Most physicians who are given the opportunity to join a private practice expect to eventually become partners. Typically, after a few years as an employee, physicians are provided partnership role by way of purchase opportunity. The purchase would be based upon the value of the equipment, furnishings, accounts receivable and goodwill. Most practices tend to lease their medical office space, so no value is attributable to bricks and mortar. However, some practices own the real estate and issues arise as to whether incoming physicians will be provided ownership in the real estate.
The majority of medical practices are still structured as professional corporations. Typically, if the real estate is not leased, it will not be owned by the practice corporation itself for both liability and tax reasons. Rather, the facility or condominium will be owned by a separate entity. This entity is commonly structured as either a partnership or limited liability company, or if a single doctor is involved, the real estate could be owned jointly with the doctor’s spouse. Thus, a physician may become a partner of the medical practice entity without becoming a partner of the real estate entity.
In the past, most physicians showed little interest in becoming a partner in the real estate entity, not having a true understanding of commercial real estate as an investment. Additionally, they may not have been able to produce the financial requirement for buy-in to the entity or felt the location was not suitable. Whatever the reason, it was more likely than not that an incoming physician did not consider the investment. Today, with greater access to information and investment opportunities, physicians are very interested in real estate.
Prior to being added to a practice group, it is important to know the culture and seek like strategies for ancillary or investment opportunities. As per example, most senior physicians within the practice group may not share access to real estate ownership. Because real estate development, purchase and management is a significant investment of money (and time), it is understandable that incoming physicians would not be allowed access. Because of this, the senior physicians maintain that they will hold on to it as an investment for, or throughout, retirement. We are seeing some leeway here, though.
As an incoming physician, it would be important to take a good look at the real estate piece, no matter the situation of lease or purchase. If it is a lease, there will exist a written lease between two entities. The lease should not be above fair market value rental rate and in place for a reasonable period of time, both to be discussed further. If the rent is too high, perhaps to provide tax benefits to the owners of the real estate, there will be less capital to improve the practice. If the term is too short, you will face renegotiation of the rent too often, which will tends to create more advantage for owners that lease space. If the term is too long, the rent will likely step up each year to become a larger proportionate share of liabilities for the practice group.
In the situation of ownership, if the real estate is owned by one or more senior physicians, the practice will likely seek to relocate if they decide to sell the real estate. In order to avoid this situation, in addition to a long-term lease or a short-term lease with options to renew, the real estate owner(s) could give the non-owner practice partners an option to buy the real estate at an appraised value upon retirement or death, or a right of first refusal.
Now let’s assume that all parties wish to have an incoming physician buy in to the real estate entity. This may either occur at the time as the purchase into the practice entity or at the point the doctor has completed his or her buy-in. If the latter option is pursued, presumably, they will be more able to afford the buy-in to the real estate. In any event, the main issues will become the buy-in price and manner of payment.
The price can be determined in a few ways. One is simply by mutual agreement of all parties. Another method is simply using the original cost of the real estate if it was recently purchased, or the original cost plus annual CPI (Consumer Price Index) increases. The most common method, however, is by means of an an appraiser or broker opinion of value through appraisal or our brokerage entity. The fees could be as low as $500.
Once the price is determined, the manner of payment needs to be approached. One option is to simply pay each owner his or her share up front. If that is not possible, a promissory note could exist in favor of each real estate partner with payments made over time with interest.
A common method exists for partners to refinance the mortgage to as close to 100 percent financing as possible. The new partner would simply sign the new mortgage and be equally responsible for the debt without having to pay any out-of-pocket buy-in. The existing partners are able to pull out the cash equity at that time to realize a return on their investment. When interest rates are declining, refinancing is more likely to occur. A caveat is, if interest rates increase, the existing partners may not be willing to choose the method of refinancing due to larger interest payments, and, presumably, lesser real estate value.
Should a partner leave or retire from the medical practice, will they become obligated to sell his or her interest in the real estate and should the remaining partners be obligated to purchase his or her interest? If so, at what price? Thus, it is important to have the document treated carefully or via retainership of legal counsel.
Often times the inclusion of a physician to a practice group involves several items, including real estate, that should be addressed with business intelligence. MREA is capable of assisting in your next physician addition, partner acquisition or real estate transition. Contact your local representative for assistance.