Hi, @Paul Moore, @Sherman K sawhney, @Kenny Ware - below are the considerations the DST broker highlighted to me. I was under a time pressure to complete my 1031x with a relatively small boot, so I chose to work with a broker who had a relationship with the sponsor with a track record, performed the due diligence and could answer my questions vs. doing my due diligence directly with the sponsor. Also, given this was my first DST, I wanted the guidance and legwork from the broker.
From the broker:
As I mentioned in my earlier email, their DSTs are not scrutinized by an independent third party broker, so it is incumbent upon the investor (you) to perform their own due diligence.
One thing to look at is the creditworthiness of the tenant. The rent projections are only worthwhile if the tenant can be counted on to pay the rent every month. Unless I am mistaken, Atrium and MedCost are health insurance providers and this DST would be their headquarters. Therefore, it appears in this instance that the building is not a medical office building for providing medical services but rather an office building housing the corporate headquarters for a health insurance company. A medical office providing essential services (such as a dialysis center) is a trustworthy source of income - even during a pandemic like we are in now - because they generate revenues by providing services that people must have or else they could die. The risk in that model is the possibility that the entire population of people who need those services (or at least a substantial portion of that population) might be wiped out by the pandemic such that the medical service provider no longer had enough patients to service. But the "healthcare" DST that you are considering does not appear to fit that model. That building is not built to provide medical services, and that tenant does not provide them. That tenant generates revenues by receiving insurance premiums in excess of the medical claims it pays out. The risk in this model is that the pandemic takes hold of the population and spreads at a rate that causes claims to exceed premiums. In that event, the tenant may default on their contract to pay their rent. So you ought to look into the creditworthiness of the tenant. What is their current profit margin? How much cash do they have in reserve? How long could they continue to pay rent if they stopped being profitable?
Another important factor which a broker-dealer would examine, and which you would do well to investigate, is how much time is left on the underlying lease. One colleague I spoke with said that he had discovered a healthcare DST sponsor who sold directly to investors (like this arrangement, although he couldn’t remember for sure whether it was this sponsor you are considering) who was able to project higher returns for investors by buying properties where there were not many years left on the underlying lease. The value of the same property with the same tenant will vary greatly depending on the length of the lease term. Assuming for a moment that the tenant is rock solid (which I explained above is something that you should look into), a lease with 20 years left on it is going to be very valuable because it translates into 20 years of dependable income. However, the same property and tenant with only 3 years left on the lease is going to sell for a fraction of that amount because it represents only 3 years of dependable income, after which there are questions (risks) which have yet to be answered. Will that tenant renew? Who has the leverage in renewal negotiations? If the underlying lease could expire during your projected hold period for the DST, it is possible that you could have a building with no tenant and thus no rent collection and no monthly disbursements. If the lease is set to expire within a handful (say, less than 10) years after your hold period, there is a risk that you will not get adequate value for the property upon the sale and exit from the DST investment. The reason for this is that the buyer will want a significant discount on the property to compensate for the risk that the tenant might leave. You should also consider that every office lease renewal is questionable now that companies have restructured their operations to allow more people to work from home. Corporations will no longer need the same amount of office space going forward, now that the model for working remotely has been proven. Any corporation who can downsize their office space and does not do so will be doing a disservice to their shareholders.
Tenant creditworthiness and lease term are two of the major factors which a broker-dealer examines on behalf of the investor. Since you don’t have that advantage in this instance, I would encourage you to look into those factors yourself and consider the risks. The sponsor should give you any information you request, inlcluding copies of the underlying lease and related documents. Hopefully, you will have a tenant with stellar credit and solid financials, who also has a business plan that accounts for the possibility of claims spiking in a pandemic, and who is locked into a long-term lease. In that event, it would seem more likely that you will hit the projections.
