By most accounts, the medical office sector has been a star of commercial real estate. It has been holding up better than the rest during the downturn and it outperformed most other areas of the commercial real estate sector during the good times.
The property type isn’t bulletproof, though, especially in Orange County.
“We’ve hung in there, but it’s not totally immune,” said John Wadsworth, vice president for the healthcare properties division of brokerage Colliers International.
Colliers data released this month show OC’s medical office market, which totals about 7.8 million square feet, to have ended the second quarter with a vacancy rate of 12%.
That’s up from about 10% vacancy at the beginning of 2008 and 11.2% at the start of 2009—although well below the roughly 20% vacancy rate seen for OC’s office market at large.
Much of the empty space is in new developments that have yet to be leased up, particularly in Irvine, according to Wadsworth.
In total, close to half a million square feet of medical office properties has been built in OC in the past two years, according to brokerage data.
About eight new for-sale and for-lease projects, totaling 350,000 square feet of space, were built in Irvine alone during the past two years, according to Wadsworth.
Irvine “was recklessly overbuilt” in the past couple years, he said.
Roughly 250,000 square feet of that Irvine space has yet to be filled. Irvine’s medical office market is now about 25% vacant.
There are signs that there’s more pain to be felt in the market before the end of the year.
Medical office markets across California were already beginning to weaken prior to the recession, “but the intensity has increased measurably over the past few months,” according to a report released this month by Marcus & Millichap Real Estate Investment Services Inc.
The brokerage is expecting vacancy rates in OC’s medical office market to creep up at a slower pace into next year.
Troubled Assets
Whether that translates into more medical office properties going back to lenders—as has happened to the office market in general—remains to be seen.
Medical office space is the commercial real estate sector with the smallest amount of troubled assets nationally, according to New York-based Real Capital Analytics Inc.
About 1% of the national medical office market is troubled, with those distressed buildings worth less than $250 million, according to the research company’s data. That’s well below the $18 billion of distressed assets in the office market at large.
A few of those troubled assets are in OC.
Most notably, Irvine Medical Arts LP, owner of a three-story medical office building in the Irvine Spectrum, filed for Chapter 11 bankruptcy in June.
Irvine Medical Arts’ 63,000-square-foot property, near Hoag Memorial Hospital Presbyterian and Kaiser Permanente’s Irvine hospital, opened its doors last year. It was built by Lake Forest-based Enterprise Commercial Development Inc., which did not file for bankruptcy protection itself.
The bankruptcy petition, filed in state court in Santa Ana, listed estimates of $10 million to $50 million for assets and liabilities.
Corona-based Vineyard National Bancorp held a $22 million loan on the property at the time of the filing and was the building’s largest debt holder.
Vineyard’s has had its own problems since then. Its assets were taken over by California Bank & Trust, a unit of Zions Bancorporation, last month after being seized by regulators.
That’s added another level of complexity to the Irvine Medical Arts property as well as two other newly built medical office properties in Irvine that Vineyard was believed to have invested in.
The 40,638-square-foot Von Karman Medical Center and the 48,282-square-foot Canyon Medical Plaza, on Laguna Canyon Road, are both said to be facing financial issues.
It might take a month or two for California Bank & Trust to figure out what to do with the medical office properties it now has in its hands, according to market watchers.
Lawyers representing Irvine Medical Arts said they plan to engage California Bank & Trust after the Vineyard takeover concerning a consensual resolution to the case.
More recently built medical office properties in Irvine could face similar issues if the slow market for sales and leases continues, according to brokers.
Sales of local medical office buildings often topped $450 per square foot for much of 2008. Among larger deals, pricing topped out at the $26.3 million for the Garden Grove Medical Plaza, which traded for $481 per square foot, according to Marcus & Millichap.
Deals have been slower to come by this year. Sales of medical offices across the county are down nearly 75% from a year ago, according to local brokerage data.
Many doctors are waiting until the healthcare reform makes its way through Congress before committing to any new offices.
“Not only is the market concerned about the recession, there’s a second layer (of concern) with regards to healthcare reform,” said Wadsworth. “The good news is that there will be a vote after (Congress’) recess is up. Until then, there’s not a lot of movement.”
