Vital Signs 2022

VITAL SIGNS

Vital Signs 2022: Perspectives on Healthcare and Medical Office Buildings

VITAL SIGNS

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VITAL SIGNS 2022: PERSPECTIVES ON HEALTHCARE AND MEDICAL OFFICE BUILDINGS

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VITAL SIGNS

The Healthcare Sector: Moving Beyond the Pandemic and Meeting the Challenges of 2022

This time last year, the healthcare industry was in recovery mode—attempting to make up for lost healthcare spending and revitalize the workforce that was experiencing pandemic-fueled burnout. While consumer spending in the sector has been revived, there are still long-term issues affecting the healthcare clinical workforce, most notably a growing labor shortage, as well as a rise in inflation and shifting sites of care—all of which are expected to affect growth and performance of healthcare commercial real estate. Impacts of tight labor markets, inflation and rising supply chain costs have had an acute effect on the expenses of hospitals and health systems around the country. In 2022, health systems have reported a 37% increase of median labor expenses per discharge as compared to pre-pandemic expenses

in 2019, according to The Advisory Board. Not only have expenses risen for health systems, but revenue also has declined because of drops in inpatient visits, discharges and billable operating minutes. Additionally, most pandemic-era federal and state support funds have since expired, adding further stress to hospital operating budgets. As of 2022, the American Hospital Association estimates 33% of hospitals are operating at a negative margin. As this trend is expected to continue in the short term, health systems will likely be forced to make difficult decisions regarding capital expenditures, including investment in new real estate projects, as well as consider further consolidation opportunities. Despite these challenging conditions, there are some silver linings. In 2022, 92% of health systems report that utilization volumes are now within 5% of pre

Impacts of tight labor markets, inflation and rising supply chain costs have had an acute effect on the expenses of hospitals and health systems around the country.

VITAL SIGNS 2022: PERSPECTIVES ON HEALTHCARE AND MEDICAL OFFICE BUILDINGS

U.S. Healthcare Spending: Historical & Projected

8M

7M

6M

5M

4M

3M

2M

1M

Healthcare Spending in $Ms

M

2012

2018

2016

2014

2010

2022

2028

2026

2024

2002

2020

2030

2008

2006

2004

2000

Year

Source: CMS, Cushman & Wakefield Research

pandemic levels, according to The Advisory Board. Elective surgeries and other procedures delayed due to the pandemic have been the driver of patient encounters this year. Many of these procedures are now conducted at outpatient facilities, which have experienced substantial growth in the wake of the pandemic. In spite of these headwinds, the overall healthcare sector is also supported by robust secular drivers, as overall healthcare spending is expected continue to expand with a growing population entering the 65-and-older age cohort. This demographic tailwind, along with delayed and deferred demand for continuous care and elective procedures in the wake of the pandemic, likely will buoy medical office through recent market turmoil.

U.S. Population by Age

5.0

4.5

4.0

3.5

3.0

2.5

2.0

Millions of Persons (U.S.)

1.5

1.0

20 25 30 35 40 45 50 55 60 65 70 75

Age

Source: U.S. Census Bureau, Cushman & Wakefield

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VITAL SIGNS

Patient Volumes Rise Across Outpatient Specialties, While Inpatient Volumes Have Been Mixed

The point of care delivery for patients has changed, as many have begun to seek a variety of treatments at outpatient clinics. Historically, outpatient facilities were viewed as options for minimally invasive procedures. Now, patients increasingly seek the convenience and flexibility of outpatient clinics that may be closer and more convenient to where they live and work. The Advisory Board has forecasted that total inpatient volumes are expected to dip slightly— by negative 1.1% over the 2021–2026 timeframe—

while outpatient volumes are expected to grow by a robust 7.3% in the same time span. Inpatient volume decline is forecasted to be driven by losses in orthopedics, obstetrics, oncology and spinal specialties. While outpatient volume is net positive across specialties, the big winners are projected to be psychiatry, spine, orthopedics, vascular and cardiology. Clearly from this trend, outpatient operations are expected to capture some market share of procedures once deemed “inpatient” at health systems.

