Medical office buildings (MOBs) offer stable cash flow with long-term leases and reliable tenants backed by healthcare demand that’s immune to economic cycles.
Why Medical Office Buildings Outperform
According to the National Association of Real Estate Investment Trusts (Nareit), medical office buildings have:
- Average cap rates: 6-8%
- Occupancy rates: 92%+ (highest of all commercial)
- Lease terms: 7-10 years (vs. 3-5 for traditional office)
- Tenant credit quality: Excellent (medical practices rarely fail)
Demographic tailwind: According to the U.S. Census Bureau, 10,000 Americans turn 65 daily, driving healthcare demand through 2030.
Types of Medical Office Properties
Type 1: On-Campus MOB
Location: Adjacent to hospital campus Tenants: Hospital-affiliated physicians, outpatient services Lease structure: Often hospital master lease (strongest credit)
Advantages:
- Highest quality tenants
- Lowest vacancy (hospital sends referrals)
- Premium rents (15-25% above off-campus)
- Easier financing
Disadvantages:
- Higher purchase price ($250-350 per sq ft)
- Hospital may have right of first refusal
- Competition limited (controlled by hospital)
Disadvantages:
- Higher purchase price ($250-350 per sq ft)
- Hospital may have right of first refusal
- Competition limited (controlled by hospital)
Typical deal:
- 30,000 sq ft building
- Purchase: $8.5M ($283/sq ft)
- Cap rate: 6.5%
- Lease: 10-year hospital master lease
- Rent: $28/sq ft triple net
Type 2: Off-Campus Multi-Tenant MOB
Location: Near residential areas, high visibility Tenants: Mix of specialists (ortho, cardio, dermatology, dental) Lease structure: Individual practice leases
Advantages:
- Lower acquisition cost ($150-220 per sq ft)
- Rent growth potential (staggered lease expirations)
- More available properties
Disadvantages:
- More management intensive
- Higher tenant turnover risk
- Tenant improvement costs
Typical deal:
- 25,000 sq ft building
- Purchase: $4.5M ($180/sq ft)
- Cap rate: 7.5%
- 8 tenants (average 3,000 sq ft each)
- Average lease: 7 years
- Rent: $24/sq ft NNN (net, net, net)
Type 3: Single-Tenant MOB
Location: Varies Tenant: Single large practice (20+ providers) Lease structure: Long-term absolute net lease
Advantages:
- Simplest management (one tenant)
- Strong credit (established practices)
- Low cap rates (5.5-7%)
Disadvantages:
- Single tenant risk (if they leave, 100% vacant)
- Less rent growth (long-term fixed lease)
- Lower returns
Market Selection Criteria
Best markets for medical office (per CBRE Healthcare):
Growth markets:
- Phoenix, AZ – Retiree migration
- Dallas-Fort Worth, TX – Population growth
- Tampa-St. Petersburg, FL – Aging population
- Nashville, TN – Healthcare hub
- Raleigh-Durham, NC – Research triangle healthcare
Key metrics to evaluate:
- Population 65+: Growing faster than 2%/year
- Household income: $75k+ median
- Hospital proximity: Within 3 miles of major hospital
- Competitors: Under 20,000 medical office sq ft per 1,000 residents
Understanding Medical Office Leases
Lease structures:
1. Gross Lease:
- Tenant pays flat rent
- Landlord pays all operating expenses
- Less common in medical office
2. Modified Gross:
- Base year established
- Tenant pays increases above base year
- Common in multi-tenant buildings
3. Triple Net (NNN):
- Tenant pays rent + all expenses (taxes, insurance, CAM)
- Most common in single-tenant MOBs
- Landlord has minimal expense risk
Typical lease terms:
- Term: 7-10 years
- Rent increases: 2-3% annually
- Renewal options: 2-3 five-year options
- Tenant improvements: $30-60 per sq ft (landlord paid)
- Free rent: 3-6 months for buildout
Example lease economics:
- 5,000 sq ft cardiology practice
- Base rent: $25/sq ft NNN = $125,000/year
- 3% annual increases
- 10-year term with two 5-year options
- Tenant improvement allowance: $200,000 ($40/sq ft)
Tenant Improvement Considerations
Medical tenants require specialized buildouts:
Common requirements:
- Plumbing for exam rooms ($10-20k per room)
- HVAC upgrades (medical-grade filtration)
- Medical gas systems (oxygen, vacuum)
- Lead-lined walls (for X-ray rooms)
- Specialized electrical (imaging equipment)
- ADA compliance (wider doors, accessible restrooms)
Costs:
- Standard medical office: $50-80 per sq ft
- Surgical/imaging suites: $100-150 per sq ft
- Dental offices: $80-120 per sq ft
Amortization: Built into rent over lease term (landlord recovers cost)
Due Diligence for Medical Office
Essential investigations:
□ Zoning verification: Confirm medical use allowed □ Environmental Phase I: Required by all lenders □ ADA compliance audit: $2,000-5,000, identifies violations □ Rent roll verification: Contact tenants directly □ Insurance requirements: Medical malpractice exposure □ Parking analysis: Medical office needs 4-5 spaces per 1,000 sq ft □ Certificate of Occupancy: Verify square footage □ Review all leases: Personal guarantees? Assignment rights?
Financing Medical Office Buildings
Loan options:
- CMBS loan: 25-30% down, 7-8%, for $2M+
- Bank portfolio loan: 30% down, 7.5-8.5%, relationship-based
- SBA 504: 10% down, for owner-occupied medical practice
Lender underwriting focus:
- Rent roll stability (prefer leases with 3+ years remaining)
- Tenant diversity (no single tenant over 30% of income)
- Location (prefer on-campus or near major hospital)
- Property condition (deferred maintenance = higher rate)
According to Commercial Mortgage Alert, medical office has lowest default rate of commercial real estate at 0.8%.
Tax Benefits of Medical Office
Depreciation:
- Building: 39 years
- Land improvements: 15 years
- Tenant improvements: Over lease term or 15 years
Bonus depreciation: Cost segregation typically identifies 20-25% of building for accelerated depreciation
1031 Exchange: Medical office to medical office is common strategy for upgrading portfolio
Exit Strategies
Typical hold period: 7-10 years
Exit options:
1. Sale to REIT: Medical REITs actively acquire (Healthpeak Properties, Physicians Realty Trust) Target: Stabilized assets with strong credit tenants
2. Sale to private investor: Strong buyer pool (individual investors, family offices) Medical office seen as “bond alternative”
3. 1031 into larger property: Use equity to upgrade to better location or larger building
Historical appreciation: 3-4% annually (per Green Street Advisors)
The Bottom Line
Medical office best for:
- Conservative investors seeking stability
- Those with $1M+ to invest
- Long-term hold strategy (7-10 years)
- Desire for passive income
Returns to expect:
- Cash-on-cash: 8-10%
- Total return (with appreciation): 10-13%
- Cap rates: 6-8%
