DST.EDU Series B- Asset Classification Discussion  Medical Office

Editor’s note- this is part nine of a ten-part series on the var­i­ous asset types of DST offer­ings.

Delaware Statu­to­ry Trusts (DSTs) con­tin­ue to gain in pop­u­lar­i­ty among cash investors and 1031 tax deferred exchange investors. Investors seek­ing diver­si­fi­ca­tion may include Med­ical Office Build­ings (MOB) in their port­fo­lio.  

Part 9: Med­ical Office Build­ing Asset Clas­si­fi­ca­tion Dis­cus­sion

April 28, 2024
Orig­i­nal post-June 23, 2022

By Al DiNi­co­la, AIF®. CEPA™
DST 1031 Spe­cial­ist
NAMCOA® — Naples Asset Man­age­ment Com­pa­ny®, LLC
Secu­ri­ties offered through MSC-BD, LLC, Mem­ber of FINRA/SIPC

The need for med­ical ser­vices con­tin­ues through­out the Unit­ed States. Large and medi­um hos­pi­tals ser­vice the needs of a vast num­ber of the pop­u­la­tion. Most of the invest­ment would be focused on the small­er med­ical facil­i­ties that han­dle out­pa­tient ser­vices that do not require an overnight stay. There are a vari­ety of out­pa­tient ser­vices that include kid­ney cen­ters, surgery cen­ters, ortho­pe­dic offices and many more.  There has been growth in many areas of the coun­try and not just in south­ern states where many retirees tend to relo­cate. The per­for­mance of this asset class has been con­sis­tent.   The MOBs may be sin­gle site offer­ing or there may be a port­fo­lio of loca­tions in an offer­ing.  Spe­cif­ic per­for­mance of the MOBs asset class may be hard to zero in on  because many MOB have been includ­ed in the over­all office asset class. Some typ­i­cal office asset class offer­ings may have con­cerns for occu­pan­cy with the abil­i­ty for employ­ees to work from home. How­ev­er, the MOB require full staffing to han­dle the grow­ing needs of patient ser­vices.  The MOB pro­vides med­ical pro­fes­sion­als facil­i­ties to han­dle the vari­ety of needs of patients includ­ing surgery cen­ters.  When the facil­i­ties are pro­fes­sion­al­ly man­aged physi­cians and med­ical spe­cial­ists can focus on the needs of the patient. Invest­ing in DST as well as MOB are not for every­one. How­ev­er, there are rea­sons to con­sid­er invest­ing in the asset class.  Based on the vari­ety of med­ical ser­vices, pro­ce­dures and require­ments of the pop­u­la­tion of the US, the med­ical office asset class may be worth con­sid­er­ing.

Strong His­tor­i­cal Per­for­mance
There has been a steady growth of the med­ical real estate space when com­pared with the gen­er­al office space. In addi­tion, long-term occu­pan­cy rates in MOB have steadi­ly increased when com­pared to oth­er office spaces. Accord­ing to the CBRE 2024 Health­care Real Estate Investor & Devel­op­er Sur­vey Results, invest­ment vol­ume increased by 15% quar­ter over quar­ter Q4 2023 to $2.0 bil­lion, bring­ing the full-year total to $7.1 bil­lion.  That is for the sec­tor and not what has been invest­ed in DSTs. Metro areas like Los Ange­les, Wash­ing­ton, DC, and Atlanta may top the mar­kets. How­ev­er, there are pock­ets of areas through­out the US where migra­tion has increased the need for MOB. Each geo­graph­ic area has their own unique demo­graph­ics sup­port­ing the invest­ment.

When you vis­it a med­ical office build­ing you may be aware of the amount of equip­ment that has been installed and oth­er spe­cial­ty build-out com­po­nents. The fea­tures of cer­tain build­outs include not only the wait­ing room and offices but all high-tech test­ing devis­es, mon­i­tors, plumb­ing needs, oper­at­ing rooms, recov­ery rooms, spe­cial wiring for elec­tron­ics, spe­cial­ty gas­es and many more fea­tures. With all these ten­ant improve­ments it is easy to under­stand ten­ants stay­ing longer than tra­di­tion­al office renters who may be run­ning a busi­ness such as a law firm.  There would be a tremen­dous cost involved with mov­ing equip­ment and switch­ing to a new loca­tion. For this and oth­er rea­sons there is a sta­ble occu­pan­cy rate for MOBs and have demon­strat­ed con­sis­tent rent growth over the past years. This sta­bil­i­ty has also enabled land­lords to increase the dol­lar per square foot rents.

DST spon­sors rec­og­nize Investor Demand
DST spon­sors rec­og­nize the strength of the MOBs his­tor­i­cal per­for­mance over the past few years.  Espe­cial­ly in the sun belts (south­west and south­east US) where there is an expan­sion of the med­ical office asset class. For this rea­son, spon­sors are seek­ing oppor­tu­ni­ties to offer cash investors as well as 1031 exchange investors qual­i­ty offer­ings.  How­ev­er, the task of bring­ing on offer­ings is more dif­fi­cult than you would imag­ine.  There is com­pe­ti­tion for the assets of insti­tu­tion­al investors and pri­vate investors. There are more REIT offer­ings than DST offer­ings.

Even dur­ing the Great Reces­sion, the med­ical office build­ing sec­tor demon­strat­ed resis­tance to the mar­ket slow­down.  This may have pro­vid­ed an indi­ca­tion of how the asset class would per­form in future turn­downs as well as the COVID pan­dem­ic.  The resilience to a down­turn and the per­for­mance of the MOB drove the increase in investor inter­est.

