Stockdale’s Andrew Saba On Medical Real Estate’s Supply-Demand Imbalance

Health care-related property has become one of the commercial real estate industry’s more in-demand niches and safe harbors, and now it’s become one of its more competitive hunting grounds.

Los Angeles-based Stockdale Capital Partners has been building into that demand since launching its open-ended health care fund in 2023. Since then, Stockdale’s health care platform, led by managing director Andrew Saba, has expanded to other markets around the country including Phoenix, Austin, and Fairfax, Va.

The thesis is relatively straightforward: Demand for outpatient care is still rising, the U.S. population is aging, and new supply has become increasingly difficult to deliver. Construction costs, labor expenses and capital markets pressure have pushed projects back or stopped them altogether, all while medical tenants need more space near patients and health systems.

That imbalance has made medical outpatient buildings more attractive to institutional capital, real estate investment trusts and newly formed joint ventures. And Stockdale sees rent growth, strong occupancy, long-term leases and more competition for the best properties.

Commercial Observer spoke with Saba about Stockdale’s national health care strategy, the supply-demand imbalance, and how artificial intelligence could eventually reshape the way health care tenants use space.

The following has been edited for length and clarity.

Commercial Observer: Tell me about Stockdale’s approach and your view of the market and the general fundamentals.

Andrew Saba: High level, the fundamentals of the sector have not changed. We’re seeing a continued demand for outpatient space across the country, and our collective thesis is that that will be bolstered by the aging population that’s currently in place and is expected to peak over the next four to six years.

Stockdale launched an open-ended health care fund about three years ago and has expanded across the country. Can you talk about how the strategy has evolved, or has it just been growing since then?

We target health care real estate through both of our funds — our dedicated health care fund, and then also an opportunistic fund.  

The profiles of assets are very distinct as we’re thinking about the various different executions. The majority of what we’re targeting in our opportunistic fund are more of what I call buy-to-suit, where we would acquire a building for a client, or heavier office-to-medical conversion, where it just needs a complete repositioning of the asset.

That’s versus our health care fund, which is targeting more stabilized or semi-stabilized existing health care assets that either need some slight lease-up or value-add through capital improvement or otherwise. But just two very different profiles.  

We’re now looking nationally across both of those vehicles for opportunities. I would say generally we’re targeting the top 50 metro areas, with a preference for where we’ve seen a lot of patient migration — predominantly throughout the Sun Belt and West/Southwest U.S. markets.

What percentage would you say of your business is office-to-medical conversion?

It’s certainly a smaller portion of it. The majority of our efforts are focused on the health care-dedicated fund. Those opportunistic assets are harder to come by, and certainly harder to have conviction in, just given that it’s just a much riskier business plan.

We still see opportunities throughout the U.S. Frankly, because of all the demand and the interest in the sector, there’s increasing competition from our peers and colleagues for all types and kinds of assets. And so we’re definitely seeing that, especially so in the last five to six months here.

That’s great. Or maybe it’s not if you don’t want so much more competition?

Right. Selfishly, it cuts both ways, right? It’s great because all that does is help improve the valuation of some of our existing assets, just given that there’s such a demand and appetite for the sector. But at the same time, it makes buying a little bit more difficult.

You talked about it at the start, but the strategy or the thesis is largely based on what a lot of people are looking at with the aging baby boomer population, and just the number of patients needing space?

Yes, and it’s anchored in the fairly inelastic demand for health care. It tends to be pretty high priority when certain medical maladies are continuing to plague the various different patient populations. So, generally speaking, people will forgo all kinds of other elective purchases to prioritize their own health. The majority of every person’s health care spend, roughly 60 percent of it happens after 65 years old.

The commercial real estate market in general is seeing such declining construction activity. Is that playing a role in this sector as well? And can talk about how that’s playing a part in supply–demand balance?

This sector has not been insulated from rising construction costs. A lot of materials and labor cost increases have pushed projects, as we say, to the right, or deferred them, and what we’ve seen over the last eight to 12 quarters is decreasing construction deliveries.

At the same time, you have an increasing demand for outpatient space. And, so, if you look at some of the Revista data, what they’re tracking is across the U.S. you’re seeing occupancies push well into the mid-90s [percent], retention is hovering around the upper 80s, low 90s, and there’s frankly just not a lot of places for people to go.

And some folks have posited that office assets that are just deemed obsolescent now are great candidates for conversion. But medical generally isn’t going to be enough to satisfy the needs of an office project that’s beyond, say, 80,000 to 100,000 feet.

So as you think about some of these 400,000- to 500,000-plus-square-foot office buildings, there’s not too many markets where it would make sense to try to convert that to medical — unless there was just an absolute tremendous amount of pent-up demand. And, even then, the asset needs to meet the requirements in terms of having the parking and the infrastructure and the deck-to-deck heights to accommodate what health care is looking for today.

