Category: Principal Perspective

The administrator of a large specialty practice once shared that she had 50 priorities in her field of vision and real estate was not one of them. Unless there is a pending lease expiration or strategic initiative to open a new site, real estate strategy was not top of mind. 

As most medical practices will eventually confront a lease expiration or a strategic initiative, it is essential they establish a defined set of real estate principles to avoid becoming a passive player in an important decision that will have significant financial implications for a decade or more. All groups should develop an organized framework to best ensure real estate decisions align with the practice’s strategic, operational and financial objectives. 

When it comes to real estate, medical groups typically fall into one of three categories: 

The 15-Year Rule

From a financial perspective, ownership is attractive if the group has a high degree of confidence that the building will serve its needs for 15 years or more. Most analysis suggests that it takes at least this length of time before ownership is financially advantageous over leasing. Deciding to own requires a trifecta of confidence: in the market, building location, and building size. If any of these factors are uncertain, the practice would be better positioned to lease so that it could relocate, consolidate, downsize or expand if the need arises when the lease term expires. 

In addition to long-term confidence in the real estate investment, groups should have full buy-in from all physician partners. Practices that have different ownership structures between the clinic and the real estate partnership may encounter conflicting interests. The practice could want to pursue a strategy that is not advantageous to the real estate partnership such as downsizing or relocation. Best practice to avoid such a scenario is to only allow active physicians to be in the real estate partnership and require all physician partners to be equal investors in the real estate partnership.

Collaborative Planning

Groups intending to be real estate owners generally start the process one of two ways: on their own or in partnership with a real estate professional. Although certainly not required, partnering with a healthcare-focused real estate professional is highly recommended for transactions of this scale. Buying and/or developing within the medical market is a multi-million-dollar transaction requiring a high degree of sophistication, so collaboration is often a strategic necessity.

The real estate professional will facilitate:

• Due diligence
• Governmental approval process
• Financing
• Legal documentation
• Consultant engagement (architect, contractor)

Although these services can be contracted on a fee basis with a developer, partnering with the developer on ownership affords the clinic with the optimal financial structure. The developer will deliver both cash for the equity investment and banking relationships that bring much more favorable terms than if the clinic were to finance the real estate on its own. 

The Davis Approach

The key to successfully implementing a real estate strategy is partnering with the right real estate professional. With a focus only on healthcare real estate and an approach that optimizes the objectives of its clients, Davis is positioned to be the ideal real estate partner for a variety of healthcare organizations and specialty medical clients.

Davis has completed 40 medical outpatient developments (from 10,000 to 150,000 square feet) and 65 healthcare-related investment/acquisition transactions (totaling $989M in value). Davis shapes its role around the objectives of its practice clients—developing for the client, in partnership with the client, or providing its expertise on a fee basis for the client. 

Ready to make real estate a strategic advantage instead of an afterthought? Email Michael Sharpe at msharpe@davishre.com to start the conversation.

The outlook for healthcare real estate (HRE) in 2026 and beyond is broadly optimistic, though tempered by lingering market and policy uncertainty. Fundamentals remain strong: national occupancy is near 93%, rental rates are rising 3–5% annually depending on market, and construction activity remains below historical norms. With interest rates expected to trend downward in 2026, capital markets activity is likely to accelerate.

Healthcare Industry Overview

Rising Spending Masked by Reimbursement and Labor Pressures

Any assessment of healthcare must account for mounting operational pressures and policy uncertainty, both of which directly influence healthcare systems’ real estate strategies.

Healthcare spending continues to grow at record levels, with total U.S. expenditures estimated at $5.25–$5.3 trillion in 2024—more than 8% annual growth and well above GDP. Spending now represents approximately 18% of GDP and is projected to exceed 20% by 2033. Growth is driven by increased utilization, technological advancements (including AI), and inelastic demand from an aging population. At the same time, rising costs are intensifying concerns around affordability and long-term sustainability.

