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Friday, Dec 1, 2023

Medical Miracle: Niche Asset Type Is In Demand

Calabasas-based Agora Realty & Management entered the robust medical office space organically.

“We’re in the grocery-anchored shopping center business, and over time we started seeing more health care tenants in those shopping centers because a lot of the health care systems are now looking at the same metrics that the retailers used to look at in terms of density, income levels, area amenities,” said Cary Lefton, chief executive of Agora Realty.

Cut to October, when Agora announced the $30 million acquisition of a 75,000-square-foot medical office building, Tarzana Medical Plaza, located at 5525 Etiwanda Ave. in Tarzana.

Agora’s investment echoes the ongoing interest in medical office buildings, which tend to be synonymous with long leases and higher rental returns.

When it comes to medical-office space, two narratives unfolded last year.

“As far as leasing goes, 2022 was a particularly active year throughout the submarkets that we cover,” said Jacob Mumper, vice president at Colliers. “In the second half of 2022, sales cooled down. (There was) a pretty direct correlation in timing with the shifting lending environment and the rising interest rates.”

Medical buildings are usually located near hospitals, as their tenants are specialists providing an ecosystem for referrals. The suites tend to have a customized build-out to accommodate water lines, technology, waiting rooms and other special features.

While the general office market throughout Los Angeles continued to see a rise in vacancies and negative net absorption in the fourth quarter, the medical office sector saw active leasing.

“Medical office buildings withstand economic headwinds better than most asset classes,” Mumper said.

Bill Boyd of Kidder Mathews said it’s clear why firms and REITs such as MedProperties, Meridian, Healthcare Realty Trust, Ventas and Welltower continue to invest in medical real estate.

“As our boomer generation continues to age — 10,000 people a day in the U.S. turn 65 — that’s a huge, huge demographic bubble coming through our culture and the need for medical space isn’t going to diminish,” Boyd said.

Leasing thriving

Chris Isola of Jones Lang LaSalle Inc. traces the rise of medical leasing to a period of upheaval for retail.

“Five to seven years ago, the big trend was converting retail space into medical,” Isola said. “When retail was going through change and there was a lot of vacancy in retail shopping centers, every landlord was curious about leasing to medical groups.”

Yair Haimoff of Spectrum Commercial Real Estate has seen a lot of activity on the leasing side.

“As far as leasing goes, we have practices that are growing, even within our buildings like the Northridge building there’s a tenant that took additional space,” he said. “We did one deal with an outside tenant that came in, an urgent-care group that took the space. We just leased our last unit, Riverside Medical Building in Sherman Oaks. We just leased our last unit at the Northridge Medical Building at 18433 Roscoe Blvd. in Northridge.”  

Haimoff said there is also a growing trend of doctors buying medical office condos, which are individually owned units within a large multi-unit building. 

“Medical offices are doing very well,” Haimoff said. “We sold another medical complex in Oxnard — a complex of four buildings that we sold to a doctor. On the purchase side of it, there’s a lot of specialists who want to buy their own unit because the cost of doing the tenant improvement work in these medical suites are very expensive. If I’m going to spend $150-$200 a square foot on the tenant improvement costs, I’d rather own it than lease it.”

Isola also sees medical office conversions happening at traditional office buildings. For example, tenant Southern California Orthopedic Institute leased space at 30870 Russell Ranch Rd. in Westlake Village and California Fertility Partners signed a lease at 2045 Sawtelle Blvd. in Japantown.        

“Now we’re seeing a number of office landlords who are experiencing historically high vacancies in their buildings are looking to medical to say, ‘Well, can I convert a portion of my building to medical office instead,’” Isola said. “It’s tricky because medical is a big parking user and a lot of office buildings don’t have the parking to support it.”

Fourth-quarter sales

Leader: Cary Lefton, chief executive of Agora Realty & Management, at his office. (Photo by Thomas Wasper)

Despite the recent cooldown in medical building sales, deals were still happening during the fourth quarter.

Agora’s three-story Tarzana Medical Plaza — which came 90% occupied with tenants that include Providence Healthcare Systems, Cedars-Sinai Medical Care and Unilab Corp. — was acquired in an off-market deal.

For Agora, this acquisition is a value-add opportunity; Agora will complete an interior and exterior renovation. The interior renovation will include upgraded elevator cabs, modern corridor finishes, lighting upgrades, and expanded and renovated lobby areas with enhanced wayfinding. The firm will also add solar panels to reduce operating costs.

“The building is strategically located next to the new Providence Cedars-Sinai Tarzana health care campus set to open in April, with access directly into the hospital,” Lefton said.

Agora’s purchase of Tarzana Medical Plaza is one part only of the firm’s medical-minded aspirations. Agora is also creating three ground-up medical buildings in North Las Vegas as part of a mixed-use retail project.

“We’re seeing a synergy between health care and retail,” said Lefton. He added that the Vegas project will involve shops and restaurants with two medical offices buildings and a micro-hospital.

In addition, Agora has plans for a medical project in Orange County that includes a repurposed building.

“We’re able to tap into our experience in how we worked with retailers in the past to identify demand in desirous locations and apply the disciplines we learned in that sector in the health care sector,” Lefton said. “We’re building relationships in the health care sector, which is helping us understand their demand in terms of real estate.”

