Practice owners who also own the practice’s property often grapple with a dilemma post-close: Do you sell the real estate or hold onto it? The truth is, there is no right answer to this question. It involves personal preference, risk profiles, estate planning, and, most importantly, the long-term potential for the building in its geography.
Let’s start with the criteria you should consider when deciding whether to own or sell your property:
- Ownership: If you or your family own the property, it’s more feasible to own long-term than if you have two or three partners co-owning the building. In the latter situation, you’ll need to consider where the owners will live and your potential relationship in 8 to 15 years when the lease expires. It’s easy to be a sole-owner-landlord. On the flipside, it grows increasingly complex with more than one owner, especially as those multiple owners age (and even pass away). With that in mind, partnering with the heirs of your current partner is a plan you should evaluate.
- Geography: The locations that tend to receive the highest valuations – Los Angeles, San Diego, San Francisco, NYC, Washington D.C. – are also the places where you’ll retain the most value in the property long-term. When real estate is in a densely populated area, it has scarcity’ value as there’s fewer alternative options available. In these areas it’s relatively easy to find a new tenant should the hospital forgo lease renewal. In rural areas, exurbs, and even low-density suburbs, the buyer could decide not to renew for many reasons, including: needing to increase or decrease the clinic size (depending on performance), relocating, or building their own facility.
- Cash Flow: Especially if the mortgage is fully or mostly paid off, your property will serve as a strong cash flow generator throughout the life of the lease and any renewal periods. This type of passive income is wonderful as you slow down and earn less income from your veterinary practice!
- Mortgage: Once you sell your veterinary hospital to a corporate buyer (even if you retain a minority stake), your building is no longer ‘owner occupied’ and becomes an investment property. If you have no mortgage, this is irrelevant. However, if you have a substantial mortgage, your interest rate might increase when it’s converted to an investment property mortgage. The loan to value that a bank will lend against will change as a result.
- Lease Duration: Your single-tenant building will sell based on its rent rate, lease term, and tenant credit quality. Once the lease term dips below 10 years, the property value starts to decrease (due to a shorter duration lease). Your property value won’t change drastically whether you have a 15-year or 12-year lease term when you sell. However, a 7-year lease term will lower the value of the same property that has a 10-year lease term.
- Diversification: Assess how much the building represents your total net worth. Does the single asset represent an appropriate amount of diversification of your total assets? If the building takes up a large portion of your net worth, you might consider selling or pursuing another diversification strategy.
Holding real estate long-term or throughout the lease term is a good plan in the right circumstances. At Ackerman Group, our goal is to help you evaluate the risks of long-term property ownership in conjunction with your personal financial goals to reach the best decision.
The option to sell your real estate is a multi-faceted one. Here are some scenarios where selling your property makes sense:
- Two or more property owners. The number of owners can create issues down the road, especially if owners pass away or move out of town.
- Practice outgrows the property. The practice is growing and needs room to expand, but there’s no more space available or no avenue to a viable expansion.
- Older building with a long-term lease. The likelihood of a clean renewal at the end of a 7 or 10-year term is lower for dated buildings with no recent remodels.
- Decline in neighborhood quality. What will the neighborhood look like in the next decade? If the future looks bleak, you may not want to own a building or business in that neighborhood.
- Multiple heirs that lack business know-how. If you are planning to leave your heirs a fair amount of money, it can be problematic to include an illiquid real estate asset, especially one that’s approaching the end of an initial or renewal term. Decision-making among siblings or heirs can pose a challenge. Selling and transferring your money into more liquid assets may simplify estate planning.
- Building value hits a peak. Your property’s valuation is likely near a peak right after you sell your practice. Why? This is because of the long duration lease (remember, most lease renewals are only for five years, not 10), and securing a tenant with good credit. Even though you forgo consistent cash flow when you sell, having the cash to reinvest can be an appropriate strategy.
If you decide that you want to explore a sale, there are several practical options that include tax deferred strategies. Selling your property typically means significant tax payments, many of which can be deferred if you invest in a more diversified portfolio or another property. To learn more about tax deferral strategies, read our article on Selling Real Estate: What are Your Options?