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Thought Leaders: Medical Office Produced Superior 3.2% NOI Growth Over Last Two Years

Healthcare Capital Markets Perspective

November 2018

  • Medical office buildings are associated with durable income, but they also offer consistent and positive income growth compared to other property classes.  The three dedicated MOB REITs produced 3.2% growth in net operating income over the last two years compared to only 0.57% for U.S. office REITs during the same period.  Medical office NOI growth has been consistently positive historically, albeit in single digit range.  Office, by contrast, is more volatile and cyclical.  The past two years illustrate this point as office NOI experienced superior year over year growth of 14% during 2014 and 2015 but turned negative in late 2016, and only trended positive again in mid-2018.
  • Revenue growth from medical office is generated primarily from contractual rental increases that typically range between 1.5% and 3.0% annually as well as positive releasing spread.  Major metros and top tier hospital campuses are associated with more favorable rent escalations and releasing spread given the higher tenant demand for medical office space.  Some escalations are calculated using CPI, which benefited tenants in recent years with low inflation, but it may shift as inflation picks up.
  • Healthcare Realty Trust, Physicians Realty Trust and Healthcare Trust of America are three medical office building focused public REITs that report same store revenue and net income growth each quarter.  Collectively, over the past two years, the three REITS averaged 2.6% annual revenue growth on a trailing 12-month basis.  Additionally, medical office owners can control expense growth by optimizing property management services.  Over the same timeframe, expenses rose only 1.5% on average, resulting in a higher net income growth rate of 3.2%.
  • Rental escalation clauses differ for multi-tenant buildings versus single tenant buildings.  Healthcare Realty Trust reported in the 3Q 2018 that its average rent escalation was 2.9% for multi-tenant and 2.4% for single tenant properties.  Landlords may have more negotiating leverage with smaller tenants that prefer shorter duration leases, often at on-campus locations with limited supply.  Single tenant properties frequently have longer lease terms with larger tenants, lowering near term risk, but also limiting rent growth.

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Justin Hill
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