December 8, 2020
Some old adages will do just fine here. You know, like the one about throwing the baby out with the bathwater or cutting off your nose to spite your face.
Physicians in the midst of a practice sale or merger naturally focus on the economics of the deal. Too often, any real estate component is ignored and the consequence is a significant loss of value in the real estate that mitigates the value gained in the sale or merger. To make things worse, the property also becomes more difficult to finance, which will negatively impact the returns. It doesn’t have to happen that way. Let’s examine why this occurs and how it be avoided.
A medical building’s value is driven first and foremost by the strength of the lease and its likelihood of renewal. In the case of an owner-occupied building, the chances that the owner/tenant will default on the lease (to itself) are very low, while the chances that the owner/tenant will renew the lease (to itself) are very high.
The minute that the owner of the practice is different from the owner of the building, the special incentive to sign and maintain a lease disappears. The property that had been termed “owner-occupied" (most favorable) is immediately reclassified to “commercial real estate” (less favorable).
The value of the building is reduced and available financing terms are not nearly as good. Loan to value ratios are lowered and rates are raised. Amortizations are shortened and guarantees are expanded.
The Cardiovascular Conundrum
In 2011, a 25-doctor cardiovascular group in Alabama built and occupied a 90,000-sf MOB worth more than $20 million. In 2013, however, the members became employees of the hospital and the hospital took assignment of the remaining 10-year lease. The original financing terms in 2021 and the doctors are finding it very difficult finding a bank to extend a new loan anywhere near the original terms. Why? Because there is no new lease in place and the doctors are no longer owners. In fact, the hospital has shown no real interest in its renewal. The doctors have no control to force a lease extension. So, while other practices are taking advantage of today’s low rates and locking in new, 10-year loans, these surgeons are scrambling to refinance the debt for a term and fixed rate of just 28 months. When and if the hospital renews the lease, rates may well have increased. This story is just one version of many documenting unforeseen negative repercussions from the sale of a practice. That said, it doesn’t have to end this way.
The Bottom Line
Never lose sight of the fact that your building is an integral part of your practice. Therefore, it must be an integral part of your negotiation. Employ an expert to assist in this aspect of the discussions who will assure the value is recognized either through long-term lease commitments or sale to the buyer or another third party. Remembering the real estate early will avoid future remorse.