Labor remains the industry’s largest and most volatile expense, accounting for 50–60% of provider costs. Workforce shortages and intense competition have driven higher wages, signing bonuses, and enhanced benefits. While automation and AI offer long-term potential, the capital required for implementation restrains near-term adoption. Balancing labor costs with quality care will remain one of the industry’s most complex challenges.

Despite historic spending levels, reimbursement uncertainty persists. Hospitals face evolving government policies, shifting payer mixes, value-based care transitions, and rising technology costs—all of which complicate revenue forecasting and long-term planning. As a result, many healthcare systems are taking a conservative approach to real estate decisions, including consolidating into owned facilities, reducing space commitments, or delaying action until greater clarity emerges.

Market Conditions

The same forces shaping healthcare operations are influencing HRE fundamentals. Occupancy and rental rates continue to rise, while new supply remains constrained. These conditions set the stage for tighter markets and increased competition for high-quality assets heading into 2026.

2026 Outlook and Predictions

Limited Availability Will Constrain Expansion

National occupancy climbed to approximately 92.7% in 2025 and is expected to rise further in 2026. In many markets, expansion and relocation options will be limited. Replacement space, where available, will command premium pricing due to surging costs in raw material and construction over the last few years.

Supply Constraints Will Drive Rental Growth

Strong tenant demand combined with modest new deliveries will continue to push rents higher. New clinical developments in markets such as Minneapolis are expected to command $35–$40/SF NNN, with surgical space exceeding $40/SF NNN. Tenant improvement allowances for full buildouts now range from $80–$100/SF representing an increase of $10–$15/SF above pre-pandemic levels. Annual rent growth has moved above 3% and is expected to track inflation, which the FED is forecasting to remain elevated relative to historical norms.

Cost Pressures Force Users to Reconsider Strategy

Healthcare users accustomed to leasing existing space are increasingly experiencing sticker shock as development, leasing, and property tax costs rise. In high-tax markets such as Minneapolis, occupancy costs can squeeze operating margins, prompting users to reassess expansion plans and explore alternative strategies.

Capital Markets Strengthen as Rates Decline

As of December 2025, the Federal Reserve’s target rate stands at 3.50%–3.75%, with expectations for one to two additional cuts in 2026. Cap rates are already compressing, with trophy assets trading in the high-5% range and stabilized outpatient facilities generally between 6.0% and 8%, depending on asset quality and tenant credit.

Further rate cuts should accelerate cap rate compression, particularly for high-quality and credit-backed assets. Credit STNL transactions are expected to trade in the mid-6% cap range, while large portfolio sales may push into the high-5% cap range for the first time since early 2022. Declining bank spreads and more favorable loan terms will further enhance deal economics.

Construction Costs Remain Elevated

Healthcare construction costs continue to outpace other sectors, driven by sustained demand for modern facilities and lingering supply-chain constraints. While slower development activity has eased competition for labor and materials, pricing has yet to meaningfully decline. Absent a broader economic downturn, material reductions in construction costs appear unlikely. Long-term tariff risks—particularly involving steel, concrete, and lumber—could further pressure pricing.

Deal Activity Accelerates

Capital that retreated following the rate spike in 2022 is returning as conditions improve. Owners previously constrained by refinancing challenges are beginning to see relief, and deal velocity is expected to rise through 2026 and 2027. Large portfolios are increasingly coming to market, supported by strong institutional demand and modest cap rate premiums that are once again sufficient to spur activity.

Looking Ahead

Healthcare real estate remains a fundamentally “need-based” asset class, supported by demographic trends, inelastic demand, and the ongoing shift toward outpatient and community-based care. While the healthcare industry faces meaningful operational and reimbursement challenges, these dynamics have not diminished the long-term demand for well-located, high-quality medical facilities.

Rather than serving merely as a defensive allocation, healthcare real estate has matured into a core investment asset—one positioned for sustained relevance and growth as the U.S. population ages and care delivery continues to evolve.