Out­pa­tient Loca­tions
Many Amer­i­cans have expe­ri­enced tak­ing some­one to an out­pa­tient cen­ter or going your­self.  The inno­va­tions in tech­nol­o­gy and effi­cien­cies in surgery cen­ters pro­vide excep­tion­al care and results for patients. There are also sev­er­al oth­er spe­cial­ty ser­vices such as kid­ney dial­y­sis cen­ters, ortho­pe­dic cen­ters and a vari­ety of oth­er facil­i­ties.  Num­bers of out­pa­tient cen­ters con­tin­ue to increase and do not show any signs of slow­ing down. The ratio­nale for the increase may be con­nect­ed to the patient look­ing for more access to health­care (poten­tial­ly being more afford­able) and con­ve­nient loca­tions.  The tra­di­tion­al “in hos­pi­tal” loca­tions tend to be more expen­sive and by patients uti­liz­ing out­pa­tient cen­ters it may reduce the patients’ out of pock­et expens­es.

MOBs Asset Class may be reces­sion resis­tant.
COVID 19 accel­er­at­ed the vir­tu­al or tele­health alter­na­tive to the tra­di­tion­al office vis­it. How­ev­er, as well exe­cut­ed this new tech­nol­o­gy per­formed this type of online med­i­cine is not an accept­able sub­sti­tu­tion for tra­di­tion­al med­ical ser­vices.  The use of tele­health also prompts oth­er ques­tions such as what is the long-term effi­cien­cies, qual­i­ty and safe­ty not to men­tion all the in per­son needs such as lab work, x‑rays, and phys­i­cal exams. As with any new tech­nol­o­gy the med­ical pro­fes­sion­als need to mon­i­tor the effec­tive­ness for the safe­ty and health of the patients. Not to be over­looked would be the COVID-relat­ed elec­tive surgery cen­ters being closed.

Ten­ant Cred­i­bil­i­ty & Respon­si­bil­i­ty
In a DSTs there will be a mas­ter lease that reflects under­ly­ing cred­i­bil­i­ty and cred­it wor­thi­ness of the ten­ant occu­py­ing the space. The ten­ant may occu­py a sin­gle site loca­tion or may have mul­ti­ple loca­tions in a port­fo­lio. In many MOBs, includ­ing DST offer­ing, the ten­ant typ­i­cal­ly enters into a triple net lease (NNN). This lim­its the investor expo­sure to esca­la­tion of expens­es.  The secure dis­tri­b­u­tions may not have as much upside elas­tic­i­ty but will offer con­sis­tent returns.  The Pri­vate Place­ment Mem­o­ran­dum (PPM) that all DST investors need to receive pri­or to invest­ing will lay­out many aspects of the offer­ing includ­ing the poten­tial risks asso­ci­at­ed with the invest­ment.  Also, the back­ground of the ten­ant leas­ing the space, terms of the lease, rental increas­es and oth­er analy­sis would be illus­trat­ed.

Poten­tial Dis­tri­b­u­tions & Exit Strate­gies
 The PPM would also illus­trate the pro­ject­ed annu­al dis­tri­b­u­tion (typ­i­cal­ly paid month­ly) and the exit strat­e­gy for the poten­tial sale of the asset. The exit strat­e­gy as with oth­er DST offer­ings include receiv­ing poten­tial pro­ceeds from the sale (at which time the investor would be respon­si­ble for their cap­i­tal gains tax­es to be paid), exe­cute anoth­er 1031 into DST offer­ings, or exe­cute anoth­er 1031 into a tra­di­tion­al brick and mor­tar real estate.  Recent­ly some spon­sors have intro­duced an alter­na­tive in a 721 UPREIT. Details on the IRS 721 will be fea­tured in future arti­cles.

DSTs are not for all investors. The acqui­si­tion of a DST is for accred­it­ed investors only. Con­tact your invest­ment advis­er for addi­tion­al details on how a DST may be a solu­tion to your 1031 Exchange and suit­ed for your invest­ment future. For more infor­ma­tion on how to prop­er­ly set up an IRC 1031Tax Deferred Exchange or if you are an accred­it­ed investor and would like addi­tion­al infor­ma­tion on a DST con­tact Al DiNi­co­la at 239–691-8098 or email adinicola@namcoa.com.

This is not an offer to pur­chase or solic­i­ta­tion to pur­chase any secu­ri­ty, as such be made only through an offer­ing mem­o­ran­dum or prospec­tus. Invest­ing in secu­ri­ties, real estate, or any invest­ment, whether pub­lic or pri­vate, involves risk, includ­ing but not lim­it­ed to the poten­tial of los­ing some or all of your invest­ment dol­lars when you invest in secu­ri­ties. You should review any planned finan­cial trans­ac­tions that may have tax or legal impli­ca­tions with your per­son­al tax or legal advi­sor. NAMCOA, LLC is a Reg­is­tered Invest­ment Advi­sor, reg­u­lat­ed by SEC (Secu­ri­ties and Exchange Com­mis­sion).

NAMCOA’s cor­po­rate office is locat­ed at 999 Van­der­bilt Beach Road, Suite 200, Naples Flori­da 34108. Secu­ri­ties Offered through MSC-BD, LLC, Mem­ber of FINRA/SIPC. 8215 SW Tualatin ‑Sher­wood Rd, Suite 200 Tualatin, OR 97062. MSC-BD, LLC and NAMCOA are inde­pen­dent­ly owned and are not affil­i­at­ed.

Thank you.

NAMCOA® — Naples Asset Man­age­ment Com­pa­ny®, LLC