Likewise, physicians in established centers and real estate ventures may want to consider whether to continue owning the current property or entering into a sale-leaseback arrangement and becoming a tenant. They can then re-deploy the sales proceeds into other projects or uses.
Tom Garceau, senior vice president of Fischer Financial, discusses five areas physicians should consider when making real estate decisions for their practice or surgery center.
1. Building or buying can mean more control and additional income. One of the main advantages to owning your own property is that you can build a facility to meet the exact needs of your practice or ASC.
“It is challenging to find pre-existing space that ideally suits the physicians’ needs,” Mr. Garceau says. “A substantial amount of build-out can oftentimes be required if you do [lease a space.]”
Additionally, owning the property may make it easier for expansion in the future.
Real estate can also be an income generator, according to Mr. Garceau. By owning the property, rent paid by the practice or ASC can create additional income to the physician/landlord(s).
2. Leasing property means less capital investment and more flexibility. Leasing a property for your practice or ASC allows groups to retain space while minimizing invested capital.
“Many times landlords will reimburse all or a significant portion of the improvements physicians need to make to the space,” Mr. Garceau says. He also notes that rent payments are fully deductible.
Another benefit to leasing property is that it is easier to relocate operations without the burden of selling a vacated facility. “Selling a vacant property has lower value to investors and therefore limits potential buyers to owner-users,” Mr. Garceau says. “Many times practices [or ASCs] outgrow their current space, or the demographics of the area change. This may result in the need for the practice to move. Leasing property provides maximum flexibility for accommodating changes in the group practice, unlike owning property which requires more lead-time for planning.”
3. New physician/partners can feel resentment of a practice-owned real-estate entity. One of the unforeseen challenges to owning your commercial real estate can be potential resentment from new physicians or partners in your practice or ASC, according to Mr. Garceau.
“Politics can be a volatile and disruptive issue,” he says. “New physicians [who aren’t members of the real estate entity] are not getting the same return as the physicians who are in the [ownership] group. An imbalance occurs in the overall ownership structure, and new physicians may feel resentment toward sharing in the practice’s rent expense that generates income for other physicians.”
4. Changes in group composition can create difficulties when owning a facility. Changes in the composition of a physician group are inevitable, and physicians may want to leave the group or the group may choose to buy a physician out. For some physician groups who own real estate, changes in ownership composition may occur as frequently as every two or three years.
“This can be a challenge, since the typical real estate partnership distributes the bulk of its available cash at the end of each year,” Mr. Garceau says. “Consequently, the partnership must either refinance the property or inject new capital into the partnership in order to fund the buyout.”
Additionally, a physician practice must also consider other entities the exiting physician may own a part of, such as the practice, a laboratory or diagnostic center as well as the real estate partnership. “If a group has numerous illiquid investments, it can be more difficult to facilitate the departure of the physician,” Mr. Garceau says.
Mr. Garceau notes that the costs of these buyouts can be substantial, and groups are often limited in their pay-out options to only their cash on hand. Other options can include borrowing against existing assets (such as the real estate) from a line of credit or using future earnings to pay the exiting physician over time.
There are hazards when a group undergoes multiple refinancing of assets to accommodate these types of arrangements, according to Mr. Garceau. “Multiple refinancing has diminishing returns both in terms of the associated costs with each refinancing and the amount of cash you are able to pull out each time,” he says. “Additionally, the loan is re-amortized with each new financing. Not only does this extend the loan payoff date further and further into the future, it also keeps interest expenses very high.”
5. It may not be necessary to continue owning property once your practice or ASC is established. Buying property allows a practice or ASC the freedom to create a facility suited to the particular needs of the group. However, notes Mr. Garceau, sale-leasebacks are a growing trend among physician real estate groups who would like to free some capital while continuing to operate at the same facility.
“A sale-leaseback provides you with 100 percent of the asset’s value while still allowing you to use the property on a long-term basis,” Mr. Garceau says. “In today’s real estate and credit environment, medical office properties have continued to hold their value. Sale-leasebacks are an excellent source of capital during these tight financial times.”
With a sale-leaseback, Mr. Garceau says the physician group will probably notice very little change. The group will still be responsible for the upkeep of the facility. However, provisions in the lease document can allow the group (which is now the tenant) to make changes if necessary.
“Investors [the majority of buyers for these transactions] are often professionals who are not local and not in a position to bring new tenants into the facility,” Mr. Garceau says. “They rely on the credit of the current tenant and their continued use of the property, so investors are enticed to make tenants happy.”
What to consider when weighing real-estate options
Understanding the financial impact of the decision to buy, lease or enter into a sale-leaseback arrangement is important. Mr. Garceau mentions the following questions groups should ask when considering buying versus leasing:
- Can the cash used as equity to purchase (or build) a facility provide a better return if invested elsewhere?
- Can you find leased space that suits your needs or can this only be accomplished by building or buying?
- How do the costs of leasing compare to the costs of ownership during the term of the proposed lease or anticipated holding period of ownership?
- What are the dynamics of your physician group? Will there be frequent ownership changes?
- How will the group’s space needs change over the years?
Mr. Garceau also suggests that groups consult with an adviser who can help them determine the impact as well as the components that add to the decision. “Advisers can help physicians understand the sale-leaseback opportunity as a capital raising strategy.” he says. “[When consulting with physician groups], we calculate the cash flow of continuing to own the property for the next 10 years (after tax) versus the cash flow of leasing, then measure and evaluate the difference.” Once this information is gathered, the group can then determine the best course of action when it comes to their real estate decisions.
Mr. Garceau is a senior vice president with Fischer Financial, which provides an array of corporate real estate services to regional, national and international clients. Learn more about Fischer at www.fischercompany.com or contact Mr. Garceau at tgarceau@fischercompany.com.
