When selling your veterinary practice, it’s vital to think about your real estate as part of your overall financial plan and how it fits into the transition of your practice. The decision tree is relatively simple when you rent your hospital from a third-party landlord, while the variables can become more complex if you’re the property owner. Whether you rent or own your veterinary facility, we’ve compiled a quick rundown of the key issues to consider for both situations before you sell.
In the Case of a Renting from a Third-Party Landlord
In about 25 to 35 percent of transactions brokered by Ackerman Group, the seller does not own the real estate. In these situations, the goal is to make sure your landlord doesn’t create problems for your practice sale. Buyers (as do you, too) want an assignment of the lease to the new legal entity that will own the hospital. This sounds simple, but there are a few significant hurdles to jump through. Not to mention, some landlords are just difficult.
- Term of the Lease: How long you “control” the property is important to every buyer. Even in the case of having three years left on the lease with two, five-year renewal options – you still have control of the property. Sometimes long-term control of the facility matters, especially where geography is concerned. Places where real estate is scarce, or build-out costs are high, like New York City or Los Angeles, longer term control matters more than in a suburb.
- Guarantee: In most instances you, the practice owner, have personally guaranteed your lease. Landlords loathe releasing tenants from guarantees, even if a larger and more financially secure corporation is your buyer. At Ackerman Group, we typically help you navigate this situation with both the buyer and the landlord to find a proper solution.
- Fees: Check your lease to see if there are any set assignment fees (Note: if terms are ambiguous, some landlords can make it costly!). Our team is happy to provide guidance, but it’s ultimately up to you, your attorney, and the buyer to ensure that the buyer’s requests for lease assignment, along with any lease changes, are reasonable. If not, there could be delays or problems with obtaining the lease assignment and closing the transaction.
In this process, unfortunately you and your buyer will have minimal leverage with your existing landlord, regardless of the buyer’s good credit. If the buyer is adding duration to the lease, or a significant enhancement to the credit worthiness of the guarantor, it does add significant value to the landlord’s building and can be used to your advantage.
In the Case of Owning the Real Estate
Sixty-five to seventy-five percent of our transactions see veterinary hospital owners controlling the real estate. In most situations, the building is a single-use property where the veterinary practice is the only tenant. Single-use buildings, especially veterinary hospital buildings with custom build outs that have limited alternative uses, are usually valued based on the key terms in the lease (annual rent, escalation and length of lease, etc.). The right lease terms will give you options regarding the question of whether to sell or hold the property, and creates enhanced value regardless of your choice.
Key Lease Terms
Ackerman Group, along with your attorney, will guide you through lease negotiations with the buyer to maximize the value of real estate for you. The must-have items to negotiate include the following:
- Rental Rate: Buyers want to pay fair market rent for the property, this much is true. But with a single-use, specialized building like a veterinary practice, it’s challenging to settle on a fair rate. In reality, market rent is a range and not a certain dollar amount. Remember that every dollar of higher rent you get from the buyer means one less dollar towards your EBITDA. The question then becomes: Does the practice trade at a higher multiple than the real estate?
- Term: The term is critical to obtaining maximum valuation for your property. Securing a five-year lease is common, while getting the buyer to agree to a 10-year lease is attainable if the property is in decent shape. With certain geographies, property owners have been able to secure 15-year leases. It’s worthwhile to note that older buildings that haven’t been remodeled for decades generally receive 5-year leases.
- Rent Escalator: While many commercial leases use a Consumer Price Index (CPI) escalator, using a fixed percentage escalator is the norm in the veterinary industry. However, rent escalators are evolving because of the recent inflation spike in the second half of 2021 and moving into 2022.
- Landlord vs. Tenant Responsibilities: In a true triple net lease (NNN), the landlord has no responsibility, and the rent is essentially a ‘bond payment’ with no costs. Triple net leases are uncommon in veterinary properties. In veterinary facilities, the landlord may have replacement (not maintenance) responsibility for the foundation, structural walls, roof, HVAC, and potentially the parking lot. Our team helps you and your attorney on these issues. The more the landlord is responsible for, the more ‘reserves’ you need to maintain.
- Tenant or Guarantor: Understanding who your tenant is and their financial viability is crucial. The tenant or a guarantor of the lease should be the right entity within the buyer’s corporate structure to protect against default risks.
While there are other terms in a NNN lease, these are the most important ones. At Ackerman Group, we work with you and your attorney to negotiate favorable terms and make certain you understand all the details of your lease. We cannot emphasize this enough: A strong lease is the key to securing full value for your real estate, regardless of your decision to sell or to hold!
This article is meant to be an introduction to the key issues impacting your real estate in any given transaction, whether you rent or own the veterinary practice property. If you need more in-depth real estate guidance, look no further than our other resources to help:
- Should I Sell or Hold Real Estate Long-Term?
- Tax Deferral Strategies for Selling Your Veterinary Property
We’re here to help guide you through the transition process, and that includes equipping you with the knowledge to make thoughtful and educated decisions. If you’re interested in learning more about how Ackerman Group helps you find the best price, terms, and fit for your practice, learn more and contact us.
 Real estate typically trades based on a capitalization rate (cap rate) which is the inverse of a multiple. For example, a practice may trade at 10x EBITDA which is a 10% cap rate. A 12.5x multiple is an 8% cap rate. The cap rate is essentially the cash-on-cash return assuming there is no debt on the property. So, if the rent is $100,000 and it sells for a 5% cap rate (20x) or $2.0 million, there would be a pre-tax cash on cash return of 5%.