Suneel Chilukuri, M.D., F.A.A.D., F.A.C.M.S. is Director of Cosmetic Surgery at Refresh Dermatology and a board certified, internationally recognized expert on cosmetic and reconstructive surgery. Austin Wheeler is the Founder and National Real Estate Director of Practice Real Estate, specializing in helping medical professionals open successful practices by finding the best locations.
As a driven, accomplished individual, you likely spent many long hours throughout your life working while your friends played. You graduated top of your high school class, studied hard in college, made it through the rigors of medical school and residency, and worked as an associate in a practice. You now own your own practice, as a solo practitioner or with partners, generating revenue, maintaining a staff, and occupying professional office space. But are you running your practice or is your practice running you?
To answer that question, you must first ask yourself if your practice is making money and not just enough money to cover expenses. Is your practice making the kind of money you worked so hard throughout your life to attain? If your answer to that question is “no,” than understanding how to profitably run your practice by utilizing real estate income for long-term wealth is essential. Making the right real estate decisions can significantly impact your financial outcome, and it is, therefore, extremely important to understand and analyze your real estate options to determine which option is best suited for you personally and for your practice.
- Consider these critical questions:
- Is owning real estate for my practice a good investment?
- In what situations is leasing a solid real estate strategy?
- When is it the right time to buy other business investment properties?
- Most importantly, what are ALL my options?
The Three Options
Typically, medical professionals have three options to choose from when it comes to how they occupy medical office space, and each has advantages and disadvantages.
Commercial real estate can be a sound investment with returns equal to the risk. Historically, real estate can be a good place to protect your money against inflation, and banks often offer great financing deals. At the same time, there is also considerable risk. It needs to be said that one should plan a real estate purchase carefully and never purchase just to avoid leasing, as there is no such thing as truly free rent. Another key consideration is location. There’s an old adage in the real estate business: it’s all about location, location, location! This adage should be followed when looking at investment opportunities AND when planning for the success of your practice.
When considering purchasing, ask yourself where the property fits into your portfolio and your long-term plan. Is the property part of your retirement plan? For example, will you have an associate purchase a portion or all of the property as a “buy in” for partnership? Do you plan to keep the property for cash flow after retirement? Will the property be part of a generational plan for inheritance? What are your plans for the expansion of your practice?
The Pros of Purchasing as an Individual
- Fixed Cost: When you own the property, you are able to predict the rent your practice will pay to a greater extent.
- Smart Business: Although owning typically costs slightly more in the short term, it generally makes more sense in the long run. If your practice can afford it, you should consider it.
- Good for Recruitment: If structured correctly, real estate can be used as part of your recruiting package and create liquidity for retiring physicians.
- Potential Financial Gain: Depending on the location, there is always the chance your real estate could appreciate.
The Cons of Purchasing as an Individual
- Location: You may have to sacrifice location strength and visibility, as the perfect location may not be for sale or too expensive when you are ready to buy, making prime real estate a less viable option for a single practice.
- Commitment: Once you buy, it is often more expensive to move when you own, and the capital you have allocated to the property is fairly not liquid.
- Capital Intensive: It will initially cost you significantly more capital to own than lease, and you will no longer have access to that initial capital.
- Attention Intensive: As the owner, you may need to hire a property manager. All repairs, fixes, and problems are your responsibility. There is no landlord to call when things go wrong.
- Group Practices: You will have owners buying in and out of the practice. Each individual will have different expectations as to how to handle the real estate and what is “fair.”
- Lack of Financial Appreciation: Specialized medical office condos do not financially appreciate the same way larger, multi-tenant projects do. The buyer of a multi-tenant project is buying an income stream, while the buyer of a condo is buying for their specific use and need, and don’t forget that you are not in control of the monthly association fees as a medical condo owner.
- Loans are Often “Joint and Several”: If the proverbial ship goes down and some partners drown faster than others, be prepared for the financial wave.
- Potential Financial Loss: People often invest in real estate expecting an automatic money maker, but people also lose lots of money in the real estate market every day. You may drive around wondering how people own and make money on all the buildings you see, but that is simply not the case. Many incredibly skilled, smart physicians have lost money investing in real estate. Please don’t invest in real estate with the expectation that you’re guaranteed to make a fortune.
In a lease arrangement, you sign an agreement to pay rent with many of the same features as signing a loan. A lease often requires a personal guarantee, or if not, your practice will guarantee payment. Generally, you pay for the finish out of the space above a tenant improvement amount paid by the landlord. At the end of the lease, you will walk away from the money you’ve put into the space. When renting, you partially or significantly fund someone else’s mortgage; they are taking on the risk and you are paying the return.
The Pros of Leasing
- Reduced Upfront Capital Investment: The funds you save on an initial investment may be used to purchase equipment, hire more staff, or invest in marketing to grow your practice. Returns on investment in your operating business typically outpace your real estate investments.
- Flexibility: You have the option to move without finding someone to take your space once the term of the lease is complete. Consider brokering an exit clause in your lease in the event you need to vacate before its expiration.
- Less Risk: Real estate market changes will not affect your real estate costs for the duration of your lease; your rent will be what was agreed to in the lease.
