For many doctors, the idea of purchasing both the dental practice and the practice real estate feels like a worthwhile investment. But there are some instances where leasing the real estate may be the better route for you and the practice.
Buying a dental practice is an intricate process and determining how to transition the real estate adds another layer of complexity. With the significant financial implications and all of the moving pieces involved, it’s key to know early on if you’re going to buy or lease the building.
“It’s critical that the real estate plan is negotiated at the same time as the practice transition,” said Sarah Oliver, Cain Watters & Associates financial planner. “This allows both parties to know the total economic deal and helps prevent either party from being tied down to a less-than-ideal long-term plan.”
As you begin to develop a plan that’s right for you, consider these factors and ensure you’re educated on the front end.
Reasons to Buy the Real Estate
Buying the practice real estate can offer many advantages. First, it’s an opportunity to build equity in an asset that is a different asset class than stocks, bonds, or your home.
“For most doctors who are going to practice in the same location for 20 or 30 years, it makes sense to purchase the real estate, pay the loan down over time and have an asset at the end to sell,” Sarah said. “Building that equity value in the real estate is the number one reason I would recommend a doctor to purchase it.”
Buying the real estate also allows you to better control the ability to expand in the event that you outgrow the space. If the geographical location is highly favorable, buying the real estate secures the location and future of the practice. Also, the idea of paying yourself the rent may be more appealing than paying a landlord, and a mortgage can often be more fixed over time than rental rates, which typically rise over time.
Reasons to Lease the Real Estate
There are situations where leasing the real estate may be a better option in the long run, and sometimes, leasing is temporary and comes with an option to purchase in the future.
Many real estate loans require a 20% down payment, which can be tough to swing when you’re also trying to buy the practice. By leasing, you can build some cash flow to eventually buy the real estate in the future (if you have the option).
Some locations just don’t lend themselves to purchasing. A busy metro area in New York or California, for instance, is likely going to come with a steep price, so leasing would be the more cost-effective route.
Additionally, if you anticipate outgrowing the space or may have different needs in the future, this may be a reason to lease. This allows your practice flexibility to obtain a different space in a short amount of time.
Simultaneously Purchasing the Real Estate and the Practice
Similar to renting an apartment versus owning a house, you may be thinking, “If I’m going to pay all the rent, I want to own it.” If you have the liquidity, you love the geographical location and you’ve done your due diligence, it’s generally a good idea to purchase the real estate. However, there are a couple of factors to consider if you’re purchasing the practice and the real estate at the same time.
Separate Transactions: Buying the real estate is considered to be a completely separate transaction from the practice sale. Because of this, the process comes with its own set of details, a separate loan, different negotiations to consider and an entire plan of its own. You’ll want to be prepared for this unique process, and your transition consultant and financial advisor can help guide you here.
Negotiating Together: While they’re two separate transactions, you can actually negotiate with the seller on the purchase of the real estate and the practice together, giving you some leverage.
“For example, the selling doctor may have an overinflated view of the building’s worth and want a rental rate higher than fair market value,” Sarah said. “You can take that and then negotiate to pay less for the practice. You can also propose walking away from the entire deal if you don’t get the real estate.”
Purchasing Rights: If the real estate is not in the cards right now but possibly will be in the future, make sure you understand and have documentation of your purchasing rights.
An option to purchase clause in the lease agreement states that the buyer can purchase the real estate at a set time in the future. Including this clause in the agreement will keep the opportunity open for the future.
The right of first refusal (ROFR) clause is also helpful because it gives the buyer a chance to purchase the real estate before anyone else does. The key difference between the ROFR and option to purchase is that a buyer can exercise their option to purchase anytime during the option period for a specific price, whereas in a ROFR, the buyer has the opportunity to purchase only if the seller chooses to sell.
“As long as the purchase options are in place, it’s not critical to buy at the same time,” Sarah said. “Buyers can first see the cash flow from the practice, start to tackle their practice loan, and build some extra cash for a down payment.”
If you don’t purchase the real estate at the same time as the practice, the key is to at least negotiate the future plan at the same time and know what’s going to happen with both the practice and the real estate early on in the transition. This will allow you to prepare for the steps ahead and avoid any unexpected circumstances.
What if I Don’t Have the Choice to Purchase?
In some cases, you may not have a choice to buy the real estate. The seller may not own the building, or the practice may be located in, for example, a hospital building. This is completely out of your control or negotiating power.
Sometimes, sellers who own the building want to hold on to the real estate. In this instance, the seller would become your landlord, you would be the tenant, and there would be a lease agreement in place.
Some buyers see the inability to purchase the real estate as a deal breaker and choose to walk away from the practice opportunity altogether. Some buyers even have the perspective that they won’t truly own the practice unless they also own the real estate. But to be a thriving practice owner, these factors are not mutually exclusive.
“You can own a successful practice without owning the building,” NDP Partner Christy Ratcliff said. “You can even move the practice and build a new building. Just know that there are many people in various parts of the country who never own their real estate and have just as much success.”
Consider the total picture and the practice opportunity as a whole. If the practice has good cash flow, your due diligence presents green flags, it’s in a favorable location, and the practice is still a great opportunity, then the real estate shouldn’t hold you back from being a practice owner.
A Team in Your Corner
While the practice real estate is not typically the focal point at the starting line, it certainly shouldn’t be a decision left until the end. Having a financial advisor like Cain Watters & Associates and a dental transition advisor like NDP on your team can provide guidance through the purchase process. We can help you understand the practice cash flow, estimate the building size needed to run the practice, document what you can afford and put all the pieces together.
