San Diego is seeing increased interest from investors in its medical office market. According to a 2021 second quarter medical office market report from Cushman & Wakefield, the sector is seeing growing demand, with low vacancy and increased rental rates.
“There is definitely a shift in investor focus…We’re seeing that across the board. We’re seeing higher prices per square foot. We’re seeing lower cap rates continue to compress along all the spectrums of healthcare, inpatient rehab facilities all the way on the acuity scale of just your standard medical office building,” Joe Zurek, director of Cushman & Wakefield’s Medical Advisory Practice. “You’re seeing increased investor appetite from those who are already in the sector, naturally, but you’re also seeing new interest.”
According to the report, San Diego’s medical office vacancy was 6.2 percent during the second quarter of the year. Across the board, vacancy rates in San Diego’s submarkets also remained in the single digits, with the highest vacancy reported in North County at 8.8 percent. The lowest vacancy rate, however, was reported in San Diego’s Central Suburban submarket at 4.2 percent. In addition, the market absorbed approximately 119,892 square feet, with all classes reporting positive absorption.
“We’ve had single digit low vacancy in every submarket across San Diego. This is the eleventh consecutive quarter where we’ve had that, and when it’s been above that, it’s maybe been a few submarkets while the others remained in the single digits,” Zurek said. “That is going to provide a great benchmark for strength. Vacancy should stay there because there’s not a lot of options for people. Rent should continue to increase just based on what’s available and given the cost to do the deal and now the increased interest from investors.”
In the second quarter of 2021, rental rates in San Diego’s medical office market did increase to $3.25 per square foot. According to the report, this is a 2-cent increase from the previous quarter and a 15-cent increase from the same time last year.
“The rents are up compared to last year and compared to the last quarter…Another interesting thing we’re seeing is construction costs,” Zurek said. “When you used to look at a medical building from scratch, that’s anywhere from $80 to $120 per square foot. That’s increased from minimum $100 to $150, and we’re seeing a lot of landlords push the rents to accommodate for that.”
According to Zurek, the rise in construction costs as well as a lack of available product has led to a major trend in the conversion of unused retail space to medical offices. While there remains a lack of available space, the report showed only 12,000 square feet of the 300,000 square feet of medical office space currently under construction is currently available to third party providers.
“The owners of those retail and neighborhood offices are being more receptive to that, partially because of medical but also partially because of the current state of their alternatives…We’ve also seen your third party providers, whether its a dermatologist or an oral surgeon, saying instead of being in your traditional medical office building they’re telling us, “My first priority is to be in a boutique retail or freestanding office type building setting where I get the visibility, where I get the access and parking that my patients are now expecting and requiring,’” Zurek said.
Looking ahead, Zurek does not anticipate these trends to fade anytime soon. As more investors continue to show interest in San Diego’s office market, the report shows vacancy will continue to decline and more retail properties will be converted into medical office space.
“We say COVID-19 didn’t start these trends, it just accelerated them…Part of that is moving out into the community, having easier touch points and more continual and regular visits with the populations they serve, and you’re not going to get that if you’re in a high acuity, high cost on campus, parking is horrible, access is horrible, MOB. You’re going to get that with the small neighborhood health clinic down the street where you can stop by between other appointments during the week and everything is pushing that way,” Zurek said.