Does that help push rents up for your existing places?

Yes, we are seeing rental rate increases across the country, generally. Because health care tenants sign longer-term leases, you’re not necessarily seeing that immediately reflected in the national data. And a lot of that is because you’ll sign a lease with a doctor from 2020 to 2024, and in all likelihood it’s at least five years, in most cases seven to 10 years, and in some cases even longer. 

So you’re not really going to see that true mark-to-market for several years to come, because those are fixed-rate increases in most cases.

Are there a lot of institutional funds and capital now kind of chasing medical office and health care?

Absolutely. From `23 through, I would say, the latter part of `25, pretty much all of the REITs were more or less quiet and/or on the sell side, whereas today we’re starting to see some of the REIT activity entering the buy space again.

Despite some of them looking to dispose assets selectively, it seems as though now they’re starting to participate in processes. And, then, over the course of the last five to 10 years, you’ve seen a lot more institutional capital come in, and, combined with the REITs now approaching the buy side again, we’re now also seeing institutional capital move into the space — some from groups that were historically capital allocators working with operators somewhat akin to us. 

You’ve also had no less than eight to 10 newly formed joint ventures nationwide that are all targeting fairly similarly stabilized or semi-stabilized health care real estate. 

So you’ve got a dearth of product being built, you’ve got an existing supply, and then more than 50 to 60 percent of medical outpatient buildings are actually still on the balance sheets of hospitals. It sets up an interesting dynamic where there’s actually a bit of a battle for these assets, especially the really good ones.

You’re seeing these processes solicit offers from anywhere north of 12 to 15 buyers, and potentially more.

How do you think this is going to play out for the market in general over the next 18 months or three years?

Historically, the sector has traded at a relative premium to the 10-year Treasury. And, with a few exceptions when there was near-term volatility in the Treasuries, we’ve observed, call it, a 170- to 200-basis-point premium to the 10-year Treasury for where the core assets are trading.  

And, when I say that, I just mean a long-term, fully leased asset that has long-duration leases in place at acquisition. So those deals were typically trading 1.7 percent to 2 percent wider on the entry purchase price than the commensurate 10-year bond pricing.

Obviously, in today’s elevated rate environment, we’re seeing pricing get even more aggressive for assets across the continuum of risk profile, from core all the way through opportunistic, as a result of the capital chasing deals and, frankly, just the lack of deals to be had. 

So I think that that is likely to continue, especially as you think about a construction pipeline that’s still a little bit muted relative to where it was leading up to and in the early phases of the pandemic, and obviously where it is today relative to the demand for that space.

Interestingly, a lot of that development is system-driven, and the space that’s being delivered is more or less spoken for, or at least materially pre-leased. Because, for the sector itself, it’s very rare that developers will build speculatively. So, they’re building to meet demand that is in the pipeline. 

So, any potential unmet medical user demand that’s there, it’s all getting solved by the construction pipeline that’s currently getting delivered.

How does AI play into these models for medical real estate?

I was actually just reading an interview with a gentleman named Eric Larson, who was a long-term health care consultant with a group called the Advisory. He’s since broken off and formed his own firm. He published a paper that talks about disruption in the health care space. It’s not specific to the real estate. But I think as we glean takeaways from that, how I think about it is: We’re likely to see a reduction in the need for administrative space.

As we think about traditional office build-outs, especially with non-health system tenants, there’s usually a provision for administrative — both patient-facing as well as billing and collections behind the scenes — and I think those spaces are likely to be repurposed for additional clinical uses, which ultimately is good. That will help satisfy the unmet patient demand, because it’ll just increase clinical throughput.

And, there’s like a multitude of different tasks that I think AI will help alleviate some of the burden of in the sector. I don’t know about you, but presently it takes me anywhere from one to two months to get in to see any specialist or primary care provider. Think about that in the face of having a pressing issue. Anything that can improve clinical throughputs to allow that timeframe to shrink, I think, will actually just help improve clinical outcomes for patients.

And when I think about what AI is actually capable of, we’re literally just scratching the surface. In the U.S., patient data is, frankly, very difficult to come by and hard to work with. There are a few groups that control a tremendous amount of the patient data and information in the country, and they have the ability to extract insights about their own patients that would be very helpful as you think about having a machine that has access to essentially perfect medical data and legacy knowledge across infinite case files and studies. 

So, being able to reference all of that and then look at the symptoms that a certain patient is presented with and synthesize that across the whole realm of history within an instant. I think it’s exciting, and we’re just at the forefront of that.

Gregory Cornfield can be reached at gcornfield@commercialobserver.com.