Should You Own Your Medical Office Space?
If you own or operate a healthcare practice, you are required to cut an unavoidable check every month to pay for your office space. After payroll, real estate is typically the second highest expense in any healthcare business. The good news is that your real estate costs are negotiable! That makes it the number one opportunity to substantially impact profitability over the life of a practice.
This being true, the question to answer is “Should you own or lease your office space?” The answer depends on a number of factors, such as:
- What is the age of your practice?
- In what market or area of town do you want to be located?
- How close are you to retirement?
- Do you have an exit strategy?
- What is your current financial position?
- What real estate options are currently available?
The reality is there is no ‘one size fits all’ answer to purchasing versus leasing. When properly represented, leasing can offer some very compelling benefits such as flexibility or financial concessions such as free rent, free built out period, a tenant improvement allowance and more. However, for those who want to take a deeper dive into the benefits of purchasing, the following reasons make commercial real estate ownership very attractive.
Increasing Your Net Worth
The typical healthcare practice is looking for new ways to increase revenue. For example, a doctor might bring in a specialist, purchase a new piece of equipment, offer new services or even expand to add more operatories or exam rooms. Those are great options and worth considering to increase revenue; but most of those ideas also require the practice to take on additional overhead.
Real estate ownership involves taking a payment you already make every month, and adjusting ‘who’ is getting paid. If you own, then your monthly mortgage payment goes toward increasing your net worth by typically thousands of dollars every month as you pay down principal on the loan; versus if you lease, then you still cut a check every month, except the landlord’s net worth increases each month. Over a ten to twenty year period, the difference is typically hundreds of thousands and even millions of dollars in favor of the person who owns the real estate, either the practice or the landlord.
Tax Implications
The equity benefits of ownership are common knowledge. Not as commonly known are the tremendous tax benefits afforded with ownership.
Typically, the real estate is owned by an LLC which is formed by the practice owner(s). Rent and operating expenses are then paid by the practice entity to the LLC. The practice can write off rent and operating expenses on its taxes, the same as it would if the real estate were owned by an unrelated landlord.
Given that the doctor owns both the real estate LLC and the practice, do the taxes on the rental income paid to the LLC negate the practice’s write-off benefits for rent paid? In short, no, but a CPA should be consulted to evaluate the precise implications.
It is true that the LLC will be taxed on rental income. However, the LLC also has a number of additional write-offs that substantially reduce this tax liability. In addition to the mortgage interest deduction, the LLC can depreciate the building and land improvements. The standard straight-line deprecation for commercial property is 39 years. Some property improvements can also be accelerated. For example, while the land itself isn’t depreciable, the land improvements can be depreciated over 15 years or less, using cost segregation methods.
Put in simple numbers, if $1,250,000 was paid for a property, and the land was worth $250,000; then the remaining $1,000,000 could be written off over 15 to 39 years. That’s a minimum of an additional $25,000 of tax deduction annually.
By leveraging depreciation timelines, known as cost segregation, a CPA can sometimes nearly wipe out the entire tax liability on rental income. These tax deductions provide another compelling reason to own.
Retirement and Exit Strategy
Some people are disciplined enough to put thousands of dollars into their retirement every month. If you do, that’s great. But why stop there when you can double your efforts by leveraging ownership in your healthcare office? On the other hand, if you don’t have the discipline to fill the coffers, then owning your office space is a forced way to bolster your retirement strategy.
So, what happens to the property when you retire?
When you’re in a lease and are ready to retire, it’s a simple exit. You close the practice or assign the lease to the buyer of the practice and you’re done. The value of the practice you have spent your life building is the only item you have to sell. If you own your real estate, you have a number of options to consider:
- Sell it to the practice buyer and either cash out or 1031 exchange it, increasing your real estate investment portfolio
- Sign a long term lease with the buyer and receive the additional cash flow at thousands per month
- Or a combination of the two… lease it to the new practice owner and create an annuity, and then sell it and cash out years down the road when the new practice owner is ready to buy the real estate also
In a practice transition or sale, it’s very common for the real estate to be worth more than the practice.
Evaluating Your Options
It’s important to have realistic expectations about available and viable options in the market, because sometimes it’s simply not an option to own. Variables such as the city, part of town, square feet needed, type of building, etc., can collectively or individually eliminate all realistic possibility of ownership in a specific market, where ownership is nearly impossible. For those reasons alone, it is vital to have expert representation to fully vet all of your options for you.
Additionally, it’s wise to look at all of your options to determine if leasing or owning is right for you. Evaluate retail and office spaces. Cover all your ground and compare your top three to five options before making a decision. If you have a property in mind and think “This is the one!”, that could be true. Still, take the time and due diligence to validate that choice by comparing it to the rest of the market.
As a medical professional, you want to lay your head on your pillow every night for the next 10-20 years and know you made the right decision, instead of thinking “I forced it and I know I didn’t make the right decision, or I didn’t do my due diligence.” You can’t make an informed decision if you don’t know your options.
Overall, if you have a chance to own and the numbers are favorable, then ownership can be a tremendous opportunity to maximize profitability, increase net worth, and end the lease negotiation wrestling match with Landlords every 5 to 10 years.