Aging U.S. Population Expected to Drive Demand for Medical Office Space

In July of this year, the current economic expansion will become the longest in U.S. history. As economists speculate over how much longer the current cycle may last, real estate investors are probably busy hedging their bets by searching for defensive investments that offer higher yields, and medical office space could be just what the doctor ordered.

Driven by an aging U.S. population, within 10 years the amount of medical office space needed is projected to be 16 percent more than today, based on current trends. That’s greater than the combined medical office space in New York, Los Angeles, Chicago, and Dallas–Fort Worth, the nation’s four largest medical office markets.

This undeniable demographic trend in the U.S. is both a headwind for traditional office demand and an incredible tailwind for medical office demand in the coming years.

The aging U.S. population is likely to be the source of unprecedented healthcare spending over the next decade. The average healthcare expenditure per year for the 65-and-older population is $6,620, nearly double the average for the rest of the population ($3,400), according to the U.S. Bureau of Labor Statistics.

This age group’s need for medical services, and therefore medical space, is also reflected in the average number of visits to office-based physicians per year. With a greater need for treatment of chronic health conditions, the 65-and-older population averages 6.6 visits per year, while the rest of the population averages just 2.5 visits per year, according to a 2015 report by the National Center for Health Statistics, a division of the Centers for Disease Control and Prevention.

The U.S. population is forecast to grow by 22.9 million people over the next decade (7 percent cumulative growth.) Based on the total population and total medical office square feet in CoStar-tracked markets, the average amount of current medical office space per person is 5.3 square feet.

However, this does not reflect the outsized need for medical services — and by extension, medical office space — created by the aging population. Over the same 10-year period, the 65-and-older population in the U.S. will increase by more than 17.7 million people (34 percent cumulative growth.)

Based on the ratios observed in the number of visits to office-based physicians, it is estimated this age group will require 11.2 square feet of medical office space per person, more than twice that of the total population.

As such, the additional medical office demand generated by this age group alone is estimated to be 197 million square feet. Using the same methodology for all age groups, the total medical office space that needs to be added over the next decade is just over 208 million square feet.

The medical office sector has always benefited from the stability of its main employment driver, ambulatory healthcare services, which has never experienced negative year-over-year growth, even during economic downturns.

Furthermore, healthcare spending, another driver of medical office demand, has experienced strong growth this cycle. The nation’s health expenditure per year has grown at an average annual rate of 4.3 percent since 2010, according to the Centers for Medicare & Medicaid Services, compared to 1.7 percent inflation.

These compelling trends would appear to ensure strong future demand and make medical office a solid defensive investment to cushion the impact of the next downturn.

Risks to Medical Office Demand

While demographic trends are working in favor of future demand for this property sector, there are several risks investors should consider.

1. Retail Siphoning Medical Office Demand: One risk that CoStar has been tracking is the share of medical tenants that are leasing space in non-medical office buildings. One property type that appears to be gaining favor with medical tenants is retail space, which now houses 14.6 percent of medical office tenants, up from 13.9 percent in 2010.

It is important to note that the population-based projection of 208 million square feet already takes into account a share of demand going to non-medical office properties. However, medical office demand could be at risk if there is a significant increase in the share of medical tenants that lease space in retail or other non-medical office properties.

2. Enough Medical Workers to Go Around: While the U.S. population appears to require more medical office space as it ages, leasing that space requires sufficient healthcare companies and workers available to lease the space as tenants. In CoStar-tracked markets, there is currently 218 square feet of medical office space for every ambulatory healthcare services employee.

Over the next 10 years, this employment sector is projected to add more than 1.3 million jobs, which translates to 288 million square feet, holding the ratio constant. Nearly 40 percent more than the population-based projection of 208 million square feet, owners of medical office may find lease-up to be even faster than expected.

However, there are two trends that could hold back medical office demand somewhat. First, the U.S. is facing a significant shortage of physicians to keep up with this projected medical care demand. According to the Association of American Medical Colleges, the nation will likely be short between 40,000 and 120,000 physicians by 2030.

While the forecast for ambulatory health care services is factoring in this trend, there is a risk that the forecast is overly optimistic. It is also possible that medical practitioners improve efficiencies, out of necessity or innovation, allowing them to serve more patients with the same amount of medical space, thereby lowering overall demand for physical space.

3. Changes to Healthcare Policy: Healthcare spending is tied to healthcare policy, and healthcare policy is always exposed to political changes. As such, a repeal or scale back of the Affordable Care Act would likely reduce the number of people insured, and consequently, the average amount of spend per person.

Though investors should be aware of ongoing news in the industry, the key driver of future medical office demand, the 65-and-older population, should remain near-fully insured due to its eligibility for health insurance under Medicare. As was observed when the Affordable Care Act was passed, changes to the law should have a minimal impact on healthcare spending for this age group.

The aging U.S. population is expected to be a fundamental driver of medical office demand in the coming years. Vacancies in this sector are relatively low, at just 8.6 percent, and construction has remained in check over the current economic cycle. Average investment yields in this property sector are favorable, at 7.3 percent, compared to 6.6 percent for total office investment, as of 2018.

Investor appetite for medical office seems to be increasing, as sales volume reached an all-time high in 2018 and a number of large medical office portfolios recently traded . At this point in the cycle, the demand prospects and muted supply pipeline in the medical office sector make it an appealing option for most real estate portfolios.

Kevin Cody is a consultant for CoStar Market Analytics .