In part 2 of a two-part series geared towards the veteran ophthalmologist, Collin Hart, MBA, CEO, managing director of ERE Healthcare Real Estate Advisors highlights key variables that will positively impact your bottom line as you progress toward your career and life goals. Read Part 1 to discover which common practice management scenarios may affect the dynamics of your practice real estate investments.
5 Considerations for Your Practice Real Estate | Part 2
Collin Hart, MBA, CEO & Managing Director − ERE Healthcare Real Estate Advisors
As changes in ophthalmology continue and as you progress toward your career and life goals, youʼre beginning to think about a succession plan. Whether that is a traditional retirement or a partnership with private equity, you may still have real estate assets that serve your practice. Transitioning your practice could change your goals for these holdings.
Given the continued need for healthcare and convenient patient access, your clinic and surgery center real estate hold significant value, not only as the center of patient care, but also as investments. Depending on your career strategy and your future objectives, now may be an opportune time to capitalize on your investments.
With an informed real estate strategy and proper structuring, you have the opportunity to maximize the value of your assets. In this article we will highlight key variables that will positively impact your bottom line.
How did you establish your lease rate?
We have encountered a variety of lease rates for ophthalmic real estate. Some are at a market rate, many are not. How was yours determined? Did you simply want to cover your mortgage and real estate expenses? Was the rate based on a slow, but steady return on your investment? Did you set up the lease as a profit center? Regardless of the initial reasoning, a practice transition provides the ideal opportunity for restructuring.
A market-rent analysis can be conducted by an impartial third party. You can also determine a market rate by contacting colleagues in your area. Establishing a market lease rate is more art than science, and exact comparables for highly specialized clinical or surgical space are sparse.
In the end, whatʼs important is setting a rent that the practice is comfortable paying, that youʼre satisfied to receive as a return on your investment and is not artificially low.
Right-sizing your rental rate allows for a more accurate valuation of your practice and establishes a more predictable rental expense for your new practice partner.
Negotiating a new lease
While you were the tenant in your building, your lease document may have been straightforward. Operating with a new partner, however, requires more sophisticated documentation that adequately governs your relationship with the new tenant. What is the length of the term? Does the rent increase each year or is it fixed for the duration? Who makes repairs to the building, parking lot and HVAC systems?
As the landlord, having fewer responsibilities with the potential for increasing income is in your favor. Locking in these provisions for a long period creates certainty of cash flow and reduces the potential for unexpected tenant negotiations. Lease terms of 10, 12, or 15 years are common — and should be welcomed — because they provide the practice buyer long-term control of the operation they are investing in while also affording you security of income as the landlord.
A well-structured, long-term lease also has the potential to transform your facility into investment-quality real estate, positioning it as a desirable asset for institutional real estate investors (often real estate investment trusts, or REITs) seeking secure cash flow. If owning the facility becomes a burden, selling the property with a long-term lease in place could create a windfall for you.
New Tenant, New Risk
As the owner-occupant of your clinical real estate, you maintained an intimate knowledge of your operations and practice profitability. The likelihood of receiving your rental payments and maintaining the facility was a 100 percent certainty. Moving toward a new partnership or an employed model of practice introduces new variables. Can you always count on your new practice owner to pay you rent? With reasonable certainty, yes.
But what if there are disagreements in your employment agreement, with your original physician partners or unanticipated changes in the market?Can you rely on receiving your rent in troubled times?
In the event of a default on rental payments, knowing your tenant can significantly impact your recourse as the property owner/landlord. Who signed the lease? Was it a newly formed business entity or a parent company? Did the tenant provide financial statements to you?
Know your tenant.
Valuing Your Practice Versus Valuing Your Real Estate
While contemplating a practice sale, you may also be entertaining the idea of selling your real estate. Youʼll create tremendous liquidity, cementing your overall succession plan. Although this path can be attractive, itʼs important to understand the differences in valuing your practice versus valuing your property.
While working with a practice broker, investment bank, or potential partner, youʼll be quoted a valuation for your practice according to a multiple of your EBITDA (earnings before interest, taxes, depreciation and amortization). Real estate is valued similarly, but as a multiple of annual rent. In todayʼs market, valuation multiples for ophthalmic real estate can be up to 50 percent greater than that of your practice.
Although a few practice partners may also be willing to acquire your real estate, they wonʼt value it as aggressively as a pure-play real estate investor. Separating your practice operation from your real estate assets creates maximized value for your career exit strategy.
The Time Value of Money
Youʼve collected rental income from your real estate over the course of your practice. Youʼre accustomed to the monthly cash flow. The prospect of continued rental income after a practice sale is even more attractive. The practice will always need a physical location and, in turn, youʼll always have a tenant.
However, as medicine changes, will your facility continue to suit the needs of your private equity partner? Ten years from now, will they need the same amount of space or be willing to pay you the same rental rate? Will your surgery center, then 15, 20, or 25 years old, need significant capital improvements to remain a viable facility for your tenant? Will you have to search for a new tenant?
If you could collect the next 12 to 15 yearsʼ worth of rental income today, without worrying about ongoing building management, maintenance or market risks, would it be attractive? Many ophthalmologists would answer “yes,” but most are unaware of the path to get there. A real estate sale and leaseback could help you achieve your objective.
A dollar today is worth more than a dollar 10 years from now.
Whether youʼre in the final stages of negotiating a sale of your practice or are beginning to explore the idea, itʼs important to understand that your practice real estate also has significant value. Establishing a basic knowledge of the previous concepts will help to secure your ongoing investment or, if you elect to sell, the tenets can enable you to maximize your propertyʼs value.
Although you likely have a real estate agent friend who helped you sell your last home, the world of investment real estate is nuanced. Having an adviser with specialized expertise in lease structuring, negotiations and transaction management is critical to ensure a successful outcome.
ABOUT THE AUTHOR
Collin Hart is the CEO and managing director of ERE Healthcare Real Estate Advisors where he leads the company’s strategy to provide executive level advisory to owners of healthcare real estate. Before co-founding ERE Advisors, Collin was a director in the real estate division of a private investment banking firm where he focused on advising physician partnerships and hospital systems in sale-leaseback transactions.
Collin earned his MBA from the SC Johnson School of Management at Cornell University.