Five-Year Growth Outlook Favors Ambulatory Providers

Inpatient Volume Growth, 2021-2026 Advisory Board’s Market Scenario Planner

Outpatient Volume Growth, 2021-2026 Advisory Board’s Market Scenario Planner

Overall

Overall

-1.1%

7.3%

Cardiology

8.3%

Cardiac Services

1.2%

Vascular

12.1%

General Medicine

2.1%

E&M

6.0%

General Surgery

-0.8%

General Surgery

1.7%

Neurosurgery

9.3%

Oncology

2.9%

Oncology

-3.4%

Orthopedics

10.0%

Spine

-2.3%

Spine

11.6%

Orthopedics

-5.7%

Radiology

4.1%

Obstetrics

-4.9%

Psychiatry

18.7%

-8%

2%

12%

-10% -5% 0% 5% 10% 15%

Source: Revista Med, RCA, Cushman & Wakefield Research

Source: Revista Med, RCA, Cushman & Wakefield Research

VITAL SIGNS 2022: PERSPECTIVES ON HEALTHCARE AND MEDICAL OFFICE BUILDINGS

Hospital Budgets Under Stress: Inflation, Supply Chain and Declining Revenue

Although there are few areas of the economy on which inflation has not had a dramatic impact, its arrival to healthcare was delayed—but its effects are already being felt. Per-enrollee spending within private health insurance plans dropped just a half of a percent in 2020 before rising 5.5% in 2021 and continuing to rise thereafter. Further increases are projected for 2022 and 2023 at 8.3% and 7.2%, respectively. Per-enrollee Medicare and Medicaid spending both have similar projections: Medicare is projected to jump 5.1% in 2022 and 3.3% in 2023, while Medicaid is projected to increase 6.7% in 2022 and 6% in 2023. Out-of pocket health care spending dropped by 3.7% in 2021. Projections show it jumping 4.6% in 2022 and 6.1% in 2023. While hospitals are experiencing the effects of inflation on multiple fronts, they have experienced them acutely within their supply chains. For both pharmaceuticals and general supply, expenses had already grown substantially during the 2020-2021 pandemic time period. The American Hospital Association estimated that during that time, drug expenses grew by 36.9% and supply costs increased by 20.6%. Since then, expenses have increased noticeably.

Healthcare real estate operations have also seen increased costs, attributable to supply chain bottlenecks and increased staffing costs across various building service providers. In general, medical office buildings saw expense growth hit a record high in Q1 2022. While revenues were also growing, revenue growth since has slowed and been outpaced with growth in expenses. In terms of healthcare systems specifically, revenues have experienced an even more turbulent year— with decreases across the board. Discharges, inpatient minutes and operating minutes all decreased as a result of higher numbers of patients with more acute sicknesses and smaller available labor pools to treat them. As with medical office buildings, hospitals have experienced some slowing in the growth of expenses over September and October. However, this slowdown has been insufficient to counteract the decreases in revenue, likely driving many health systems to reevaluate critical decisions regarding any future large scale expenditures—including in their real estate portfolios.

Healthcare real estate operations have also seen increased costs, attributable to supply chain bottlenecks and increased staffing costs across various building service providers.

Revenue & Expense Trends for Medical Office Buildings

6.0%

5.0%

4.0%

3.0%

2.0%

1.0%

0.0%

2017 Q1

2021 Q1

2018 Q1

2016 Q1

2019 Q1

2022 Q1

2017 Q3

2021 Q3

2018 Q3

2016 Q3

2019 Q3

2020 Q1

2022 Q3

2020 Q3

NOI Growth

Revenue Growth

Expense Growth

Source: Revista Med, Cushman & Wakefield Research

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VITAL SIGNS

Challenges to the Healthcare Labor Pool: Shortages Across Talent & Geography Nearly 1.5 million healthcare jobs were lost during the first two months of the pandemic as clinics were temporarily closed and non-emergency services were restricted or postponed. Though many jobs have since returned, healthcare employment remains below pre-pandemic levels, down 1.1% or 176,000 fewer workers, according to the U.S. Bureau of Labor Statistics. This decrease will continue, as the number of retirement-age physicians will almost double from the current 12% to 21% by 2026. States in the Northeast, including Maine, Rhode Island, Vermont and New Jersey are expected to feel this strain more acutely. In addition, 29 states will not be able to keep up with demand for nurses over the next five years, as more than 900,000 are expected to permanently leave the profession. Pennsylvania and North Carolina are expected to be hit the hardest by this shortage. However, 21 southern states, including Georgia, Florida and Texas, are expected to see a surplus in health care talent as a result of strong demographic growth across the Sun Belt. Currently, 9.7 million people work in lower-paying healthcare-sector jobs, including home health aide positions, the need for which will continue to rise over the next five years. But at the current rate, more than 6.5 million workers will vacate those positions, and fewer than 2 million will fill those roles. California and New York are expected to suffer the greatest hits, with each of the two states projected to lose a half million members of the workforce by 2026.

