Whether you have decided to build your own dental, medical, optometric, or veterinary practice, or you are looking to expand or relocate your existing practice, you have some important decisions to make. Do you want to lease or buy space for your practice? If you decide to buy commercial space, do you want to buy a building that will house only your own practice, or buy a larger commercial building for your space and become a landlord to other businesses in the building?
Some factors to consider that may help you with this decision-making process include:
- The stage you are at in your practice. Is it a good idea to invest in commercial real estate, or a better idea to begin or continue your practice by leasing space and investing more in developing your own business?
- What financial resources do you have available for you to purchase a commercial building in addition to investing in your practice? What type of loan can you get? Are you eligible for 100 percent financing on a commercial building that will house your professional practice, or will you need to make the customary down payment of 20 percent of the purchase price?
- If you decide to lease, you will likely be faced with rent increases when your lease comes up for renewal. Make sure you negotiate terms that keep the rent increases at market rates.
- What is your comfort level with the risks involved with purchasing commercial real estate?
As with almost every life decision, there are pros and cons to think about for each option.
Leasing Professional Office Space
Leasing commercial office space has far fewer upfront costs than purchasing it. Generally, the property can be leased with only a security deposit equal to about one to two months of the lease value. This frees up cash you can use for developing your practice, like investing in equipment, paying competitive wages to your team, marketing your practice, and other business expenses.
You should be able to negotiate with the landlord an allowance for making modifications to the space that will meet the needs of your specific professional practice. This is often termed “Tenant Improvement Allowances.” This term must be made a part of your written lease agreement. Do not expect this to happen based only on a handshake with the landlord.
The location of your practice is a critical factor in determining its success. This is as true for an optometrist, physician, or veterinarian as it is for a dentist. There may not be good options for purchasing a building in a desirable location that will generate enough traffic for you to build a successful practice.
Leasing may be better for predicting the success of your practice than buying space in a less profitable location. You may have increased revenue due to an ideal leased location, which makes leasing a better financial option.
Leasing gives you more flexibility if you decide in the future that you need to relocate. There may be good reasons for you to need or want to move your practice. This is a much easier process if you either wait for your lease to expire or negotiate an early release with your landlord than if you need to sell your commercial space or building before relocating.
Although not as advantageous as purchasing when it comes to your taxes, leasing does have some tax benefits. You can deduct your lease payment, property insurance, utilities, and maintenance.
Remember that after years of practice in the same leased location means you will not benefit from any appreciation in the value of the property, your landlord will.
Owning Your Own Practice and the Commercial Space
There are significant advantages to owning both your practice and the commercial space where it is located. Some advantages are:
- You have more control. You are only limited in your growth by zoning regulations. You are not limited by your landlord’s guidelines. You are your own landlord and have flexibility over how to use the space.
- You have more stability. It is easier for you to project the annual costs based on your mortgage contract, property taxes, property insurance, and do not have to worry about annual increases in your lease or even a canceled lease.
- You have tax benefits. Your tax benefits range from deducting your mortgage interest from your taxes along with depreciation allowances.
- Increase in equity. Unless there is another recession, and you need to sell during that recession, the value of the commercial property can increase to a level that will help fund your retirement.
- Sell the practice and keep the building. If you sell just the practice and keep the building, you can then lease back the real estate to the new practice owner to generate passive income.
- You may qualify for a 100 percent mortgage. There are specialty lenders for certain specialty practices. For example, some lenders are familiar enough with the dental profession that they will provide 100 percent financing and mortgage loan packages that are attractive. This allows new dentists and other doctors who have not yet generated a cash flow and do not have funds for a down payment to purchase a building in addition to purchasing a practice. There may be similar loan packages for other professionals.
Downsides of Owning Your Own Commercial Real Estate
There are risks with any investment. Consider:
- The property may lose value. If the character of the neighborhood changes over time, you will possibly lose your equity, or not build up equity, and your practice may even suffer.
- You may be required to put down a hefty chunk of cash, generally 20 percent of the purchase price. This is money that you might be able to put to better use by investing in your practice by marketing, purchasing equipment, team development, and other business expansion investments.
- You are responsible for maintenance, repairs, property taxes, the impact of changing zoning regulations, payment of utilities, and so forth.
Owning Your Own Larger Commercial Building and Leasing Offices to Other Business
There are advantages and disadvantages to owning your own commercial building with several business suites. You use one suite for your own professional practice and lease the others to other practices or businesses. As with all other options, there are pros and cons to doing this.
Pros: You are in control of the inside and outside of the premises. You decide how the landscaping is done and what signs are put up.
