Vacancy rate for medical office buildings remains stable

Ulf Buchholz

Many medical office parks, such as the Medical Pavilion at Southern Palms on Fort Apache Road near Southern Hills Hospital, have high vacancy rates.

By Buck Wargo

Fri, Nov 20, 2009 (3 a.m.)

The medical office market, even though it is slumping, is outperforming the rest of the local commercial sector because it doesn’t have the same level of distressed properties facing foreclosures, industry analysts said.

CB Richard Ellis reported the average valleywide vacancy rate in the third quarter was 16.5 percent, about the same it has been all year. By contrast, brokerages are reporting that the office market as a whole has approached a vacancy rate of 25 percent.

“It is still challenging,” said Bruce Follmer, a senior associate with CB Richard Ellis. “We are starting to see light at the end of the tunnel, but it is still going to be a tough year.

“Money is tight. Physicians are having the same money ills as a lot of other people.”

In general, many people aren’t spending as much money on elective care as they have in the past, Follmer said. For example, rather than get Lasik surgery, people opt to stay with contact lenses or eyeglasses.

Softer demand has doctors less willing to invest in building or buying a medical building. Financing is already tight, and doctors are required to put down more money to buy or build, Follmer said.

“The banks are working with them, but it’s not like it used to be,” he said.

Soft demand is also lowering rents that building owners can command from doctors and other medical tenants.

Lease rates dropped in the third quarter to $1.77 per square foot, down 9 cents from the second quarter. The high vacancy rate has given tenants bargaining power, with landlords offering more allowances for new tenants to improve the office space, analysts said. They are also offering low or no rent.

“The leasing activity has definitely picked up. It is better than it was a year ago when nothing was happening,” Follmer said. “Guys (are) out there offering great deals that I haven’t seen in 20 years of doing this. We are doing one-and two-year deals.

“Everybody is trying to fill out their building so they can survive. In two or three years, they think things will be back to normal. Right now, physicians are taking advantage of it,” he said.

Building owners are offering at least one month of no rent payment for every year of the lease and, in some cases, as much a year for a five-year lease, Follmer said. In some cases owners are giving tenants whatever improvements they want to get them to move in, he said.

The highest vacancy rate is in the southwest valley at 35 percent, CB Richard Ellis reports. The lowest are in North Las Vegas, 1.1 percent; the central-west valley, 8.6 percent; and west valley, 10.8 percent.

Follmer said the high vacancy rate will ultimately lead to foreclosures for all office space.

“The commercial foreclosures haven’t hit yet,” Follmer said. “We haven’t even come close because most of the banks want to work with their existing clients and don’t want to take (buildings) back. It kills their balance sheets.”

But analysts such as Follmer said medical office space is in a better position than general offices because doctors and medical practices are more stable than other businesses, such as mortgage brokers, which have closed shop.

As a sector, the medical office market has avoided much of the problems of the traditional office market, according to Marcus & Millichap, a research firm. The reason is the number of new health care jobs that are being created.

John Vorsheck, regional general manager of Marcus & Millichap, said the vacancy rate is expected to creep up through early 2010, but the sector is in much better shape than other industries. With an aging population, the need for medical care will grow.

Few medical office buildings have been foreclosed because of that, Vorsheck said. But overbuilding couldn’t be absorbed quickly enough, especially in the southwest valley, he said.

“There was a tremendous amount of speculation in that area,” he said. “It is an unfortunate situation, and a lot of owners are paying for it.”

Properties near hospitals and in high-visibility areas have a better chance to survive, he said.