VITAL SIGNS 2022: PERSPECTIVES ON HEALTHCARE AND MEDICAL OFFICE BUILDINGS

Update On the Medical Office Building Sector

Leasing Markets After occupancies had slightly fallen off into 2020, there has

Occupancy Trends in Medical Office Buildings

93.0%

been noticeable growth. Currently, occupancy for US MOBs is 92% in Q3 2022, remaining largely flat for the year so far. Leasing activity has increasingly moved to higher-quality assets in the medical office space. This trend has not been unique to medical office, as other asset types also have experienced leasing activity concentrated among trophy assets in the wake of the pandemic. However, leasing momentum has generally continued with some tenants seeking to lock in longer term leases in new buildings to mitigate potential inflationary risk.

92.5%

92.0%

91.5%

91.0%

90.5%

2017 Q1

2021 Q1

2015 Q1

2018 Q1

2016 Q1

2019 Q1

2022 Q1

2017 Q3

2021 Q3

2015 Q3

2018 Q3

2016 Q3

2019 Q3

2020 Q1

2022 Q3

2020 Q3

Quarterly Weighted Avg Occupancy

2015 - 2021 Avg Occupancy

Source: Revista Med, Cushman & Wakefield Research

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VITAL SIGNS

Medical Office Buildings: Capital Markets Update Despite costs of capital generally increasing and investors being more cautious when it comes to acquisitions, the number of total transactions in 2022 has remained strong as medical office buildings are seen as safe-haven asset types for investors to reallocate their portfolios. As predicted in Vital Signs 2021, volumes continued to increase into 2022. At face value, the transaction volume of Q3 2022 was more than 30% higher

as well as leasing and property management services to over 30 million square feet in the United States. Removing this merger and the associated commercial real estate acquisitions, the total sales volume during Q3 2022 was $2.6 billion, or a nearly 50% drop from Q3 2021. The impact of rising interest rates and the inability of medical office buildings to keep pace with inflationary expense growth will continue to have a cooling effect on transaction volumes going forward into Q4 2022 and the new year. However, this is a temporary and recoverable impact as inflationary pressures lessen. Q1 and Q2 volumes were markedly higher than their 2021 counterparts, as the impact of inflation and interest rates had not yet fully impacted capital markets.

than in Q3 2021, at $7.2 billion as compared to $5 billion. This increase was heavily influenced by the merger of Healthcare Trust of America (HTA) and Healthcare Realty Trust (HRT) in July 2022. The merger resulted in a combined entity with over 700 healthcare real estate properties totaling approximately 44 million square feet,

Medical Office Buildings: Transaction Volume by Quarter ($B)

$12 B

$10 B

$8 B

$6 B

$4 B

$2 B

$ B

2017 Q1

2021 Q1

2015 Q1

2018 Q1

2019 Q1

2016 Q1

2022 Q1

2017 Q3

2021 Q3

2015 Q3

2018 Q3

2019 Q3

2016 Q3

2020 Q1

2022 Q3

2020 Q3

MOB Hospital

Source: Revista Med, Cushman & Wakefield Research

VITAL SIGNS 2022: PERSPECTIVES ON HEALTHCARE AND MEDICAL OFFICE BUILDINGS

MOB cap rates, which had in recent years compressed at a greater rate than other asset types such as office, reached a low point of a 5.5% national median in Q1 2022. As of Q3 2022, cap rates have increased to 6.00%. This rise is due, in part, to the increased cost and limited availability of debt, but it is also a reflection of the composition of deals that were brought to market. Owners of stabilized core holdings were more likely to hold rather than sell into a declining market. Not surprisingly, a larger percentage of core plus and value-add transactions raised the median cap rate by 50 basis points in just 6 months. Like many asset types, buyer pools for MOB have been constrained by lack of available debt. To some extent, Q3 2022 metrics are still representative of deal environments during Q1 and Q2, as many Q3 deals were awarded during this time span. Looking forward to Q4, further cap rate inflation is possible as rate hikes, recession concerns and geopolitical conflicts continue to affect pricing.