You control who the other tenants are and can lease suites to those who may have businesses that enhance your own. For example, if you are a pediatric dentist, you may want to lease space to a pediatrician. If you are a veterinarian, you may want to lease space to a pet supply store.
You are building equity that you can use for your retirement. You may want to sell the building and cash out your equity. You may want to keep the building, rent your space to another professional practice, and collect rent from the new tenant as well as other tenants who are already leasing from you.
Cons: Your increased landlord duties will take away from the time and energy you could be devoting to maintaining and building your own practice. You will have to:
- Monitor lease due dates.
- Collect rent.
- Respond to tenant complaints and requests for repairs.
- You will need to provide for routine maintenance needs such as landscaping, weekly yard maintenance, snow removal, HVAC repairs, window cleaning, parking lot repair, and more. Although you can hire a management company to do these tasks, that will cost you money and you will still need to monitor the management company to be sure it does all the tasks you have contracted with it to perform.
- It will be very difficult if you decide to move to another location—either across town or across the country. You may need to sell the building to free up your cash to make the move possible. If you want to keep the building, you will need to hire a competent managing company to take care of the property when you are unable to do so. This will increase your costs of owning the building.
Pitfalls to avoid:
- Choosing the wrong building. Narrow your search to just two or three places. View them several times. Have the properties inspected by a professional so you know the property’s history and its current condition. Be sure you are informed about any renovations that have been completed and any future repairs that may be required.
- Choosing the wrong location. There may not be many opportunities for buying commercial property in an area that has the demographics you need to build your practice. This may be a factor that makes it more sensible to lease space instead of buying it.
- Not evaluating the market. Check occupancy rates, unemployment in the area, the demographics, property taxes, competitive price per square foot, and more.
- Going it alone. You need the help of real estate professionals skilled in transactions for commercial space and professional practices.
Recommendations for commercial building ownership:
It is a good idea to keep your business of owning a commercial building separate from your professional practice business. Your practice should lease space from your commercial building business. This maximizes the value of each business and separates the responsibilities and liabilities between the two.
- When your commercial real estate business charges your practice rent for the practice space, stifle the tendency to charge yourself low rent. Your rent should be priced at fair market value in order to maintain the value of the building, which is determined primarily by the amount of rent it generates.
- To be profitable, you should plan on keeping the property for at least 10 years.
- When selling the property, you will have a better return if you sell it to someone who has the same type of practice as you do.
It is Imperative to Engage in Due Diligence Before Closing Escrow on Your Purchase of Commercial Real Estate
Due diligence is needed to inspect the property and consider every aspect of buying and owning the particular property. All current lease agreements need to be evaluated. Financial statements must be reviewed. The property should be inspected by a professional for any renovations or repairs that are needed.
Check to be sure any previous improvements were properly permitted and met all federal, state, and local guidelines.
Any commercial real estate purchase must not be made without conducting comprehensive financial research as part of the due diligence process. This includes a realistic evaluation of expenses:
- What is the occupancy rate and turnover of businesses that lease office space?
- What is the length of each current lease? What is the potential for increasing the length and amount of the leases that will soon expire?
- What specific businesses rent the office spaces and what does each tenant pay?
- What are the monthly expenses for maintenance of the building?
- What are monthly utility costs and who pays them?
- What is the annual cost of repairs?
- Are there any planned renovations or any expected repairs? If so, consult with a trusted contractor who can give you an accurate bid for completing the projects.
- Evaluate the tax advantages. Do not overestimate the tax benefits. Consider the potential of property tax increases.
- Develop a long-term strategy for how to handle capital gains taxes if you decide to sell the property in the future.
- Is the cost of the building in line with the current market when you consider square footage rates, occupancy rates, and other factors?
- Is the geographical area growing with new construction projects or property renovations, or does it seem to be deteriorating?
Do not overextend yourself. Evaluate the risks before assuming too much debt. What if an unexpected expense comes up? There may be a water leak, problems with electrical wiring, roof repair costs. Do you have reserves to cover these costs? What if there is a building vacancy? Can you survive financially for the time it may take to get a new tenant?
Contact Dental & Medical Counsel for a Complimentary Consultation
It is highly recommended that you do not try to do this on your own. Whether you decide to search for space to lease or buy commercial real estate, at Dental & Medical Legal Counsel, we can assist you with every stage of your leasing or purchasing process.
Contact us to schedule a complimentary consultation with Ali Oromchian to see how we can help and what services we can provide to make sure you purchase the building correctly. We specialize in providing strategic legal services for dentists, optometrists, veterinarians, and other doctors.
