Discussing the possibilities and future of the intersection of healthcare and commercial real estate
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This week’s episode of the Providers, Properties and Performance podcast is an interview where Galen Nuttall interviewed me on his Clean Bill of Wealth podcast. On Galen’s Clean Bill of Wealth podcast, he interviews physicians and professionals about financial health. As a certified financial planner, he helps physicians make financial decisions to help grow their wealth. We discussed the benefits of, and differences between, active and passive ownership in healthcare real estate.
[1:34] How I support physician owners and investors
I am the managing principal at DOCPROPERTIES, and I help physician owners and investors in the healthcare real estate asset class. This is another way for physicians to build their personal wealth, and I want it to be easy for them to understand. It makes a lot of sense for them to own the building they practice in, either just for their own practice or something big enough for them to occupy and have tenants.
There are a lot of costs involved with owning a practice, in addition to the time and money physicians invested in their education, fellowships, and training. Typically, when they get into mid-career, they want to invest in themselves. Investing in property is one of the ways they can do this.
If the physicians are real estate savvy, sometimes they do become investors in other property types. Healthcare real estate, however, seems easy for them to understand in general. They can typically look at the tenant mix and see if it is going to be a property that will survive with tenants long-term.
There are many financial aspects to them owning their own property. First, there is an ownership structure, which can involve all the physicians in the group or just some of them. They typically sign a lease with the practice for tax purposes. The property itself appreciates, and here in the U.S. the interest rates are currently low. So it’s a good time, for many reasons, to invest.
[5:09] The stage when physicians tend to look at investing in healthcare real estate
Typically, I don’t see a lot of early career physicians looking to invest. They are just out of school, and many have a lot of debt. In addition, they may not have decided if they are going into private practice or if they are going to be a hospitalist to start. Those early in their careers are making a lot of decisions, and funds are typically tight.
When they get into mid-career, however, they start having families and thinking about the future. They may also start to get frustrated about being squeezed with costs, and they start to think more about making their money work for them. They may be looking to expand, or they start thinking about the cost of leasing plus building out tenant improvements. The lease versus own analysis likely helps perpetuate this decision further because when they start looking at their numbers and the improvements they need, any landlord is not going to supply 100% of those improvements. They may come up to a certain point for a specific lease term, but the practice has to come up with the rest of it. Even if they sign a 10 year lease, they don’t own the space at the end of 10 years. They will either have to keep renewing the lease or they will have to move and pay improvement expenses again.
Looking at expanding becomes another pivot point. If the practice is big enough to occupy its own building, say 20,000 square feet or so, they may start thinking it would make more sense for us to go into a building where they could do an adaptive reuse or building their own space. Some places have a lot of available land to potentially build on, where this wouldn’t be possible in more dense cities and geographic areas. From there, they have a lot of flexibility with regard to refinancing, owning it, and giving distributions.
When the practice, or part of the practice, thinks they have about 10 years left, they can put a lease on it and sell it to an investor as a sale leaseback. Owning, therefore, offers a lot of options for the physicians throughout the life cycle of their business. I actually recently met with a group that offers ownership structures for physician groups. They help with sourcing financing and they develop structures where a practice with multiple buildings could be owned by different physicians under one umbrella.
Physician ownership is good for recruiting, because they can offer ownership options for new doctors coming into a practice. Then, as physicians get toward the end of their careers and want to cash out, there are options available for that as well. It can really be a good economic benefit for a practice rather than a source of expense like a leased property is.
[10:40] The stage when physicians can benefit from support to invest in healthcare real estate
If they are looking to buy, it’s nice to have a bit of a runway. To build, you probably need about 2.5-5 years. Three years would probably be typical, because even if you find something right away there is a lot of time involved. When physicians have 3-4 years left on their lease, that is a good time for me to get involved. With a long runway, we can look for deals that make the most sense rather than having them feel like they need to make decisions under the gun.
I help source properties as well as sell properties. I know a lot of different industries, and I have insight into whether certain people or parties will fit together more than others. There are investor groups that prefer different properties depending on size, the tenants, the practice, the location, and other characteristics. My job is to help the practice get a building or to match them with an interested investor when they are ready to sell their property.
