Ken Rubin, CPA, PFS
If you properly apply the information in this article, you should be able to retire wealthier than the vast majority of your colleagues. Real estate is a big passion of mine, and I was excited when I was invited to write this article and share this information.
Owning your office building is a phenomenal wealth-generating tool for many reasons. Dentists who lease their offices typically spend several hundred thousand dollars on tenant improvements (TIs) for the office, and in doing so ultimately make the landlord wealthier. At the end of the lease, the landlord gets to keep the TIs and gets to charge increased rent to the next tenant because the dentist improved the property.
When you own real estate and make mortgage payments, a portion of that payment (the principal portion) effectively goes into your pocket because it pays down the debt and increases your equity in the property. However, when you are a tenant paying rent, you’re making someone else rich—the landlord. Your payments do not build up any equity for you, and you do not get to enjoy a career’s worth of inevitable gigantic appreciation accumulated during multiple real estate cycles. You’re pouring rent money down the drain.
Owning your building also allows you to use external signage and banners to effectively promote and build your practice without the risk of receiving a denial from your landlord to do so. Ever wonder why they’re called landlords?
Owning your office will help you avoid one of the most common problems when you prepare to sell your practice—inability to assign your lease to a buyer. Many lengthy articles have been written on this subject alone.
Owning your building gives you the option of having a built-in retirement income from the buyer when you sell. Also, when you sell you will enjoy the unparalleled tax minimization/elimination that real estate provides. Most people have heard of 1031 tax-deferred exchanges. There is also a relatively new tax break for real estate that provides tax-free benefit.
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Real estate is an I.D.E.A.L. investment
• Income—Positive cash flow from rents is collected.
• Depreciation—There’s benefit from annual tax shelter deductions of “paper write-offs” generated without spending money.
• Equity—A portion of your monthly mortgage payment goes to pay down your loan balance, resulting in an increase in your equity.
• Appreciation—As property values go up (as they historically do in the long run) you get to enjoy wealth-building appreciation.
• Leverage—This is the concept of using other people’s money to make you money. With leverage, you can control a large amount of property with a small amount of your own money. Suppose you put 10% down to buy a $1 million piece of property and receive a bank loan for the other 90%. If the property appreciates by 10% and is now worth $1.1 million, you’ve made a 100% profit. Your $100,000 investment turned into $200,000, so you doubled your money!
To understand how money works, you must understand a concept that is so critically important that it is referred to as Economics 101—supply and demand determines the value of anything.
• Real estate has a limited supply—No one is making more of it.
• Real estate has an ever-increasing demand—The US population continues to skyrocket,1 and people need a place to live. Additionally, there has been a big increase in noncitizens buying US homes (additional demand), which accounted for over 10% of US home sales in 2017.2
An increasing demand coupled with a decreasing supply explains why real estate values have gone up. History has a funny way of repeating itself, and even after the next real estate downturn, the eventual rebound and subsequent value peak during the next real estate cycle will be even higher than the previous peak. Historically this is what happens, and it should continue to do so.
Because real estate cycles last an average of 18 years,3 one must have staying power to be able to hold onto a property through peaks and troughs and the inevitable downward portion of a real estate cycle. As long as the property produces enough rental or business income to pay the mortgage and other expenses, the owner will have the staying power to hang onto the property long enough to make it to the next peak in value.
More advantages of owning real estate
There are many, many ways to make money in real estate. A big deterrent for many dentists is the fear of property management. But if you hire a professional property management company, you won’t have to spend your time and become frustrated dealing with tenants.
Beyond owning your dental office location and home, a next step is to own residential rental property (single-family residences or apartment buildings) and have them professionally managed. A classic good move for a dentist is to buy a small apartment building close to a college campus and have it professionally managed. The college kids’ parents will pay the rent like clockwork.
Some people choose to own commercial rather than residential property. I started buying residential investment real estate 30 years ago because it was basic and easy for me to understand. I’ve never invested in commercial buildings, although many people have been very successful at it.
Improving property on paper by obtaining entitlements, permits, and approvals, and then physically improving the property can be tremendous ways to make massive amounts of money in real estate. I’ve obtained numerous condominium maps for apartment buildings, which dramatically increased the value of the building, and there can be further profits when the condos are sold individually.
Splitting a parcel of land into multiple small parcels will also provide a huge increase in value. Large subdivisions of land can yield even bigger returns, but exercise caution because land can be a highly volatile asset. If you own it during a downturn in the real estate cycle, no income will be produced. If the land is leveraged with a bank loan, you still need to make the payments or the asset will be lost.
If you have a close and trustworthy friend or relative with the ability to make money in real estate but not the capital to do so, you could team up with that person. (It’s important to have a written contract.) Your partner will do all the work, and you can simply provide the capital and not spend any time. I did this with a lifelong friend in 2011, and we (actually, he) fixed and flipped over 300 area houses and condos in six years primarily using other people’s money.
Of course, real estate is not for everyone. Many dentists simply use a middleman financial planner to develop a diversified portfolio of mutual funds, which is passively managed with razzle-dazzle computer automated rebalancing. They often don’t understand the true impact of the large management fees that are automatically debited from their accounts. That model will never provide true wealth over time. Imagine if you bought just one single-family rental property every two years during your career. And yes, you can use your retirement plan money to invest in real estate.
Unlike many other investments (stocks, bonds, mutual funds, etc.), real estate has a tangible intrinsic value and a physical use and purpose. It’s a place for people to live, businesses to operate, and land to cultivate.
Like others, I’ve made my share of mistakes through the years and I’ve acquired a tremendous amount of wisdom from my experiences. As always, I am available to answer any questions to help you. Fortune really does favor the bold!
1. US census population graph from 1790. Wikimedia website. https://commons.wikimedia.org/wiki/File:US_Census_Population_Graph_from_1790.svg. Updated September 2014.
2. Olick D. Foreigners snap up record number of US homes. CNBC website. https://www.cnbc.com/2017/07/18/foreigners-snap-up-record-number-of-us-homes.html. Published July 18, 2017.
3. Foldvary F. Riding the upswing of the real estate cycle: 2012-2022. Progress website. https://www.progress.org/articles/riding-the-upswing-of-the-real-estate-cycle-2012-2022. Published August 16, 2015.
Ken Rubin, CPA, PFS, is a frequent author and lecturer on various profit maximization and tax minimization topics. Ken Rubin & Company Dental CPAs & Business Advisors has been helping dentists since 1984. Rubin is the cofounder of the Academy of Dental CPAs (ADCPA). He can be contacted at firstname.lastname@example.org or (619) 299-6161. Visit his website at kenrubincpa.com.