Medical outpatient buildings (MOBs) represent a $500 billion asset class in the US, one that has demonstrated remarkable stability, maintaining occupancy rates between 91-92% over the past 14 years according to Revista’s industry data covering 150 million square feet, and 86.1% tenant retention rate in 2025. These strong fundamentals reflect the unique characteristics of healthcare real estate that differentiate it from conventional office properties. The question for investors is whether their management approach accounts for the specialized requirements that drive these performance metrics. If not, you could be putting your asset, and returns, at risk. In the competitive landscape of healthcare commercial real estate, the difference between a thriving medical building and an underperforming asset often comes down to one critical factor: the strength of your marketing, leasing, and property management team.

As healthcare delivery continues to evolve toward outpatient care models, the role of these specialized professionals has become more vital than ever in ensuring tenant satisfaction, optimizing patient experiences, and maximizing asset value for investors.

Understanding the Healthcare Real Estate Ecosystem

Outpatient medical buildings represent a unique segment of commercial real estate, where traditional property management principles intersect with the specialized needs of healthcare providers and their patients.

Unlike conventional office buildings, medical buildings require teams that understand HIPAA compliance, infection control protocols, specialized infrastructure needs, and the critical importance of operational continuity in healthcare delivery.

The Davis Development, Investment, Brokerage and Property Management teams collaborated to deliver this expansive 3-story MOB in Maplewood, MN. Through the successful execution of this project, HealthEast was able to consolidate various ambulatory clinics into one state-of-the-art medical hub that improved patient satisfaction and organizational efficiencies. Davis quickly completed the lease up to deliver a fully-leased investment asset to its investor partners.

The Marketing and Leasing Advantage

Medical buildings function as healthcare ecosystems where the built environment, tenant mix, and services directly impact individual practice success—a dynamic that makes strategic leasing far more consequential than in traditional commercial real estate. The importance of maintaining full occupancy extends beyond typical landlord concerns about rental income: partially occupied medical buildings create operational challenges that hurt both property performance and tenant success.

For landlords, vacant medical space is particularly costly. Empty suites in medical buildings often require specialized tenant improvements and longer lease-up periods than conventional office space, while partially occupied buildings struggle to achieve the patient volumes that make remaining tenants financially viable.

For tenants, building occupancy levels directly affect practice viability. Medical professionals depend on cross-referrals, shared patient populations, and the convenience factor that draws patients to comprehensive care locations. A half-empty medical building signals market problems to both patients and referring physicians, potentially damaging the reputation and patient flow of remaining tenants. Conversely, fully occupied buildings with complementary practices create environments where patients can access multiple services in one location, benefiting all tenants.

Market Intelligence and Positioning

Healthcare-focused leasing professionals maintain relationships with hospital systems, physician groups, and emerging healthcare delivery models that general commercial brokers typically lack. They understand market dynamics like which specialties face reimbursement pressures, which are expanding, and how regulatory changes affect space requirements. This intelligence enables proactive tenant recruitment and lease structuring that anticipates rather than reacts to market shifts.

The financial impact is reflected in industry fundamentals: medical buildings maintain 91.3% occupancy rates while achieving NOI margins of 66.2%—performance that depends heavily on achieving and maintaining the full occupancy that creates value for both landlords and tenants.

Property Management Excellence in Healthcare Settings

Medical buildings require property management teams that understand healthcare-specific challenges: HIPAA compliance, infection control protocols, specialized infrastructure, and the critical importance of uninterrupted operations for patient care and safety.

Healthcare providers cannot afford operational disruptions. A malfunctioning HVAC system or power outage in a medical building can directly impact patient care. Specialized property management teams implement proactive maintenance programs, maintain relationships with healthcare-certified contractors, and ensure 24/7 responsiveness to critical issues while staying current with healthcare facility regulations, ADA compliance, and infection control standards.

