Handling Real Estate As A Practice Seller
Handling Real Estate As A Practice Seller
Most conversations during a practice transition are centered around the practice itself, and rightfully so. The productivity, profitability, and stability of a practice determine whether a transaction is feasible or fundable. Sometimes, the real estate negotiations can feel like the tail wagging the dog. However, there is a genuine need for discussions regarding how to handle real estate properly. I would like to emphasize the importance of working with a practice broker who is also a licensed real estate agent/broker because there are so many factors to consider and you should always be able to make an informed decision just like you strive to help patients/clients make informed decisions in your practice. Your options start to vary depending on if you own or lease your current office space, so we’ll discuss strategies from both vantage points.
Preparing Your Practice For A Sale – Real Estate
A quick call-back to our last blog titled “Preparing Your Practice For A Sale”. In section 4 of Overhead Control it’s mentioned that it’s important to pay yourself a market rate rent if you own the building. While it may not save you money in tax liability, what paying yourself a market rent does is it shows the true cash flow of your office for a buyer. A buyer will either be paying a mortgage or paying you rent. If you don’t pay yourself rent, they will need to calculate how much of your “cash flow” they will lose to real estate payments. The optics of taking your cash flow and subtracting their debt service (loan payments) for the practice loan is hard enough, but to also subtract a mortgage or lease payment feels daunting for buyers.
It’s more than just optics, though. The value of your building will come from the market comps and from a capitalization rate/income approach to valuation. You can’t sell an investment building for much if it isn’t taking in rental income. See a combination of “I Want To Sell, But a Buyer Doesn’t Want to Purchase My Building” and “What To Do When You Lease the Real Estate” below about having a solid lease in place and being able to market that lease to a 3rd Party investor.
What To Do When You Own Real Estate
If you own your real estate, the first thing you will need to discuss with your broker is what your market value is for a sales price and/or a lease rate. Then, the second thing you’ll need to do is decide if you want to sell your building or lease it out and be a landlord.
I Want to Sell, and a Buyer Wants to Purchase My Building
In this scenario, having a commercial real estate agent/broker do a market analysis and give you a fair market evaluation is the most important step. If you know the purchase price of the building is within the going market rate, then the main concern you have is whether or not the mortgage on the building will allow the buyer to continue to cash flow. If you’ve been having your practice pay your real estate entity (or just you) a monthly rent, then this concern is likely very low. However, if you have not been paying yourself rent and your building carries a high market value, then the mortgage on the building may create a poor cash flow for the practice. In this situation, either the buyer needs to be okay with a low cash flow or you will need to negotiate your building price. A secondary area of concern is to make sure that if you have other tenants in the building, they have good leases secured at market rates, so the buyer is set up for successful real estate ownership.
I Want to Sell, But a Buyer Doesn’t Want to Purchase My Building
In this scenario, you do have options to sell the building as long as you have a good, long-term lease in place. The term “good” here is subjective, but the overall sense is that it is profitable. My recommendation is to set up a Triple Net (NNN) lease where the property tax, building insurance, and maintenance are passed through to the tenant, so the “base” rental amount you collect will be considered a consistent income. If you have a lease that is set with the current market rate for your area, that allows the buyer to keep the practice’s cash flow, you can sell the building to a 3rd Party investor. Real estate investors would love to own a dental building and will pay a small premium for that opportunity (they’ll pay based on a capitalization rate rather than just a price based on market comps). The longer the lease term, the better the pricing will be for a sale (think 10-15 years, but no less than 5).
I Want to Lease My Building, and a Buyer Wants to Lease
In this scenario, you want to make sure you set up a lease that makes sense for the practice buyer and is profitable for you. Be sure that you have a commercial real estate agent/broker help you find a market rate here as well. Your building is likely paid off or the debt on your building is less than the building’s current value so the payments you receive will make it profitable at a lower rental rate. However, at some point, it’s likely you will want to sell the building, or maybe your spouse or children inherit the building and will want to sell. In this case, profitability needs to be beyond what the mortgage of a buyer would be, so that it’s a good investment for them as well.
I Want to Lease My Building, But a Buyer Wants to Purchase
In this scenario, you need to determine your overall goals for the building. Why do you want to hold onto the building and be a landlord? How long do you want to be a landlord? If you are absolutely set on being a landlord for the foreseeable future and the buyer is absolutely set on being a building owner, then this may not be the buyer for you, and you may have to move on. If, however, you would be willing to be a landlord for 3-5 years and then part with the building, you could set up a lease with an option to buy. Two things would need to be in place for this to happen: 1. Have a price set. This will protect you if the commercial real estate market drops and will protect the buyer if the commercial real estate market climbs. Both of you are taking a calculated and shared risk this way, and you’ve set a price you both agreed was fair at the time of lease execution. 2. Set the timeframe in which the buyer can exercise this right (i.e. the buyer may exercise their option to buy the building after the 3rd or 5th year of the lease). One thing to keep in mind here is that an option “runs with the land”, meaning it stays with the building, even if you sell it to someone else. Therefore, know that if you decide to sell the building to anyone other than the tenant, the tenant will have the right to exercise this option regardless of ownership, which will likely diminish the price you can sell it for to someone else. If the buyer decides not to exercise their option, you can both agree to terminate that right in writing, allowing you to get a full, fair market price from a 3rd party buyer.