- Less Responsibility: Unlike being an owner, as a tenant, you may simply contact the property manager when a repair is needed or a problem arises. However, if you sign a triple net lease, you are still responsible for the costs of repairs inside your office space.
- Prime Choices: Real estate developers typically buy the most desirable properties and divide them into profitable lease spaces, making the prime choices in commercial real estate not available for purchase to individuals.
The Cons of Leasing
- Limited Control: You will likely negotiate 50 to 70 terms in a lease document, and it is assured that not all will be in your favor. At some point during your lease, you may experience a situation in which you feel you are being treated unfairly and you will have limited recourse, even if you have the best lease in the world. Therefore, it is wise to utilize an experienced real estate broker and a seasoned real estate attorney while shopping for space and when negotiating the lease.
- Loss of Investment: Fixtures and build-outs become the property of the landlord at the end of the lease.
- No Investment Value: Your lease payments create no lasting value. You’re simply paying someone else’s mortgage.
- Leasing Still Involves Risk: There’s still risk, even when you’re leasing! If something happens and your practice takes a turn for the worse, you might find yourself in the unenviable position of seeking someone to sublease your space, just as you might need to sell a piece of real estate. Subleases are challenging, risky, and can leave you open to liability.
3. Purchasing in Partnership with a Real Estate Expert
When you purchase real estate in partnership with a real estate expert, you are getting the best of both worlds when purchasing a property. In addition to the obvious advantage of not shouldering the full burden of the loan, there is also the critical advantage of having an expert partner to secure better overall terms for the loan and to structure the property purchase properly. You own the property without all the risk, without putting up 100% of the equity, and without guaranteeing 100% of the debt.
The Pros of Purchasing in Partnership with a Real Estate Expert
- Support: Significantly less cash equity is required, as other partner(s) are supporting the loan obligation with you; cash obligation is similar to buying a condo unit.
- More Available Capital: Income-producing assets are attractive to a wider array of capital, with more ways to sell or refinance; they are simply worth more in a sale or refinancing scenario.
- More Locations: With a knowledgeable partner assisting in the cost of purchasing a larger property, you can secure a more high-profile location.
- Liquidity: Partial ownership in a large cash flowing asset is more liquid.
- Immediate Appreciation: Appreciation of the asset and value creation begins the very first day your practice and perhaps other tenants, move into the property; the property value of the asset is tied to the rent, instead of a single tenant building, where it is tied to the cost of the project and your ability to find someone who needs the same thing.
- Limited Liability: Once the building is complete there may be an opportunity to remove personal liability through refinancing.
- Equity Refund: Once the building is completely leased there may be an opportunity to return all or most of the equity put into the project through refinancing.
- Asset Sale Option: The partnership has the opportunity to sell and create an income event for partners as soon as the building is completely leased.
The Cons of Purchasing in Partnership with a Real Estate Expert
- Multiple Voices: Different partners have different needs, and you may not agree with every decision. Be cautious if you are a first time real estate investor as you may not have the knowledge or financial means to be the primary decision maker.
- More Care Upfront: It’s important to set the partnership up with great care so that everyone’s expectations are aligned. Failure to ensure that all parties are on the same page is a recipe for disaster.
- Part – Not ALL – of the Profit: When sharing the work and risk with a partner, the partner will want a part of the profit and upside as well. Obtaining your own financing, maintaining the property, and being a full-time property owner/manager means you will retain 100% of any profit, yet it also entails taking on all of the work and risk. Professional real estate investors earn their returns from partnering with other professionals to find opportunities and deliver projects. Finding the right partner for that next practice location can result in near-term profit and long-term wealth building through passive investment.
The Bottom Line
By being familiar with the three basic real estate options for medical professionals, you can identify the pros and cons of each and most likely have an idea of how each would work (or would not work) with your practice and long-term life goals. Real estate and commercial real estate investing are by no means “one size fits all” businesses and the trick is to fit real estate to your needs.
At the end of the day, real estate is simply another tool in your success toolkit. Unlike many other tools, it can be leveraged to grow your business and can help you achieve long-term financial success.
Additional Critical Real Estate Questions for the Dermatologist
- How proven is my business model?
- Do I have the capital to own the type of real estate that is optimal for my practice?
- Even if I do have the capital, is it best allocated towards real estate or should I consider using it to grow my practice? Which provides a better return? Do I have the capital to maintain the property and afford repairs?
- Would that capital be better used to expand to additional locations?
- Do I fully understand how to run a comparison on costs and savings of leasing vs. owning in my market? If not, who can guide me?
- What options are feasible within my market?
- Is my instinct to purchase valid because I have historically heard that owning real estate is better than leasing, or is purchasing best for my business?
- Do I see myself owning this practice in 5, 10, 15, or 20 years?
- Do I see my practice moving or expanding in 7 to 10 years?
- Is this the location where I ultimately want my practice to be?
At PRACTICE REAL ESTATE GROUP, we specialize in analyzing the options for healthcare professionals and providing solutions in the shortest period of time possible. We have the tools, experience, knowledge, and expertise to make this process objective and give you control. In the real estate market, it is critical to understand all of your options when making a large financial commitment, and Practice Real Estate Group is committed to making sure that you understand every aspect of the process.