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No question. The cost structure for new outpatient medical space has reached unprecedented heights. High interest rates, a tight labor market, supply chain issues, and record inflation have all contributed to the cost of new outpatient medical space crossing the $35 per square foot threshold and in some instances approaching $40 per square foot.  When confronted with this reality, many physician groups have elected to forego growth opportunities and/or put off relocation to upgraded/expanded space.  The status quo may help manage the expense side of the ledger but does not facilitate revenue growth.

In past cycles, low interest rates helped to negate the impact of rising construction costs. No such luck in the current cycle. From 2022 to 2024, construction costs increased by nearly 25 percent. As for interest rates, the Federal Funds Interest Rate went from 3.25% in September 2022 up to 5.5 to August of 2024 (it was recently cut to 5%). Given the reduced amount of construction demand, contractors have reduced their profit margins to stimulate business. 

While rental rates and development costs will not soon, if ever, return to the pre-pandemic baseline, the next 12-18 months should offer some relief and a degree of stability that the market has not enjoyed the past 5 years.

• Major construction items such as concrete, steel, doors, drywall and lumber have stabilized and even reduced in certain categories.
• Electric and heating, venting and air conditioning (HVAC) have continued to rise but at a reduced pace.
• The decrease in oil prices over the past year has led to lower costs for items such as roofing and adhesives.
• Commodity prices have stabilized.
• Labor costs will likely continue to rise-estimated at 3-5 percent over the next 12-18 months.

All these factors combine to create a stable construction cost environment. Unless there is a sustained recession, prices/costs will not reduce. The best we can hope for is stable pricing. 

Pent up market demands and wants will eventually burst through and once again put upward pressure on construction and development costs. With occupancy rates in outpatient medical buildings currently at 94 percent, groups looking to for new or expansion space will have limited options. Accordingly, new development is likely going to be the most viable option for growth. 

Groups looking for new or expanded space should aggressively explore options in the near term before the cost structure takes another incremental jump. Delaying action will not lead to lower occupancy costs and will lead to missed opportunities to expand the patient base and grow revenue. Groups that understand this reality and take action in the near term will be much better positioned than those kicking the can down the road and then being forced to take action in a much high-cost environment.