The real estate market has faced significant shifts in recent years, with rising interest rates and fluctuating capital costs affecting asset valuations across the board. Medical office buildings (MOBs), a historically stable asset class, are now feeling the pressure from higher capitalization (Cap) rates—a trend that has led to declining property values in 2023 and 2024. As borrowing costs have surged, many real estate owners are grappling with the impact on asset prices, even in sectors as resilient as healthcare.
Bob Waun, co-founder of Physician Property Partners (PPP) and DIRT Realty, is keenly aware of these challenges. "The rising cost of capital is affecting the valuation of even high-demand properties like medical office buildings," says Waun. "That said, Prime Medical Office remains one of the safest havens in commercial real estate. Other asset classes are seeing increased risk, but well-located medical office space is still relatively insulated."
The Impact of Rising Cap Rates on Valuation
Cap rates—calculated as the ratio between a property's net operating income (NOI) and its current market value—have a direct relationship with interest rates. When borrowing costs rise, so do Cap rates, which in turn lower property values. According to a report by CBRE, average Cap rates for medical office buildings increased to 6.9% in 2023, up from 6.2% the previous year, as the Federal Reserve's aggressive rate hikes drove up the cost of capital.
This increase in Cap rates has put downward pressure on MOB valuations. Real estate investments that once enjoyed high prices due to compressed Cap rates are now seeing their values fall as investors demand higher yields to compensate for rising borrowing costs. For medical office building owners, this shift means potentially lower returns on investment and higher financing expenses.
"A 100-basis-point increase in Cap rates can significantly lower the value of a property," says Waun. "Even in the medical office sector, where demand is strong, we're seeing the effects of higher rates play out."
How 2025 May Offer Relief
Looking ahead, many analysts believe that interest rates will stabilize or even fall in 2025, offering relief to medical office investors. The market consensus points to the Federal Reserve pausing or reducing rates as inflationary pressures ease. According to a report by Morgan Stanley, the U.S. economy is expected to enter a period of slower growth, which could prompt the Fed to lower rates in response.
Lower interest rates would lead to a compression of Cap rates once again, potentially boosting the valuation of medical office buildings. This would provide some much-needed relief for property owners who have seen their asset values decline in the past two years.
"We expect 2025 to bring some relief to investors in medical office real estate," Waun notes. "Lower rates will ease the pain we've seen in valuations, but the broader real estate market, particularly traditional office space, may not be as fortunate."
Traditional Office Faces Increasing Risks
While medical office buildings continue to be a relatively safe investment, the same cannot be said for traditional office space. The office market has been under tremendous pressure since the pandemic, with remote work and hybrid models reducing demand for office space across the country. Vacancy rates in the U.S. office sector hit a 30-year high in 2023, exceeding 18% in major markets, according to JLL.
As a result, Cap rates in the traditional office sector have soared, with average rates climbing from 6.5% in 2021 to 7.4% in 2023. These rising rates are contributing to declining property values, as investors demand higher returns to offset the risks of owning office properties in a market with weak demand.
"Traditional office real estate is facing unprecedented challenges," Waun says. "With vacancy rates rising and demand falling, Cap rates are climbing, and property values are taking a hit. In contrast, medical office space is still essential, and that makes it a safer investment in this volatile environment."
Prime Medical Office: A Safe Haven
Despite the pressures of rising Cap rates, Prime Medical Office buildings have proven to be one of the most resilient sectors in the real estate market. Unlike traditional office space, where tenants are reducing their footprints or exiting leases altogether, medical office tenants often sign long-term leases and are less likely to downsize. Demand for healthcare services continues to grow, driven by an aging population and the ongoing shift toward outpatient care.
According to BMO Capital Markets, the U.S. healthcare real estate market is projected to grow at a compound annual growth rate (CAGR) of 6.5% through 2027, with medical office space playing a key role in that expansion. This growth is bolstered by strong tenant retention and stable cash flows, making medical office buildings a safer bet for investors seeking stable returns in an uncertain real estate market.
"Medical office real estate is unique in that it’s less susceptible to economic downturns," Waun explains. "Healthcare is essential, and Prime Medical Office locations in high-demand areas are even more valuable. For investors looking for stability, this sector remains one of the best options out there."
Looking Ahead
While rising Cap rates have created challenges for medical office building owners in 2023 and 2024, the long-term outlook for the sector remains strong. As interest rates stabilize and potentially fall in 2025, the valuation pressures currently impacting MOBs may ease. In the meantime, Prime Medical Office continues to offer a safe haven in a real estate market that is increasingly fraught with risk.
For investors, the message is clear: while traditional office space may be struggling, medical office buildings—particularly those in prime locations—remain a solid investment with stable demand and reliable income streams. As Waun emphasizes, "Innovation in healthcare real estate is about more than just keeping up with the market—it's about anticipating the future and staying ahead of the curve."
In a time of rising risks across the real estate market, the steady performance of medical office buildings is a reminder that some asset classes are built to withstand the storm.
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