A Note from Chip Conk:
As we reach the end of 2024, our 18th year in medical real estate, we at Montecito are as excited as ever about the long-term prospects for our field. Significantly, we are also more excited about the short-term prospects in the coming year than we were at the end of 2022 and 2023.
The 50-basis-point interest rate reduction announced by the Federal Reserve in September, followed by another 0.25 percentage-point cut in November, is the best news our industry received all year. This eagerly anticipated development has accelerated the momentum we were beginning to see across the medical real estate landscape.
While the cost of debt for buyers is always fluid, it is generally declining to a point where it can meaningfully impact transaction activity. While this activity is unlikely to rebound to the record levels we saw before interest rates rose, we will end the year with higher acquisition volumes than in 2023.
Another sign of a rebounding market: In Q3, we witnessed the industry’s first medical office portfolio sales for 2024. While interest rates will need to fall further to attract more portfolio buyers, we are encouraged by the interest in a portfolio currently offered by Montecito. We also believe smaller portfolios will attract investors in the current market environment.
The most visible reason for our positive outlook entering the new year is our acquisition pipeline, which has reached record levels. September 2024 saw the highest number of signed letters of intent (LOIs) in Montecito’s history.
Montecito Medical Office Fund IV, our current opportunity for investors to participate with us in ownership of carefully assembled portfolios of medical office properties, has attracted more capital than any of our previous funds and remains open for additional investors into Q1 of 2025. Based on the high level of interest in these funds, we plan to launch Fund V toward the end of the coming year.
The Tailwinds Propelling Our Industry Continue to Gain Strength
Each passing year further confirms the investment thesis on which Montecito was established in 2006: Medical office real estate offers exceptionally solid fundamentals that make it both growth-oriented and recession-resistant.
In 2023, healthcare accounted for nearly 22% of all inflation-adjusted consumer spending. As the U.S. population continues to age, that spending will grow. Those age 85 and older—the cohort with the highest per capita healthcare expenditures—are growing disproportionately faster than other groups; according to the U.S. Census Bureau, they are expected to increase by 56% in the next 10 years.
As demand for healthcare services grows, and as increasingly sophisticated technology enables more medical procedures to be performed in outpatient settings, providers are shifting to medical office buildings (MOBs) away from traditional hospital campuses. In fact, 80% of new medical outpatient buildings are being developed in residential and retail areas. Besides offering greater convenience to patients, these MOBs also deliver high quality and lower costs. Occupancy rates for medical office properties are consistently outpacing other types of commercial offices, and occupied MOB space is expected to reach a record amount in 2025. Meanwhile, year-over-year healthcare employment growth far exceeded overall employment growth for Q1 2024; within the healthcare space, MOB-based employment grew at more than double the rate of hospital employment.
For all of these reasons, medical offices have grown from niche status to a full-fledged sector, and healthcare fundamentals will continue to provide strong tailwinds for our industry over the next decade and beyond.
Maintaining a Steady Presence in the Medical Office Marketplace
While the medical office field offers abundant opportunities, Montecito takes a distinctive approach to the market that enables us to seize them.
While other buyers retreated during the past 18 months, we remained active acquirers of medical properties. We continued to sustain and expand our network as a generator of potential acquisitions; now, we are enjoying the fruit of opportunities that we have been nurtured for an extended time. In 2023, we reviewed approximately $17 billion in acquisition opportunities sourced through our robust network. We expect that the final number for 2024 will be similar. We are becoming known as a go-to source for acquisitions involving individual medical office assets or mini-portfolios.
At the same time, we remain highly selective and opportunistic buyers. Last year, we closed on just 3% of the opportunities we reviewed, and we expect that amount will shrink to approximately 2.5% for 2024. Our proprietary Scout Insight technology, which I’ve often described as Montecito’s “secret sauce” for sourcing deals, remains invaluable in helping us sift through the large volume of acquisition opportunities we see, evaluate their performance and potential, and focus only on those assets that we believe will offer the best returns on our investors’ capital.
Our pioneering use of technology and data analytics in deal sourcing also offers one additional benefit: It has helped Montecito stand out as international funds and wealth managers look to capitalize on the rock-solid fundamentals undergirding the medical office real estate space.
Why Going Beyond Transactional Relationships Leads to More Real Estate Transactions
Most of all, Montecito has never taken a purely transactional approach to medical real estate relationships. Instead, we have always worked with the medical providers who become our long-term tenants to understand their challenges and help them thrive. Our success is tied inextricably to theirs.
Over the years, we have pioneered several innovations in our field based on our conversations with physicians and medical office owners. We led the field in developing a program that enables owners to remain invested in their property after selling it to us, with opportunities for deferred capital gains, monthly income, and additional profits later. In response to requests for further opportunities to build wealth through medical real estate, we launched a series of funds that allow physicians to invest alongside Montecito in entire portfolios of carefully selected and managed medical office properties. These funds have attracted investment approaching $850 million to date .
Most recently, we created MontecitoPLUS, the first platform of products and services aimed at helping providers thrive in today’s challenging environment. Through MontecitoPLUS, medical practices can increase revenues and reduce costs with solutions that range from utilizing their spaces more productively to reducing no-shows and same-day cancellations, leveraging their online presence to attract new patients, identifying optimal areas for growth and expansion, and optimizing E/M coding in ways that increase revenues, reduce payor denials, and make physicians’ jobs easier.
By aligning our interests with those of providers and by benefiting them in ways that go beyond real estate, Montecito has earned a reputation as a trusted partner. And that trust, in turn, is a significant reason why more medical office owners have entrusted their properties to us since 2020 than any other privately held buyer. (In light of this success and of our company’s innovations, GlobeSt.com and the editors of Real Estate Forum have named Montecito as a Key Influencer in Healthcare Real Estate, recognizing our team for the past seven consecutive years.)
Though medical office acquisition volume over the past two years has reflected some of the challenges experienced by buyers and sellers in all commercial real estate sectors, we believe our field is singularly positioned for growth over the coming decade. We are excited about the opportunities ahead, and we intend to make the most of them on behalf of our company and our investors.
Sincerely,
Chip Conk
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