Property management teams that understand healthcare create environments that support both patient experience and tenant operations through effective wayfinding, comfortable common areas, adequate parking, and seamless facility operations.

Long-Term Partnership Benefits

Integrated Team Coordination

The complexity of healthcare real estate requires seamless coordination between leasing and property management teams that goes beyond traditional commercial real estate operations. Unlike conventional office buildings where these functions operate relatively independently, medical buildings demand integrated strategies where leasing decisions directly impact operational requirements and vice versa.

For example, when leasing to a new radiology practice, the property management team must coordinate specialized infrastructure upgrades (lead-lined walls, enhanced electrical systems, reinforced flooring to handle the load, etc) while the leasing team structures tenant improvement allowances and lease terms and language that account for these unique requirements. Similarly, property managers must understand tenant lease terms to anticipate infrastructure needs – a departing surgical center requires different decommissioning and re-leasing preparation than a departing general practitioner, affecting both timeline and capital requirements.

Communication and Market Intelligence Sharing

Property management teams often serve as early warning systems for leasing challenges, identifying tenant financial distress, space utilization changes, or expansion needs before they become formal leasing decisions. Conversely, leasing teams provide market intelligence about emerging healthcare delivery trends, regulatory changes, and competitive dynamics that inform property management’s capital planning and operational strategies.

Tenant Retention and Expansion

Healthcare providers invest significantly in establishing their practices within a building. A responsive, knowledgeable property management team becomes a valued partner in their success, leading to higher tenant retention rates and expansion opportunities within the property.

Conclusion

In healthcare real estate, success is measured not just in financial returns but in the ability to support quality healthcare delivery within the communities we serve. The specialized expertise of dedicated marketing, leasing, and property management teams creates a foundation for this success, driving tenant satisfaction, enhancing patient experiences, and ultimately maximizing asset value for investors.

As the healthcare industry continues its shift toward outpatient care models and value-based delivery systems, the importance of these specialized real estate services will only continue to grow. Investors who recognize this reality and partner with experienced healthcare real estate professionals position themselves for sustained success in this dynamic and essential market sector.

The investment in expert marketing, leasing, and property management isn’t just a cost of doing business, it’s a strategic advantage that creates lasting value for all stakeholders in the healthcare real estate ecosystem.

Client Profile: Bill Kenney, Chief Executive Officer, Dermatology Consultants

Davis has a 15 year plus relationship with Dermatology Consultants. When Bill Kenney joined the group as CEO in 2014, he was well familiar with Davis and particularly Michael Sharpe who he had worked with while both were at Allina. After receiving his MHA degree from the University of Minnesota, Bill worked at Presbyterian Health Services and Northwestern Faculty Foundation Services before joining Park Nicollet and then Allina.  At Allina, Bill served as the President of the Phillips Eye Institute and as Vice President of the United Heart and Vascular Clinic. Below is an excerpt of an exchange Davis had with Bill.

History of Dermatology Consultants

Dermatology Consultants was founded in 1949 by Dr. Harold Ravitz in Saint Paul, Minnesota. Since its inception, the practice has expanded to include suburban locations throughout the east metro area, with clinics now operating in Eagan, Vadnais Heights, Woodbury, and Saint Paul. With a team of 21 board-certified dermatologists and 2 physician assistants, the practice serves over 140,000 patient visits annually.

Dermatology Consultants provides comprehensive dermatologic care, including the diagnosis and treatment of a wide range of skin conditions, specialized skin cancer surgery (Mohs surgery), and cosmetic and aesthetic services at all four locations. Supported by a dedicated staff of 160 employees, the organization remains committed to its mission: “To provide exceptional skin care in a safe and welcoming environment.”

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What Sets Dermatology Consultants Apart

Dermatology Consultants distinguishes itself through consistently high levels of patient satisfaction, timely communication of pathology results, and a strong culture of engagement among both physicians and staff. This is demonstrated by long-standing employee tenure and a history of physician retention. Its facilities have been thoughtfully updated to optimize patient flow and enhance the overall care experience.

