Vital Signs December 2023: Healthcare Sector Outlook

VITAL SIGNS

The Healthcare Sector: Leasing Performance Remains Strong Despite Capital Constraints

This time last year, major topics included the budgetary pressures on healthcare systems, the tight labor market and moving beyond pandemic recovery. Now we face greater challenges as well as solutions as healthcare systems continue to face labor constraints and healthcare assets face restrictive equity and debt in the capital markets landscape. Long existing challenges with labor shortages and costs continue to plague the sector, with inflation, short staffing, long hours and contract labor driving healthcare unions to push for new agreements. While talent continues to flow into the sector, particularly as nursing and physician assistant roles grow in popularity, labor will be a continual challenge for the sector in the medium term. 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. Health systems first began to experience this pain last year and it has only become more pointed with an overall slowing economy. In the first half of 2023, Syntellis Performance Solutions reported that operating expenses grew by 8.3%, continuing a post pandemic trend. At the release of our previous edition of Vital Signs, revenues were also down— since the beginning of 2023 they have risen by 12.5%, outpacing expense growth, according to Syntellis. Growing operating revenues from rising patient encounters and outpatient operations recently led Moody’s to upgrade the sector’s rating. Additionally, most pandemic-era federal

and state support funds have expired, adding further stress to hospital operating budgets . As of 2022, the American Hospital Association estimates 33% of hospitals were operating at a negative margin . As this trend is expected to continue in the short term, health systems have been forced to make difficult decisions or delay investment in capital expenditures, new real estate projects and consolidation opportunities. Despite these challenging conditions, there are some silver linings. Healthcare systems have begun to reassess their real estate portfolios to evaluate and consolidate administrative space that may have become underutilized with the adoption of hybrid and remote work. Additionally, healthcare operators, health systems and new entrants in the space have been eyeing well-located but vacant or financially distressed office assets that may be ideal candidates for conversion to clinical uses. In Northern Virginia, for instance, Virginia Hospital Center recently acquired 3601 Eisenhower Blvd., a 145,000-square-foot (sf) traditional office building, for $21.5 million—a 43% discount from what owner Monday Properties had paid for the same asset in 2018 1 . Virginia Hospital Center plans to convert the asset into an ambulatory surgery center and medical office building (MOB). However, this trend will take time to fully manifest, as only a relatively small number of office assets have both an ideal location and adequate infrastructure, including floorplate sizes, for clinical medical uses.

Healthcare systems have begun to reassess their real estate portfolios to evaluate and consolidate administrative space that may have become underutilized with the adoption of hybrid and remote work.

1 Commercial Observer, November 2023: “ Virginia Hospital Center Acquires Alexandria Office Building at Major Price Cut”

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