Investing In Medical Office Space ________________
Given recent worldwide events, it is no surprise that interest in medical office buildings
(MOBs) has increased significantly. The formerly niche product has moved front
and center as multifamily yields have compressed in recent years and the current retail and
broader office investment landscapes have seen a large scale disruption related to the
ongoing COVID-19 issue.
What Is Medical Office Space? ________________
Simply, a medical office asset is an office building that is used for medical purposes
(but you probably could have guessed that). More specifically, a medical office building
can range from a 1200 sq ft dentist’s office in an older converted home to a modern hospital
complex measured in the millions of square feet.
Where you focus your time will naturally depend on the market you are in, the type of tenant
you like to serve, and the v. As with most asset classes, if you prefer to invest in
institutional grade real estate but don’t have the net worth to do it alone there are
other options you can look into.
Why Medical Office Is A Strong Investment ________________
Stability Of Tenants One clear benefit to medical office tenants
is the relative stability they can offer. Compared with an average office tenant, particularly
with those in smaller markets or facilities, doctors and dentists are often higher income
professionals. That doesn’t mean that they will never default on their leases, after
all a doctor is a person and you need to vet them like you would any tenant. Beyond personality
specific issues, there is general business risk, and certainly much has been made about
the climbing levels of debt required to enter the medical field.
That rising debt and general expense of doing business has led to a trend of practitioners
joining larger practices as opposed to branching out on their own. That type of organization
could be a single location, a regional chain, or a national corporation. As with most tenants,
the larger the organization, the better the credit from a bank’s point of view, and
that can make your debt profile pretty attractive. An additional benefit of a medical tenant
is longevity. Similar to a retailer, most medical office building tenants serve a local
community through a physical presence. Once they have selected a site and built a loyal
following it would require a severe change in circumstances to warrant a move. Medical
offices can also be expensive to fit out, making existing facilities additionally “sticky”
for the tenants. Time will tell how much the rise of telemedicine
is able to disrupt this need for a physical presence, but I expect we still have a long
way to go before a majority of medical or dental visits and procedures can be done over
the internet. Financing Candidates
As described above, the relative financial strength of tenants and their stability of
location can make them ideal candidates for financing real estate. In my ongoing discussions
with commercial mortgage brokers, medical office is one of the few assets that is still
attracting strong debt investment from CMBS and life companies alike.
One of the best day one operating deals I acquired on behalf of a family office was
a newer (less than 5 years old) fully occupied class A medical office building just outside
a major market. Because the sellers were a partnership of several practices and also
the majority tenants (not an uncommon occurrence for practitioners looking for an investment
return - see our earlier blog post about purchasing the real estate for your own business), they
were willing to negotiate extensions to their leases in order to get the price they wanted.
By extending and staggering the leases prior to close, we were able to attain long term
debt at full leverage and a low rate. The spread between the cap rate and the debt meant
that we were able to purchase a performing and well built asset at a 16% operating return
day one. Potential Tax Benefits
I am not an accountant, and I am not going to do a write up of the 2017 tax code (as
always, please consult your own CPA!), but one provision of the tax code seems to present
a massive benefit to owners of medical office assets: the increase of accelerated depreciation.
In discussing various asset classes with a cost segregation provider a few months ago,
he felt that on the average a medical office asset would be able to shift a larger share
of its assets forward than other asset classes. In some instances, up to 25% would be possible.
In this theoretical case, a purchaser of real estate could purchase an asset with 25% equity
and a 75% loan. By doing a cost segregation on the asset, the purchaser may be able to
effectively take a year 1 loss equivalent to contributed capital. That is a big paper
loss to help offset gains elsewhere in a portfolio. Of course, all individual circumstances are
different and all properties are different, so I would encourage you to speak not just
to your CPA but also a cost segregation provider about what they are currently seeing.
One Caveat With Medical Office Space - Management ________________
While I wrote this post to highlight some of the benefits to purchasing a medical office
asset, I did want to call attention to one “negative” aspect. Proper management of
any asset is critical to its success as an investment, but I believe this is especially
true in medical office. For a small investor used to leasing traditional
office space, finding qualified medical tenants isn’t as simple as putting up a Craigslist
post, and once you do find one, larger regional and national will often have a complex bureaucratic
system to navigate. Additionally, the longer lease terms and in depth build specifications
can also make an error more costly to the owner.
So, Should You Invest In Medical Office Buildings? ________________
As medical office buildings continue to rise in prominence as an asset class, I think it
is important for all real estate investors to consider its potential role within a portfolio.
Certainly the recent market dynamics have highlighted the benefits of having tenants
likely to be deemed “essential” by both governments and their customers. Coming out
of this COVID era, I expect the key investment points of relatively stable tenants and attractive
financing to remain for the long term. Tax rules are always going to be less fixed
than underlying fundamentals, so I encourage all investors to find and keep a good real
estate CPA and cost segregation expert on their teams.