By Rich A. Campbell, III CCIM
Many medical practices assume that owning their real estate is something to be aspired to, while in reality owning the property where a medical practice sees patients may not always be the best option. When weighing out leasing versus owning, it is important to look at the occupancy cost of leasing regardless of the ownership of the physical building. There are plenty of instances where leasing creates not only a more flexible arrangement, but may also be the better financial decision as well. In any event, the practice itself should never be the purchasing entity of a real estate asset. The practice needs to always be a tenant through a lease that is signed with a separate building ownership.
When searching for real estate, the practice must do so with the intent of taking care of “practice needs” as the most important priority. Ownership should be of lesser importance. Once the appropriate location is determined, the practice should be prepared to sign a lease agreement with whomever the owner is, regardless if members of the practice also own the building. If there is an ownership opportunity available, the owners of the practice will want to run a pro forma to assess the value of ownership of the building. The pro forma helps determine what the cost of occupancy (rent plus expenses) needs to be to create a viable purchase opportunity. The cost of occupancy that is in the practice lease has to be a fair market value rent and not a “boosted” rent to justify the purchase of the asset.
In purchasing the real estate, a separate building ownership is typically in the form of a limited liability company (LLC). This LLC will own 100 percent of the building with the physicians having the option to own portions of the LLC or the entire LLC. The cleanest way in which to set up the LLC is when the owners of the practice acquire the same percentage of ownership in the real estate LLC, however this set up is not mandatory. As the practice moves forward, a buy/sell provision can be incorporated to accommodate any make-up of ownership that is not equal. Buy/sell provisions can be found within the Operating Agreement and the provision will exist with or without equal ownership. Having a good buy/sell provision in the beginning of a new acquisition may save partners from unnecessary emotional hardship when they need to move in and out of the LLC. The management and control of the LLC is also very flexible and can be drafted in the operating agreement to give control elements to an LLC manager even if they are not 51 percent owners of the LLC.
Most medical building acquisitions involve properties that are either non-medical buildings needing to be converted to medical, or existing medical buildings that require a good amount of work to accommodate the new practice needs. If a fair market deal is achievable and maintained, there are some advantages of being an owner occupant, including the ability to contain turn-key tenant improvements in the budget, financing the improvements over 20 to 25 years which may render financial benefits, possibly limit up-front cash, and keep the occupancy cost lower for the tenant.
The bottom line is that it is imperative that the practice is not unnecessarily weighed down by a high cost of real estate. The practice must focus on the lease agreement, making sure the terms match the practice’s monthly budget as well as availability of cash for tenant improvements. The golden rule will always prevail – the practice is always the tenant.
Rich A. Campbell, III CCIM is the Founder of Veritas Medical Real Estate Advisors.