Small-City Outpatient Buildings Rally Amid Office Slump

Changing demographics and high borrowing costs are driving rent growth in the outpatient medical office sector, even as sales activity slows and new construction lags. According to a new report from Colliers, the capital-intensive nature of outpatient medical facilities, combined with elevated borrowing costs, is pushing rents up in markets across the country, particularly in midsize cities.

Colliers found that the vacancy rate for medical outpatient facilities is around 7.5% nationally, while the broader office sector’s vacancy rate reached 17.5% at the end of June.

The report highlights that midsize cities have been the biggest winners in terms of rent growth for the subsector over the last 12 months. Des Moines, Grand Rapids, and Myrtle Beach saw the largest year-over-year rent increases at 9.6%, 6.1%, and 6.0%, respectively. Still, average rent growth across all markets rose by 2.2%, with Boston and Miami seeing increases of 2.9% and 3.7%, respectively.

Aaron Jodka, Colliers’ director of U.S. capital markets research, attributed the rent growth to rising development costs. He noted that, on a per-square-foot basis, medical development costs reached $528 at the end of June, while construction costs on hospital campuses can be as high as $1,000.

“The cost of occupancy for tenants is high, as medical users tend to invest substantial capital into their space, increasing their probability of renewal,” Jodka said. “This trend is particularly evident in medical facilities, where tenants’ investments in their spaces reduce turnover. Combined with construction costs limiting new groundbreakings, the recipe for continued rent growth is in place.”

Colliers also found that the four largest markets for medical outpatient facilities in the U.S. outpaced the national average rent growth in 2023. However, construction starts fell by 44.8% last year, with only 10.8 million square feet of new space delivered. Currently, approximately 31.9 million square feet of new space is under construction.

While rents are rising in midsize and large cities, the medical outpatient subsector continues to face challenges in terms of sales activity. Colliers reported that total sales volume decreased from $19.1 billion in 2022 to $7.36 billion in 2023. Cap rates for the subsector also rose by 80 basis points, reaching 6.7% this year.