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Challenges and Opportunities

As with many independent medical practices, they face ongoing challenges related to rising operational costs—particularly staffing and medical supplies—without corresponding increases in insurance reimbursement rates. To address this, Dermatology Consultants has collaborated with other independent dermatology groups to negotiate improved payer contracts and leverage collective purchasing power. These strategic partnerships have helped strengthen their financial position and preserve their independence.

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Accomplishments

Over the past 11 years, Bill has worked closely with his physicians and leadership team to support and grow the practice. Notably, they completed new construction offices in both Saint Paul and Woodbury and refreshed the Vadnais Heights location to better serve its patient base. Bill also played a key role in physician recruitment and has been proud to lead a seasoned and highly competent leadership team that continues to drive the organization forward.

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Retirement Horizon

Bill’s healthcare career spans five decades, during which he had the privilege of leading organizations committed to delivering high-quality patient care. He and his wife Maggie have thoughtfully prepared for their next chapter and look forward to an active retirement that includes travel, volunteerism, continued teaching and working on their pickleball game (timing not as of yet firmly defined).

Having served as an instructor in the University of Minnesota’s Health Services Management undergraduate program for over a decade, Bill recently developed a course in group practice management, which he will teach alongside the existing healthcare administration and management class. Additionally, he plans to renovate his family cabin in Northern Wisconsin, and will remain active on two community boards.

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Valued Traits in a Service Provider or Partner

The qualities Bill values most in a business partnership are honesty, trust, integrity, and clear communication. These attributes have been consistently demonstrated throughout his relationship with Davis, particularly in his work with Michael Sharpe over the past 11 years.

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How Davis Has Supported Our Business Goals

“Davis has been an outstanding partner in helping us evaluate market opportunities and make informed decisions regarding facility planning and lease negotiations”, said Bill during this interview. “Michael Sharpe possesses not only a deep understanding of the regional market but also a keen awareness of how our physician partners think and make decisions. His expertise has been instrumental in supporting our long-term success.”

The second Trump administration has placed tariffs at the center of its economic strategy, wielding them as instruments to recalibrate trade balances and revitalize domestic manufacturing. This policy shift creates a transformative dynamic for commercial real estate investors, developers, and tenants who must now adapt to an uncertain economic terrain.

Economic Reverberations

The financial strain of tariffs will likely hurt American households’ wallets in the near term, with projections indicating an additional $1,200 in annual expenses for typical families. This belt-tightening translates to upcoming economic headwinds—potentially shaving 0.4 percentage points from GDP growth while simultaneously pushing inflation measures upward. The Fed’s preferred inflation gauge, Core PCE, could hover around 3.1% throughout 2025, significantly overshooting the central bank’s 2% target.

This creates a delicate balancing act for the federal reserve. Should tariff-induced price escalations embed themselves into wage structures, the Federal Reserve might maintain current interest rate levels. Alternatively, if the economy stagnates while price increases prove transitory, the Fed could pivot toward stimulative rate cuts. This monetary policy uncertainty directly influences capital costs for property acquisitions, refinancing, and development projects.

Construction Realities and Development Dynamics

The development sector stands particularly vulnerable to tariff pressures, as construction budgets could swell by 3-5% under a regime of 25% tariffs on North American imports alongside elevated duties on Chinese goods. This cost increase threatens to sideline development projects industry wide across all asset classes.

These supply constraints could create varied outcomes. Initially, property fundamentals might strengthen in markets where new deliveries pause, allowing demand to absorb recent inventory expansions. However, extended development droughts could eventually create supply deficits in sectors already experiencing tight vacancy, particularly in prime office submarkets where flight-to-quality trends continue to drive demand.

