In representing healthcare groups and specialized practices in leasing and purchasing clinical space for decades, we have found that some medical practitioners reach a crossroads—is it time to stop paying rent to a landlord and own the facility where they provide care? As a tenant only advisory firm, when we evaluate a potential medical office purchase, we utilize a framework that balances strategic fit, risk profile and the financial implications. In the healthcare world, the issues of fit are often far more consequential than the purchase price itself.
Strategic Fit of the Real Estate
The strategic fit of owning clinical real estate is perhaps the most critical hurdle. To justify purchasing a building, a practice should have at least a ten-year expected utilization of that facility. This is especially true for physicians, as the cost of specialized medical build-outs including heavy plumbing, reinforced flooring for imaging equipment and specialized HVAC systems, makes moving far more disruptive and expensive than it is for a typical office user. Consequently, a rapidly growing multi-specialty group that may outgrow its footprint in five years, or a practice looking for a near-term exit strategy to a hospital system or private equity firm, should generally remain in a lease. Ownership can complicate a practice’s sale, as financial investors are looking for returns on the business and will have little interest in the real estate.
Getting the Apples-to-Apples Correct
The risk profile of a medical building must also align with your personal financial security. When a physician buys a building, they are relying on the strength of their own practice as the primary tenant to cover the mortgage and the building’s operating expenses. We often see doctors compare a mortgage payment to a rent payment and conclude that buying is cheaper. But this frequently overlooks the “operating expenses” associated with medical facilities that are often included with the rent payments under a “net of electricity,” “full service gross” or other gross lease arrangements. Real estate operating expenses that are generally included in a gross lease include property taxes, building insurance, water, gas, elevator maintenance, landscaping, buildings repairs and maintenance, specialized janitorial services, biohazard waste management and a myriad of other costs. These costs add 40% to 60% on top of the mortgage costs.
Furthermore, commercial real estate is highly illiquid, and most SBA loans require any shareholder owning 20% or more of the practice to personally guarantee the loan—and occupy at least 51% of the building. If a change in reimbursement rates, change in the practice ownership composition or a market downturn affects the practice’s ability to pay rent, the bank will look toward your personal assets to make up the difference.
Hidden Costs of Ownership
Beyond personal liability, another potential risk involves purchasing a building that exceeds the practice’s actual occupancy needs. While it may seem like a wise investment to buy a larger building and lease out the extra suites to other specialists, one must be prepared for the realities of being a landlord. Managing and paying for tenant improvements, carrying vacant space between tenants, legal fees and commissions, and any free rent concessions that the market demands can be a significant hidden cost and distraction from your clinical work. It is essential to identify these potential challenges upfront and purchase at a price that remains viable even under conservative vacancy assumptions around lease up and turnover.
Caution on Betting on the Future
Finally, the math must work on its own merit without relying on aggressive appreciation assumptions. While there are significant depreciation benefits to owning, which can be accelerated through cost segregation techniques, these are often secondary to the long-term goal of controlling costs. We have seen medical buildings in high-demand areas purchased at premium prices that were later worth significantly less during market corrections, or when newer medical office buildings come on the market as competition. When analyzing a purchase, the safest approach is to assume no capital appreciation over the life of the asset.
While navigating the risks of ownership requires expertise and careful consideration, a strategic acquisition—aligning the ideal property with the right price—can transform a medical practice’s real estate into a valuable asset for their eventual retirement. Hughes Marino can help you navigate the process and evaluate all of your options, whether it be leasing, purchasing or building your own project from scratch.
