News & Analysis: MOBs (October 2006)

Can cap rates keep falling?



By John Mugford


Just when many folks involved in medical office building (MOB) sales figured cap rates were finally starting to level off, recent statistics show they continued on their steady decline into the second quarter of this year.

In fact, when the national, preliminarily reported average cap rate initially dropped to less than 8 percent during the first quarter of 2005, everyone, including Healthcare Real Estate Insights, considered it a big deal – which, in fact, it was. That’s because cap rates had been in a long, slow decline since the mid-1990s, when the rate hovered around 11 percent.

The latest MOB sales statistics from national brokerage firm Marcus & Millichap indicate that the average cap rate for the second quarter of 2006 (Q2) was 7.35 percent. That, to the best of our knowledge here at HREI, is the lowest average quarterly cap rate in at least the past decade. Marcus & Millichap compiles MOB sales statistics each quarter and shares them with HREI.

The previous low reported in HREI was a quarter earlier, in Q1 2006, when the average cap rate for 96 recorded transactions was 7.5 percent.

“This past summer was a little bit strange,” says Yitzie Sommer, senior research manager in Marcus & Millichap’s New York office. “Everyone had been geared up for the Fed to raise interest rates, oil was at $72 to $75 a barrel, and you had the war in the Middle East and concerns about Iran, and there was talk about a recession stemming from the housing slowdown.

“Well, as it turned out, oil was down 25 percent, the interest rate on the 10-year treasuries dropped from 5.1 percent down to 4.6 percent – the tone changed so much. And that allowed better performing properties to go for higher prices and lower cap rates.”

PSF keeps soaring

Here are HREI, we also thought it was a big deal when the national price per square foot (PSF) topped $200 for the first time – which it did, preliminarily, in Q4 2005.

We called the $200 figure a “threshold” in our April 2006 article titled “Average MOB sale price hits $200 PSF.”

As things turned out, the average PSF for Q4 2005 was actually $188. The actual, final figure was lower because Marcus & Millichap issues preliminary MOB sales statistics within a couple of months of a quarter’s conclusion. Several weeks later, after all of the transactions have trickled in, the firm issues final statistics.

By the way, the $200 threshold was indeed broken in the next quarter, Q1 2006, when Marcus & Millichap’s final statistics indicated that the average PSF was $213 on 96 transactions.

As for Q2, Marcus & Millichap’s stats show the average PSF was $221.

At this point in time, the firm’s Q2 statistics are final, as Mr. Sommer says all of the sales have been recorded.

Here’s a look at a couple of additional national sales statistics from Q2:

  • 101 transactions, which as far as HREI can determine, is the highest number in at least several years. Certainly, it’s the highest number of quarter MOB transaction in the past year. There were 100 transactions in Q4 2005.
  • $856 million in total sales volume, also the highest number in recent years and an increase of 6.13 percent over Q1, when total sales volume on 96 transactions was $806.8 million.


Cap rates stabilizing?

For at least a couple of quarters now, industry observers have predicted that MOB cap rates would eventually stabilize and perhaps, start to increase.

So far, however, that just hasn’t been the case.

“I still think you can make the argument that cap rates could come up a few basis points in coming quarters, especially if interest rates start to increase slightly, which they are supposed to do,” says Mr. Sommer.

Even so, investors are now acquiring MOBs because of the strong fundamentals, not just because of appreciation, he adds. And that means that cap rates are not likely to skyrocket anytime soon.

“MOBs have become a much more-respected investment by a wider variety of investors,” Mr. Sommer says. “They’re now looking at effective rent growths in the 4 percent range, as opposed to 2 percent. And that is attractive.”

While MOB cap rate continue to make headlines, including two portfolio sales in 2006 with sub-6 percent cap rates, Mr. Sommer says there are still deals taking place with more-attractive cap rates. (Please see “Sub-6 cap rate reported” in the April 2006 edition of HREI. Please also see the first item in the sidebar to this story, titled “Sample transactions.”)

He points to a Q2 sale of an 88,514 square foot MOB in Indianapolis that had a cap rate of 9.6 percent. The MOB is reportedly 90 percent occupied. (Please see the second item in “Sample transactions.”)

“What’s interesting is that you can still find good deals with good returns – not all deals these days are mid-6 caps,” Mr. Sommer says. “You just have to go out and find them, and that often means looking in the middle of the country, not on the coasts, where things tend to trade significantly higher.”

PSF on the rise

As for the average sales price per square foot paid, Mr. Sommer believes the average PSF should continue to rise.

“Price per foot is based mostly on replacement costs,” Mr. Sommer says. “And those costs should continue to increase. Even though the price of oil has dropped recently, the cost of raw materials, and the cost of construction in general for a number of reasons, has continued to go up substantially.”

Marcus & Millichap also believes that the number of MOB transactions will remain strong, perhaps even continuing to increase. In just more than a year, the number of MOB transactions has increased more than 80 percent — from 56 transactions in Q1 2005 to 101 transactions in this year’s Q2.

“Buyers are still seeing better fundamentals and security with MOBs than with general office buildings,” says Mr. Sommer. “And it looks like there are still plenty of first-generation developers, which can often be doctors and doctors’ groups, who find that they probably should take advantage of all of the liquidity in the market place.

“For example, if a developer built an MOB for $100 a foot several years ago and is now being offered more than $200 a foot, and even up to $300 a foot, they figure ‘why not?’ It makes sense for them to sell and perhaps re-invest the profits. Some even use the money for another development.”

Mr. Sommer adds that real estate investment trusts (REITs) and large institutional investors continue to show strong interest in MOBs, which offer diversity for their portfolio and continued strong fundamentals. q


Selected Second and Third Quarter MOB Transactions


Property Name                        City, State        Sq. Ft.  Price ($000s)   Cap Rate          Seller/Buyer


Shady Grove MOB portfolio  Rockville, Md.  141,325         $59,310 5.9%   Seller: N/A

                                                                                                                        Buyer: WREIT

Banta Trails Professional Park    Indianapolis       88,514  $9,435   9.6%               Private LLCs

Plano Pediatric Pavilion  Plano, Texas    81,961              $23,500  8.3%   Seller: Private LLC

                                                                                                            Buyer: Cirrus Group

Mayo Clinic MOB           Rochester, Minn.           205,000    $37,500   6.2%   Seller: W.P. Carey

                                                                                                Buyer: Triple Net Properties

Baptist North MOB         Nashville, Tenn.             151,000   $25,700    6.8%  Seller: N/A

                                                                                                              Buyer: N/A

Union Medical Campus   Colorado Springs, Colo.  151,299   $21,700  8.1%  Seller: N/A

                                                                                                            Buyer: Cirrus Group

Superior Building            Newport Beach, Calif.  39,463       $15,300   N/A     Seller: N/A

                                                                                                               Buyer: N/A

St. Luke’s Medical Center   Phoenix        52,800    $12,130   N/A              Seller: N/A

                                                                                                Buyer: Global Investment House

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