Investment Landscape

Despite near-term turbulence, several factors provide underlying support for commercial real estate investment. The dollar’s recent depreciation enhances America’s attractiveness to international capital, while projections for stabilizing or decreasing interest rates—with the 10-year Treasury yield recently slipping under 4%—offer a relatively appealing financing environment.

If the tariff strategy creates a manufacturing renaissance in the US, it could bolster property demand across asset classes in manufacturing focused regions, creating geographic bright spots amid broader uncertainty.

Strategic Positioning

For property investors, the current environment demands strategic deployment of capital. The most exposed industries include those with globally dispersed supply networks, offshore production facilities, and significant stateside revenue generation. Conversely, sectors with minimal imported goods exposure—such as financial services and healthcare operations—stand relatively insulated from direct tariff impacts.

Investors should leverage this transitional period to capitalize on temporarily discounted asset valuations and favorable financing while concentrating portfolios around properties demonstrating tenant stability, pricing resilience, and strong fundamentals. Healthcare real estate continues to be a fundamentally robust asset class, attracting new investors eager to allocate capital to investments that offer greater resilience during economic downturns. The sector benefits from strong, sustained demand for healthcare services, capital-intensive tenancy, and favorable demographic trends, all of which position it for continued growth and stability for decades to come.

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 net rent threshold and in some instances approaching $40 per square foot. When confronted with this reality, many physician groups have elected to forgo 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% in 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.

• Electrical, heating, ventilation 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 an estimated 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 decrease. 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 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, but rather 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 higher-cost environment.

Capital Markets: Navigating Challenges in Healthcare Real Estate

The healthcare real estate sector faces significant challenges due to persistent high interest rates and rising material costs, affecting sales volumes, development approvals, and asset valuations. Despite these obstacles, innovative financing strategies and strong market fundamentals provide optimism for future growth as industry leaders await potential rate cuts by the Federal Reserve.

The healthcare real estate sector is navigating a challenging capital market environment, impacted by high interest rates and rising material costs. The Federal Reserve has maintained the federal funds rate between 5.25% and 5.50% since July 2023, the highest in four decades, with expectations to keep rates at this level through the end of 2024 due to persistent inflation. This has led to a significant decline in sales volume throughout 2023 and into the first quarter of 2024, as higher cap rates have widened the bid-ask gap between buyers and sellers. Consequently, healthcare asset valuations have dropped by 10-20%, causing many sellers to delay their disposition strategies.

Despite these challenges, we have successfully completed acquisitions by partnering with local lenders who offer competitive terms within their areas of expertise. However, this approach has its limitations, as smaller banks have lending caps with individual sponsors, restricting the ability to scale portfolios. To counteract this, we have employed innovative financing strategies and adjusted our capital stack to sustain growth.

On the development front, high debt costs and increased material expenses have resulted in fewer healthcare projects being approved, with many systems and physician groups opting to stay in their current facilities. This has led to higher rents for tenants and a decline in hospital transactions across the U.S., which are still below 2019 levels and are expected to remain low until interest rates stabilize.

Nonetheless, the fundamentals of healthcare real estate remain strong, supported by low vacancy rates, rising demand for healthcare services, and an aging population. In June 2024, both the Bank of Canada and the European Central Bank reduced their benchmark rates by 25 basis points, raising hopes that the Federal Reserve might follow suit over the next year. Such a move could trigger a surge in acquisition and development activity nationwide, given the substantial capital ready to be deployed in the healthcare sector.

Despite challenging economic conditions and continued operational issues for healthcare providers, the medical commercial real estate sector remains a stable and strong asset class.

Revista tracks just over 20M sf of medical buildings in the Twin Cities market area that includes both multi and single tenant buildings. It shows a 93% occupied rate which has continued to hold strong throughout the pandemic and beyond. With higher interest rates, increased construction costs and material delays, we’ve seen increased renewal and expansion leases in existing product as opposed to new leases in new construction recently, which has kept net rates and occupancy up. Revista reports a 17.5% decline in new construction starts and a projected continual slowdown through the 2nd quarter.