Cap rates for medical office buildings, which had fallen to a low of 5.5% at the beginning of 2022 have risen to 6.0%

Medical Office Cap Rates vs. Cost of Debt, Spread

8.0%

6.7%

7.0%

6.1%

6.0%

5.5%

6.0%

5.0%

5.3%

5.2%

4.0%

3.0%

2.0%

1.0%

0.0%

2021 Q1

2018 Q1

2019 Q1

2021 Q2

2022 Q1

2021 Q3

2018 Q2

2018 Q3

2019 Q2

2019 Q3

2021 Q4

2018 Q4

2020 Q1

2019 Q4

2022 Q2

2022 Q3

2020 Q2

2020 Q3

2020 Q4

Spread

Upper 25th Percentile

Median

Source: Revista Med, Cushman & Wakefield Research, RCA

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VITAL SIGNS

Consolidation Grows in the Face of Growing Pressure This year saw further consolidation in the healthcare provider space, as several notable retailers have made significant investments into primary care providers. Perhaps the most notable was Amazon’s purchase of One Medical for $3.9 billion. The purchase will enable Amazon to enter the primary care space with One Medical’s 188 sites across 29 different markets, offering fast and flexible service close to major office and residential areas. CVS also has expanded the offerings of their pharmacies to offer more primary care services. CVS’s partnership with Aetna plans to convert portions of CVS retail outlets to medical office under the branding of HealthHUB—combining this with the shuttering of 900 stores to drive traffic to key locations. “Payviders,” or insurers/payers providing direct healthcare through their own clinical teams, have been a growing phenomenon. UnitedHealthcare’s Optum Health vertical announced plans to acquire several smaller clinical entities, including Atrius Health and Kelsey-Seybold Clinic, in order to expand scale of clinical sites. The partnership also seeks to acquire service providers such as Change Healthcare and LHC to expand the planned offerings. As pressures continues on health systems and larger-scale offerings for certain specialties such as primary care and urgent care grow, we can expect further M&A activity going into 2023.

Perhaps the most notable was Amazon’s purchase of One Medical for $3.9 billion.

VITAL SIGNS 2022: PERSPECTIVES ON HEALTHCARE AND MEDICAL OFFICE BUILDINGS

Conclusion: Opportunities for Medical Office

In the face of past economic headwinds, the healthcare industry has been noticeably resilient. Through today’s economic turmoil, we can expect rising demand for care nationwide—providing opportunities for investors and occupiers who are able to manage costs and offer services that match patient demographics and diagnosed needs. In 2022, patients returned for further care, and healthcare spending has begun to rise again. Patients will continue to need further care due to deferrals from the pandemic. Diagnoses are expected to be more acute as a result of deferred and delayed care and correspondingly, may require greater treatment and intervention. There are also rays of light when it comes to the future of the healthcare sector’s path out of the dual challenges of labor shortages and rising expenses across the board. Contract labor, such as travel nurses, have been once the source of rising labor costs for health systems as they seek to cover labor shortages. But some health systems have begun to reduce their dependency on contract labor. For example, HCA Healthcare reduced its contract labor spend by 19% in the third quarter, according to The Advisory Board. Other major avenues of cost reduction identified in The Advisory Board’s 2022 survey have included

outsourcing of ancillary personnel (accounting, IT, facility work) and the increasing adoption of automation technologies, such as self-registration kiosks, robotic automated processes and artificial intelligence. The talent pipeline also has begun to grow, with the likelihood of more available caregivers over the coming years. AAMC data has shown that the number of applicants for medical school has grown consistently over the past decade, with 2021 reaching a record 62,553 applicants, a 17.8% increase from the previous year. While applicants fell somewhat in 2022, they remain higher than both 2020 and pre-pandemic metrics. Likewise, applicant numbers for nurse practitioner and physician assistant programs have been growing too. Ultimately, the challenges that the healthcare sector currently faces are opening opportunities for both healthcare providers, who can devise novel strategies to address the immense and growing need for care in the nation and healthcare real estate investors who can navigate the cross currents of the capital markets, limited medical office building stock, and continued evolution in the manner and location of care delivery.

AAMC data has shown that the number of applicants for medical school has grown consistently over the past decade, with 2021 reaching a record 62,553 applicants, a 17.8% increase from the previous year.

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VITAL SIGNS

Contributors Lorie Damon

About Cushman & Wakefield Cushman & Wakefield (NYSE: CWK) is a leading global real estate services firm that delivers exceptional value for real estate occupiers and owners. Cushman & Wakefield is among the largest real estate services firms with approximately 50,000 employees in over 400 offices and approximately 60 countries. In 2021, the firm had revenue of $9.4 billion across core services of property, facilities and project management, leasing, capital markets, and valuation and other services. To learn more, visit www.cushmanwakefield.com or follow @CushWake on Twitter.

Executive Managing Director, Healthcare Advisory Practice lorie.damon@cushwake.com Jacob Albers Research Manager jacob.albers@cushwake.com

© 2022 Cushman & Wakefield. All rights reserved. The information contained within this report is gathered from multiple sources believed to be reliable. The information may contain errors or omissions and is presented without any warranty or representations as to its accuracy.