Another medical office building purchased recently was a Glendale property at 1510 S. Central Ave., a multitenant medical building with 20 tenants, which sold at a 5.25% cap for $25 million to Dallas-based MedProperties.

Boyd, who transacted the September 2021 deal, said, “MedProperties were very bullish. Even though the return is lower on this Glendale asset, the long-term potential and the growth and the strength of the market is why they would pursue this asset versus some more affordable building around the country.”

John Foulger, MedProperties senior director of acquisitions, discussed the upside of purchasing the Glendale tower.

“We felt when we underwrote that building, when we weighed the risk with the reward, that it made sense to do it,” Foulger continued. “It hadn’t been sold. They owned it since development, so it was the first time that it’s sold.”

Foulger said ownership of the Glendale tower has been going well.

A long-term play

“We’ve been able to bring in some new tenants and renew tenants,” he said. “We’ve spent a little bit of capital on some of the common areas. We’re, generally speaking, content with the performance.”

Foulger characterizes medical office as a long-term play.

“Notwithstanding the capital markets and broader economic potential issues that we have, the fundamentals of health care real estate market are sound,” Foulger said. “There’s still consistent demand. You and I are going to continue to get sick and seek out physicians. There is some telemedicine that’s gone on, but for the most part people want to see their physician in person.”

In October, Santa Monica-based Patina Capital purchased the 37,759-square-foot Santa Clarita Medical Center, a medical/dental building in Santa Clarita, for $11.3 million in a deal transacted by Haimoff at Spectrum Commercial Real Estate. Located at 23206 Lyons Ave., the medical property stands 1.5 miles from the Henry Mayo Memorial Hospital.

“We acquired this project with the intent to place a condo map on the property and selling the condos back to the doctors,” Patina Capital principal Danny Barnes said

Barnes said he has spoken to 75% of the building’s tenants.

“The majority of the people seem intrigued with the idea of owning a space versus renting one,” Barnes said.

By virtue of the medical professionals involved, such a building makes for a good investment.

“The banks themselves view physicians as preferred borrowers,” Barnes said. “They’re looked at as a higher-end threshold. That status allows them to take out bigger loans.”

Patina is in the process of upgrading the building.

“We’re already in the middle of construction,” Barnes said. “We’re fixing up the landscaping, painting the exterior, adding signage.”

Even though his company mainly acquires multifamily properties, Patina will continue to seek out medical buildings.

“We’re looking at a handful of assets of the similar ilk,” Barnes said. “Overall, we’re excited to hopefully build a pipeline of these opportunities moving forward.”

Also in October, the sale of a pair of Beverly Hills medical buildings with a surgery center closed for $8.5 million. Located near the highly trafficked intersection of La Cienega and Wilshire boulevards at 250-256 S. La Cienega Blvd., the two-story, 6,386 square-foot property came equipped with an extremely rare freestanding ground-floor ambulatory surgery center — an offering no longer available following a 2011 ordinance by the city of Beverly Hills.

In the same month, Stockdale Capital Partners won approval from Los Angeles City Council to build a 12-story, class A medical building on L.A.’s Westside. Construction will begin later this year on a 145,000-square-foot tower at 656 S. San Vicente Blvd., adjacent to Beverly Hills and not far from Cedars-Sinai Medical Center and UCLA Medical Center.

In stark contrast to medical office, general office vacancies and negative net absorption have escalated in the fourth quarter.

“It’s not a pretty picture for landlords,” Boyd said. “Glendale has had 10 straight quarters of increased vacancy. It’s unprecedented.”

Currently, there is a tremendous amount of confusion in the tenant population.

“The tenants can’t give their current landlords very accurate answers as to what their future space needs are,” Boyd said. “Most companies just don’t know.”

That has made medical office a sound investment because their tenants are usually long term and the rents are higher.  

“Medical buildings are trading a little higher, meaning a lower cap rate, so that’s why medical is outperforming office,” Boyd said.

So for now, while the leasing of general office continues to stumble, medical office has emerged as a winning asset class. As Boyd put it, “Medical is a healthier market than office right now.” 

Meanwhile, the cooling of medical office sales in the second half of last year came about with the federal government’s interest rate hike.

“The Fed’s first 50 basis point increase in May and then the 75 basis point increase in June, it really froze the lending markets across the board,” JLL’s Isola said. “Medical office was a victim of that, too.”

According to Isola, there has been a real inability to access leverage and debt that was much more prevalent over the last three to five years, and subsequently, the capital markets activity slowed down to a halt.

“From the institutional ownership perspective, there really weren’t any institutional transactions of note in Southern California,” Isola said. “The last one that did occur was in April, when Anchor Health and Harrison Street bought a portfolio of two buildings from Stockdale Capital.”

Those assets — 2825 Santa Monica Blvd. and 9090 Wilshire Blvd. — sold for $156 million in a deal transacted by CBRE Group Inc. 

Hannah Madans Welk
Hannah Madans Welk
Hannah Madans Welk is a managing editor at the Los Angeles Business Journal and the San Fernando Valley Business Journal. She previously covered real estate for the Los Angeles Business Journal. She has done work with publications including The Orange County Register, The Real Deal and doityourself.com.

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