A $22/rsf net average rate is reported, which includes some larger single tenant rates and lower rates on challenged assets that lower the overall average rate. We are seeing net rates for multi-tenant Class A space at an average of $24+/sf for existing buildings and $28–$34/sf for new construction. There is an annual increase of between 2.5–3%; this has been increasing due to higher inflation.

Lease terms for new leases remain long, often 10–20 years, so users can secure appropriate space and request high improvement allowances in the $100/sf+ range pending lease term, credit and rate.

Operating expenses continue to increase with rising real estate taxes, cleaning and utility costs averaging another $20/sf over the base rate. Gross rental rates can reach up to $50/sf which can be challenging for a sector pressured with lower reimbursements and high labor/operational costs.

Higher interest rates also slowed sale transactions and kept cap rates higher than historical levels but still in the 6% range for quality assets. However, if we see reductions in interest rates this year as projected, we anticipate increased transaction volume, including the larger REITs.

Medical building fundamentals remain strong compared to the general office market where work-from-home trends have shuttered many office buildings. An aging demographic has supported care closer to home and the desire for outpatient facilities. The healthcare sector has opted to rename the “O” in “MOB” (Medical Office Building) to Medical Outpatient Building, there are enough differentiators to warrant this effort.

With technological advancements and the need for more outpatient care, we forecast a continued strong and stable medical outpatient building sector into the future.

 

Ambulatory surgery centers are not just the future; they are the present. More than 50 percent of all ambulatory surgeries are currently performed in ambulatory surgery centers. The growing gap between outpatient surgeries in a hospital setting and in an ASC will not abate in the foreseeable future due largely to cost factors. Insurance companies believe they can reduce costs in half or more simply by moving surgeries from a hospital to an ASC—the same surgery done in an ASC as a hospital can cost up to 75 percent less. Patients generally prefer the convenience of not having to navigate a hospital campus and being among a much more unhealthy population. Many ASCs offer a specialty focus, providing greater efficiencies for the surgeon. Additionally, surgeons can be investors in ASCs allowing them to capture a portion of the facility fee on top of their professional fee. 

The growth in outpatient surgeries (projected to grow 25 percent over the next 10 years) coupled with the movement of surgeries out of the hospital means that the development of new outpatient surgery centers will continue for the foreseeable future. Just in the past three years, Davis has worked with its clients to develop six ambulatory surgery centers across the Twin Cities. These have included both single-specialty surgery centers and multi-specialty surgery centers. The common denominator has been a desire to develop a state-of-the-art surgery center in suburban locations that are readily accessible and highly visible.

The recently completed Eagan Specialty Center in Eagan is a compelling case study. The surgery center is a joint venture between Midwest ENT and St. Paul Eye Clinic. Having reached capacity at its Woodbury ASC, the two specialty practices explored expanding in Woodbury, developing a new surgery center to accommodate both practices and disbanding the partnership with one practice taking the Woodbury location and the other developing a new surgery center. The partners ultimately decided to develop a second surgery center in partnership because it afforded the greatest opportunity for growth and profitability.

Davis worked with Midwest Surgery Center to identify patient travel patterns, market demographics and competitor locations.  As with all real estate assignments, Davis first identified the ideal ASC location (in contrast to first identifying available options). Eagan offered the preferred demographics and best complimented the Woodbury Surgery Center and the two partner clinic locations. With a focus on Eagan, Davis secured a site that had the requisite visibility and accessibility to the major regional arteries (Davis had to negotiate access easements with the adjacent property owner and the county—these challenges had kept other developers from pursuing the property).

To ensure seamless integration, Midwest Surgery Center enlisted in-house Synergy Architectural Studio for the design of both the shell building and interior ASC. This comprehensive approach allowed the building shell to align with the ASC’s requirements, emphasizing the significance of strategic planning and collaboration in the successful development of a state-of-the-art surgery center.