[12:54] Ongoing management after acquiring a property
Sometimes I come across physician groups where someone has raised their hand to manage the property, and maybe they have a bookkeeper to do profit and loss. Other than that, they are doing ad hoc management and if something breaks then they will call a vendor. If you’re a busy physician and things like that start to happen, you have other tenants that can eat away at your time and it can become a second job very quickly.
Vendors can start early in the day, but they can get sidetracked if something is not going right and they have to fix it. So a physician could be trying to see patients, or they could be doing a procedure, while a vendor is trying to connect with them to address something about the property.
If everyone in the group is a practicing physician, I advise them to hire a property management company. There is a lot that goes into managing a property, and everything has to be done well when it comes to medical facilities. Janitorial work is essential, and medical waste needs to be handled appropriately. Heating and cooling systems are critical in terms of climate control in the building, so backup generators may be needed as well. There is a lot of infrastructure that has to be addressed in a healthcare property, and it is definitely worth the money to have a professional property management company handle the day to day issues. This leaves the physicians open to do their work during the day, and maybe at the end of the day they have to look at a report, answer questions, and make some decisions.
Another important point is that the banks here in the United States like to lend to physicians because they typically have a reliable career and cash flow. The terms are very favorable, and there are also capital partners that want to help physicians when they don’t have time to do everything themselves. There are different ownership structures and joint ventures that allow for an expanding practice without having to take on all of the financial risk. It’s often not worth the learning curve and the time investment for physicians to take on everything involved in property management by themselves.
[18:55] The decision to invest in multiple properties
Some physicians might start with a multi-tenant building, and once they get comfortable with the day to day management then they might decide to invest in additional property. They can see their net worth increasing, and in the U.S. it’s very favorable to own real estate in terms of your taxes.
Physician owners do tend to grow their own practice or own other multi-specialty or multi-tenant properties. Sometimes, if the practice is big enough, they will also open a surgery center. Then they can also have pre- and post-op clinics near them, and they continue to grow that way. In addition, if they find a good lender, capital partner, or developer, they can continue to build their real estate holdings.
[21:57] Income properties and taxes
If the practice owns a building, they will sign a lease with the practice. Typically, the ownership of real estate is a legal entity of its own and the practice is a separate legal entity. I don’t want to delve too deeply into the details, as I am not a CPA, but there is depreciation in the capital improvements. The proceeds from a rental income are taxed at a lesser tax compared to ordinary income.
[24:06] Ongoing revenue and profit from healthcare real estate
The whole point of purchasing a multi-tenant medical office building is taking a portion of it while still generating profit. If you’re buying the building and developing it yourself, or buying and renovating the inside of an adaptive reuse, you need to make sure you aren’t paying too much. You need to charge a fair rate for rent and still make a profit after you finance and operate the property. The numbers have to make sense so that you can make a profit.
We have been talking about active investing in real estate, but there are also passive options. Passive investment could be a good option for people earlier in their careers as well, as there are some private investment syndications where you can just buy certain shares without having to put tons of money in. There are also real estate trusts that do 100% in healthcare real estate, and those are traded on the stock exchange. These options allow people to get into the healthcare property asset class without having to actively own and manage a property.
[27:58] Investment options
When you get into commercial property investment, you can use long-term loans. They are typically a ten-year amortization. You can get a thirty-year amortization, but it’s usually a ten-year loan that might get refinanced if necessary in order to get better deal terms.
Healthcare real estate is typically demand-driven and mission-critical, so it doesn’t get overbuilt. It can have higher vacancies in some markets and lower vacancies in other markets. I advise most practices to partner with somebody that knows exactly what is going on in their market and can advise them on lease rates, cap rates, market trends, and all the clauses involved in various contracts. Mistakes can be expensive when it comes to real estate.
[34:14] The tradeoff between training to become a physician and learning about investment
The tradeoff between time and energy is the key point here. Some physicians are overachievers and go get their MBA. If you’re not negotiating business deals all day long, you don’t know exactly the target range where things are. You probably don’t want to see patients all day or be in surgery all day and then go home and spend four hours in your email managing the business side of things. Preserving time and energy is crucial.
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