Dental practice real estate: Own it or rent it?
With all the debts new dentists have today, one way to keep costs under control is to own the practice real estate.
Any dentist looking into commercial real estate (CRE) for his or her practice should have the mentality of being "pro-real estate." In other words, you should not be afraid of real estate financing, market forces, and property management. If you are comfortable owning a home or rental property, you will most likely be successful in owning your office real estate.
My second premise is, if the PITI (principal, interest, taxes, insurance) is less than, similar, or even slightly higher (10% maximum) than a lease base rent plus common area maintenance (CAM), then it is worthwhile to think about practice real estate ownership when you buy your practice. Whether it is a condo in a medical building, a retail strip center, or a stand-alone building (my personal favorite), ownership of the space can be a real advantage.
If you lease office space, rental rates tend to rise over a 10- or 20-year period and can reach a point where you might need to consider moving the practice. Building ownership costs tend to be mitigated from large increases over time, with the exception of taxes and insurance. If you buy a practice in an area you see as a long-term neighborhood or city, then owning the real estate can help keep your occupancy costs under control for the dental practice.
Dentists purchasing CRE commonly create an LLC (or any corporate entity) to own the real estate separately from the dental practice. The dental practice then pays rent to the building LLC. Many times the dentist might own the building jointly with a spouse or a family trust. In any structure, the entity that owns the real estate enjoys interest and depreciation expense deductions, and can build equity as the principal is reduced monthly for however long the practice operates.
Tangentially, a good way to reduce the net income, and consequently certain taxes of the dental practice, is to increase the rent you pay to your real estate entity. If you have expenses that can be used in a real estate LLC, you can mitigate the rental income to your LLC. If you purchase commercial dental office real estate today and sell the building 20 years from now, you can expect a decent rate of return on your investment.
An excellent place to start when you shop around for a practice is with a dental practice lender. Ask the person to run practice numbers with a lease figure, and then run the same calculations with CRE and PITI as part of the proposal. Most specialized dental lenders really like the CRE (assuming the price is correct) because it protects the practice and the loan they are underwriting.
The lending rates and amortizations available are extremely attractive today. Some banks offer a 20-plus-year term that typically allows for the mortgage payment to approximate a rent figure. Instead of throwing money down the drain, you can build equity and have all the benefits of ownership. Even though occupancy costs average 5%-8% of collections annually for most dental practices, I believe CRE ownership is worth investigating under the right circumstances, with proper information from competent advisors.
Can real estate end up being a bad investment? Absolutely yes. If you buy at a market peak like we're seeing today in many cities across the United States, and you have to sell under duress at some point in the future, this can certainly be a devastating scenario. Also, at the end of a long ownership period, you will be forced to add back depreciation upon the sale. However, there are creative ways today to transfer or 1031 exchange property into an investment tool and defer that expense into the future. Generally speaking, when we transfer real estate and a dental practice together, from a long-term dental practice owner, the real estate experience has been a positive one. With all the debts new dentists have today, one way to keep costs under control is to own the practice real estate.
Edward R. Esposito, MBA, CVA, is a licensed practice broker, certified valuation analyst, past national president of ADS Transitions, and current owner of ADS Precise Consultants. He lectures at the University of Colorado Dental School, as well as at local and state dental associations. Contact him at (303) 759-8425 or email@example.com.