemployment. Economic indicators in the Denver market remained strong in the first half of 2016. Employment continued on its expansionary path. All-industry job growth was 2.8 percent on an average year-to-date basis through May over the previous year. This equates to 44,100 more jobs on average than in May 2015. Job growth has helped keep the unemployment rate low, which currently rests at 3.3 percent for Denver metro and 3.6 percent for Colorado – both levels well below the “natural” unemployment rate of 5 percent. Employment in health care has also increased with 2.7 percent year-to-date growth on average through May. Health care employment is expected to continue its upward trend in line with population growth. Construction. Medical office construction activity continued its momentum in the metro Denver area with 137,800 sf under construction and 170,117 sf completed in the first half of 2016. The most notable completion is Parkway Center, a 61,717-sf Class A medical office building at 4700 Pearl St. in Boulder, which is fully leased. In addition, the 45,000-sf Federico F. Peña Southwest Family Health Center and Urgent Care by Denver Health located at 1339 S. Federal Blvd. opened in April. Vacancy/availability/absorption. Positive net absorption of 22,491 sf was recorded in second-quarter 2016, bringing the year-to-date total to 65,793 sf of positive net absorption. On-campus buildings recorded negative net absorption of 5,777 sf in the first half of 2016, which was offset by a gain in net absorption of 71,570 sf for off-campus buildings. “Overall, on-campus leasing has remained steady the past year, but we still see private practice tenants reevaluating the need to be on-campus when lease expirations come around,” said Kory Fasing, senior associate, CBRE Healthcare Services, Denver. “For many tenants, there is a strong enough benefit from being on campus, but for some, it may not be worth the rental rate premium, and they may decide to move off campus to decrease overhead.” Direct vacancy increased to 10.3 percent in second-quarter 2016 from 9.9 percent in the second quarter of 2015. On-campus direct vacancy increased to 8.1 percent, while off-campus direct vacancy decreased to 12.4 percent. Overall availability was flat at 12 percent in the second quarter, a 28 basis point decrease quarter over quarter, resulting in a 1.7 percent spread over direct vacancy. Off-campus availability in the Cherry Creek submarket decreased over 16,000 sf in the quarter. Average asking lease rates. Overall average direct asking lease rates increased quarter over quarter in second-quarter 2016, paralleling year-over-year trends. Rate increases have been driven by limited quality space availability and new deliveries in on-campus buildings. “On-campus medical office building leasing is typically directly correlated to the success of the hospital itself. At the most vibrant campuses, the medical office buildings tend to have low vacancy rates and command the highest rates. In some cases, these low vacancy rates in the existing buildings have driven new development of on-campus medical office buildings, many of which have been very successful with their leasing efforts in the past year,” said Fasing. Overall direct asking lease rates reached $27.31 per sf FSG, a year-over-year increase of 25 cents per sf. On-campus direct asking lease rates declined by $1.05 per sf year over year to $29.22 per sf FSG, while off-campus direct asking lease rates increased to $26.35 per sf FSG, up 65 cents per sf year over year. As a comparison, direct asking lease rates in general office increased to a record $25.23 per sf FSG, a 4.4 percent increase year over year. Investment trends. Investment activity remained strong through the first half of 2016 as $38.8 million transacted in Denver’s medical office market, an increase of $6.8 million in sales volume from the first half of 2015. University of Colorado Health’s acquisition of 311 Steele St. in the Cherry Creek submarket for $8.4 million, or $538.47 per sf, from Oberndorf Properties marked the largest transaction so far this year. Additionally, Catholic Health Initiatives sold Thornton Neighborhood Health as part of a portfolio for $6.4 million, or $596.26 per sf, marking the highest unit price in the first half of the year. Transaction volume is expected to increase overall in 2016. Market outlook. The medical office market experienced healthy growth in key fundamentals such as investment sales volume, net absorption and increased lease rates. Despite new administration rules of the Affordable Care Act, medical facilities and offices are in demand with a much higher volume of patients. Demand from physicians and other health care users remained strong due to healthy employment growth in health care and favorable demographic trends affecting the metro Denver area. Also, aging baby boomers, one of the largest segments of the U.S. population, is creating a much larger pool of patients that are heavily dependent upon health care services. To keep up with demand, health providers and outpatient services are moving closer to end-users. As result, many urgent care centers are attracted to retail space for higher visibility and accessibility to existing and potential patients. “Almost every health care system has stepped into the urgent care game and is looking to plant their flag within neighborhood communities, thereby strengthening their brand and capturing market share along the way,” said Fasing. “They are looking for highly visible, A-plus locations with great signage at the corner of the best intersections. It’s a complete retail approach to health care real estate, which is historically not as location focused.” Denver, which is a leader in innovative health care and technology, is expected to remain at the forefront of national users’ expansion plans and capital investment, which will continue to result in strong investment activity in the metro Denver area. Strengthening fundamentals and continued economic progress will afford new opportunities to upgrade the health care system, allowing investors and lenders to drive transaction levels up.