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Space in county's medical office market limited

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San Diego County's medical office building (MOB) market, which had some bumps during the recession, has seen its vacancy slip slightly below the 10 percent level for the first time in years.

Commercial real estate firm JLL (NYSE: JLL) reported while Class B-minus and C buildings have continued to suffer, Class A and B-plus properties reap the benefits.

"Class A vacancy has been cut in half over the past two years, dropping from 13.3 percent at the end of [fourth quarter] 2012 down to 6.6 percent today," JLL said in a report.

JLL reported that with the MOB vacancy out of the double digits, investment properties have recently traded for as much as $729-per-square-foot, and unique owner-user properties have reached upwards of $500-600-per-square-foot.

"Comps in this range are limited to very specific properties and submarkets, the point being that acquisition and occupancy costs are breaking new barriers," JLL wrote, adding that Class A medical office rents in well-located properties have reached as high as $4 per square foot.

The countywide average asking rate is now at $2.54 per square foot, up 2.7 percent from 12 months ago.

The report said as the evolving health care environment becomes more competitive, providers are placing a higher value on visibility, space functionality and aesthetics.

"A growing number of physician groups are forging new partnerships and strategic relationships, allowing them to gain economies of scale," the JLL report added. "Additionally, these new relationships often allow practices to consolidate into larger and more efficient space with reduced overhead per provider while improving the patient experience through a more appealing environment for care."

JLL reported more than half the nine submarkets in San Diego are in single-digit vacancy, and most of the others will follow suit within the next 12 months.

"Consistent leasing activity and overall growth in the health care industry will lead to new highs in rental rates and sale prices in most areas by 2016," the report concluded.

The Escondido/San Marcos medical office submarket has seen both its Class A and B spaces tighten.

JLL said Palomar Health, which saw a bond rating decline in connection with the financing of its new medical center, has since satisfied rating agencies that its bonds are healthier now.

The Tri-City area of Oceanside, Vista and Carlsbad is recovering gradually, JLL stated.

Tri-City Medical Center took back the Class A 57,000-square-foot MOB at the entrance to its Oceanside campus through eminent domain last fall.

The building is expected to be put back on the market this spring for lease to private practices.

A submarket that includes La Jolla and University Towne Centre remains tight, with climbing rents. In fact, almost all the Class A and B-plus buildings are full.

A significant medical office complex now being developed at the Scripps Health La Jolla campus is a six-story, 175,000-square-foot MOB slated for a 2016 delivery.

"Some owners have lifted rents by 15-20 percent almost overnight in response to the uptick in leasing activity -- most of which is attributable to the continued growth of the Scripps and UCSD hospitals," the report added.

Jacobs Medical Center, a 10-story $839 million hospital, is under construction on the La Jolla campus of UC San Diego Medical Center, which recently celebrated reaching a $131 million fundraising goal. The 245-bed facility is scheduled to open July 2016.

Interstate 15’s three multi-tenant Class A MOBs -- 4S Health Center in 4S Ranch, Pinnacle Medical Plaza in Scripps Ranch and Pomerado Outpatient Pavilion in Poway -- have just 2,700 square feet of vacancy.

"Class B buildings should follow suit over the next couple years," JLL added.

"As the population and employment base grow, so too will its demand for space near the hospital (Pomerado) and in the high-growth areas such as 4S Ranch," the report added.

JLL reported that further south, the Frost Street buildings and other MOBs in Kearny Mesa "have been slower to experience the improving market conditions than the neighboring submarket of UTC to the north and even Hillcrest to the south," despite the presence of Sharp Memorial Hospital and Rady Children's Hospital.

JLL said those two major institutions should prevent Kearny Mesa's medical office market from being down for long, however.

Kaiser Permanente is in the midst of construction for its new $900 million, 450-bed hospital campus on Ruffin Road in Kearny Mesa. Completion is slated for 2017.

Vacancy has been flat in Kearny Mesa/Mission Valley submarket, but rents have started trending upward, and as medical groups and diagnostic providers affiliated with hospitals continue to add physicians and services.

JLL said the average vacancy in Kearny Mesa/Mission Valley will likely fall to the 8 percent range within 12 to 18 months.

East County is the county's largest submarket for medical office space, but it also has numerous aging buildings.

"The largest submarket in the county is never going to show a rapid change in vacancy and rental rates without the occurrence of a major event such as a hospital closure, but the steady population growth of East County and the lack of new development is starting to gradually bring the area’s medical buildings back to good health," JLL continued.

The problem for South County hospitals is with a lower percentage of paying customers, they are essentially kept afloat by other hospitals in their respective health systems.

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