If you own or operate a dental practice, you are required to cut an unavoidable check every month to
pay for your office space. After payroll, real estate is typically the second highest
expense in any healthcare business. The good news is that your real estate
costs are negotiable! That makes it the number one opportunity to substantially
impact profitability over the life of a practice.
This being true, the question to
answer is "Should you own or lease your office space?" The answer
depends on a number of factors, such as:
·
What is the age of your practice?
·
In what market or area of town do you want to be
located?
·
How close are you to retirement?
·
Do you have an exit strategy?
·
What is your current financial position?
·
What real estate options are currently
available?
The reality is there is no ‘one
size fits all’ answer to purchasing versus leasing. When properly represented,
leasing can offer some very compelling benefits such as flexibility or
financial concessions such as free rent, free built out period, a tenant
improvement allowance and more. However, for those who want to take a deeper
dive into the benefits of purchasing, the following reasons make commercial
real estate ownership very attractive.
Increasing
Your Net Worth
The typical dental practice
is looking for new ways to increase revenue. For example, a dentist might bring
in a specialist, purchase a new piece of equipment, offer new services or even
expand to add more operatories or exam rooms.
Those are great options and worth considering to increase revenue; but most
of those ideas also require the practice to take on additional overhead.
Real estate ownership involves taking
a payment you already make every month, and adjusting ‘who’ is getting paid. If
you own, then your monthly mortgage payment goes toward increasing your net
worth by typically thousands of dollars every month as you pay down principal
on the loan; versus if you lease, then you still cut a check every month,
except the landlord’s net worth increases each month. Over a ten to twenty year
period, the difference is typically hundreds of thousands and even millions of
dollars in favor of the person who owns the real estate, either the practice or
the landlord.
Tax
Implications
The equity benefits of ownership
are common knowledge. Not as commonly
known are the tremendous tax benefits afforded with ownership.
Typically, the real estate is
owned by an LLC which is formed by the practice owner(s). Rent and operating expenses are then paid by
the practice entity to the LLC. The
practice can write off rent and operating expenses on its taxes, the same as it
would if the real estate were owned by an unrelated landlord.
Given that the dentist owns both
the real estate LLC and the practice, do the taxes on the rental income paid to
the LLC negate the practice's write-off benefits for rent paid? In short, no, but a CPA should be consulted
to evaluate the precise implications.
It is true that the LLC will be
taxed on rental income. However, the LLC
also has a number of additional write-offs that substantially reduce this tax
liability.In addition to the mortgage
interest deduction, the LLC can depreciate the building and land improvements.
The standard straight-line deprecation for commercial property is 39
years. Some property improvements can
also be accelerated. For example, while the land itself isn't depreciable, the
land improvements can be depreciated over 15 years or less, using cost
segregation methods.
Put in simple numbers, if
$1,250,000 was paid for a property, and the land was worth $250,000; then the
remaining $1,000,000 could be written off over 15 to 39 years. That's a minimum of an additional $25,000 of
tax deduction annually.
By leveraging depreciation
timelines, known as cost segregation, a CPA can sometimes nearly wipe out the
entire tax liability on rental income. These
tax deductions provide another compelling reason to own.
Retirement
and Exit Strategy
Some people are disciplined
enough to put thousands of dollars into their retirement every month. If you do, that's great. But why stop there when you can double your
efforts by leveraging ownership in your dental office? On the other hand, if you don't have the
discipline to fill the coffers, then owning your office space is a forced way
to bolster your retirement strategy.
So, what happens to the property
when you retire?
When you're in a lease and are
ready to retire, it's a simple exit. You
close the practice or assign the lease to the buyer of the practice and you're
done. The value of the practice you have
spent your life building is the only item you have to sell. If you own your
real estate, you have a number of options to consider:
·
Sell it to the practice buyer and either cash
out or 1031 exchange it, increasing your real estate investment portfolio
·
Sign a long term lease with the buyer and receive
the additional cash flow at thousands per month
·
Or a combination of the two… lease it to the new
practice owner and create an annuity, and then sell it and cash out years down
the road when the new practice owner is ready to buy the real estate also
In a practice transition or sale,
it's very common for the real estate to be worth more than the practice.
Evaluating
Your Options
It's important to have realistic
expectations about available and viable options in the market, because sometimes
it's simply not an option to own. Variables such as the city, part of town,
square feet needed, type of building, etc., can collectively or individually
eliminate all realistic possibility of ownership in a specific market, where ownership
is nearly impossible. For those reasons alone, it is vital to have expert
representation to fully vet all of your options for you.
Additionally, it's wise to look
at all of your options to determine if leasing or owning is right for you. Evaluate
retail and office spaces. Cover all
your ground and compare your top three to five options before making a
decision. If you have a property in mind and think "This is the
one!", that could be true. Still, take the time and due diligence to
validate that choice by comparing it to the rest of the market.
As a dental professional, you
want to lay your head on your pillow every night for the next 10-20 years and
know you made the right decision, instead of thinking "I forced it and I
know I didn't make the right decision, or I didn't do my due diligence."
You can't make an informed decision if you don't know your options.
Overall, if you have a chance to
own and the numbers are favorable, then ownership can be a tremendous
opportunity to maximize profitability, increase net worth, and end the lease
negotiation wrestling match with Landlords every 5 to 10 years.