In these days when the stock market is volatile and the threat of rising interest rates challenges the value of bonds and other fixed income investments, does it make sense for a physician or dentist to own his or her office? In many cases, it does, but always go in with your eyes open. While there can be many benefits, real estate is not a liquid investment and can take time to convert to cash should the need arise. On the other hand, a good property in a favored location can not only enhance your practice, it can provide value and cash flow for years to come and can even be an important item in your estate plan.
In the simplest model, a solo or small group practitioner locates a suitable property, either a stand-alone building or a unit in an office park, usually a condominium. An agreement of sale is negotiated, the property inspected and financing acquired. Closing takes place and now you own your office and are free to set up shop configuring and outfitting the space as you see fit. Typically, you would form an entity (owned by you) whose sole purpose is to hold title to the property. That entity would then, in turn, lease the office to your practice entity. Rent would be paid by the practice as in the past, but instead of it going to an unrelated third party, it now comes to your new entity to pay the mortgage and over time, create equity in the property. The practice expenses the rent and the owning entity (or you as the owner of that entity) has income. As an added bonus, however, the tax laws allow you to take non-cash deductions for depreciation that effectively allow you to offset a portion of that income for tax purposes.
Things become more complicated if you bring in additional partners or purchase a property that includes more space than you plan to occupy and which will be leased to others. These complications include addressing economic and management issues among the partners as well as restrictions on the transfer of ownership interests in the entity owning the building. Many of these are not unlike the succession issues many of you who are in group practices currently deal with at the practice level. Another complication arises with respect to management of the property and leasing risk. Real estate requires care and maintenance. Not only can these things be beyond the expertise of medical professionals, they can be time consuming and either take you away from your practice or infringe on your time for other activities. Fortunately, there are a number of excellent property management companies that can help. Because vacant space costs money but generates no income, finding and keeping tenants is a must. Again, there are many qualified brokers to assist but market forces can sometimes overtake even the best of efforts. Of course, these services, as well as repair and maintenance expenses, cost money and must be taken into consideration in evaluating the investment.
In almost every case, the acquisition of an office property will require financing. Typically, this will come in the form of a mortgage loan from a commercial bank. The borrower will be the entity owning the property and the principal will often be required to provide a personal guaranty. Fortunately, we are presently in a favorable interest rate environment; however, there continues to be upward pressure on rates. Medical and dental professionals are usually considered to be attractive borrowers by most banks. Medical and dental office space are also uses that banks generally view favorably. A bank will generally require a down payment in the 20 – 25% range. But there are alternatives. One is the SBA 504 loan which requires only 10% down with the bank funding 50% and the SBA funding the other 40%. These loans can be especially attractive as the SBA can offer rates that are fixed for as long as 20 years.
The bottom line is that owning the office (or even an office building) in which your practice is housed can be a very attractive and lucrative investment providing income and increased value over a number of years. It can provide welcome diversification to any portfolio. Returns, however, do not come without risk. Fortunately, most of the risks can be quantified and in many cases, managed. Nothing is more important than proper planning and documentation at the outset. This will require an investment of time and money and the recognition that you are making a long-term commitment. Engaging a team experienced in such transactions is crucial. This will include accounting, financial and legal professionals. At Lamb McErlane, we have assisted in many such transactions over the years and are standing by ready, willing and able to consult with you and assist in all aspects of your office acquisition.
Roger N. Huggins is a partner at Lamb McErlane PC. He practices in the areas of Commercial and Real Estate Transactions, Real Estate and Equipment Leasing, Business Law, Finance, Banking and Contracts. His clients include individuals and businesses, ranging from small local businesses, dental and medical professionals to publicly traded corporations, lending institutions and public and private non-profit institutions. firstname.lastname@example.org. 610-701-3276.