April 28, 2022
“Bad locations, negative cash flow, high vacancies, and problem tenants” are Investopedia’s four most substantial real estate investment risks. For physician investors owning their own medical building, all these risks can be eliminated – assuming one simple guideline is followed. The ownership of the practice should be aligned with the ownership of the real estate. Whenever that guideline is not followed, the objectives of the tenant and landlord begin to diverge and the aforementioned risks are given a foothold to fester.
Optimal alignment of the real estate and the practice has two consequential components – the involvement of all the practice partners and a balance of ownership among those partners. There are several benefits to achieving both goals. To easily understand the concept, consider the following potential advantages.
Credit Enhancement / Elimination of Personal Guarantees
An equally-owned real estate entity allows for the practice to provide a corporate guarantee of the debt. This is huge. It can improve the rate, increase amortization, remove personal risk (through the elimination of personal guarantees), and enhance flexibility from covenants. Without equal ownership, utilizing a corporate guarantee can be a challenging proposition and typically requires negotiation and indemnity agreements among partners.
Facilitation of Physician Buyouts
Generally, unequal ownership is driven by the financial ability or inability of owners to invest. Because of this, in unequal structures, we see that the senior physicians are more likely to have a larger ownership position. This exacerbates the issue of buying out physician owners because now the partners closest to retirement are the ones with the largest buyout. To make matters worse, this buyout needs to be funded by younger physicians with a lower equity position and less capital available.
Favorable Lease Negotiations
Every owner has a different opinion on what constitutes fair market rent in their building. Even with outside impartial rental data, negotiations can be a contentious issue that can be avoided through equalization. In fact, equalization allows the opportunity to manipulate rents in order to maximize returns and improve tax efficiencies.
Tenant Improvement Considerations
Why do I have to contribute as much as my partner to improve a building in which he or she has triple the ownership? The disparity between practice and real estate ownership can be a divisive issue when improving an existing building, particularly with the rising cost of MOB and ASC build-out. This can lead to a delay of plans, poor ongoing maintenance, or complete avoidance leading to disrepair.
The Ties That Bind
This all comes down to the relationship between the real estate entity and the practice. By creating a structure that enforces this relationship, you can add to its sustainability and longevity. Such a structure creates an improvement in return, reduction in cost, mitigation of risk, and an all-around healthier proposition.
Schedule a call with CMAC to understand how to create the optimal alignment between your practice and the real estate.