Don’t Overlook In regards to the Actual Property!

The variety of doctor practices transacting with non-public fairness lately has elevated year-over-year within the final 5 years, with 2021 being on document because the yr with the best variety of offers on this sector. Low rates of interest and excessive valuations drove many doctor teams to promote their medical practices, usually with little or no consideration about the actual property that the practices are positioned in, a lot of which can also be owned by the physicians. This text explains why doctor practices which are considering a transaction with non-public fairness ought to pay particular consideration to the actual property property and never solely the medical observe property.

Background

Many physicians nonetheless personal the actual property property that serve their medical observe. Medical workplace and surgical procedure middle actual property holds important worth, not solely as a result of they’re the placement the place affected person care is supplied, but in addition as investments. Nonetheless, transitioning in direction of a sale of the medical observe is prone to change the targets for these holdings, or no less than spark a dialogue.

Whereas the standard mannequin of affiliate physicians systematically shopping for out the pursuits of senior companions as they retire has labored for a lot of a long time, well being care stays dynamic, requiring fixed recalibration.Not solely does this apply to a medical observe or an ambulatory surgical procedure middle, but in addition the actual property the place these companies function from, usually leading to questions like:

• How will the physicians ultimately get their capital out of the constructing?
• Are affiliate physicians in a position/keen to shoulder the debt/cost of shopping for into the actual property?
• How does a personal fairness sale have an effect on the physicians’ property holdings?

Questions 1 and a couple of are situational and extremely depending on partnership composition. Usually talking, as gleaned via dialogue and session with lots of of specialty doctor teams nationwide, the consensus appears to be that youthful physicians are extra danger averse.Possibly they’re laden with debt from medical faculty, searching for a greater work-life stability, or simply don’t like the thought of investing in a dated constructing. How do their selections have an effect on the senior companions’ actual property exit technique?

For the stability of this text, we’ll deal with Query 3 above, which is extra goal and preparatory in nature. If a doctor group is exploring a personal fairness transaction, it’s essential to even have consideration for the way actual property suits into the equation.It’s nearly all the time the case {that a} observe sale will generate extra whole worth, however actual property is second, and nothing to scoff at.

How does a personal fairness sale have an effect on our property holdings?

Most doctor teams purchased or constructed their actual property to manage the future of their observe; as owner-occupants, they’ll dictate their very own lease and lease phrases. Opposite to the “location, location, location” assumption, lease and lease phrases are the first drivers of worth in medical actual property. Let’s not neglect that this isn’t a really arm’s size association; lease is just paid from one pocket to the opposite (observe entity to actual property entity). At any level of their possession cycle, a doctor group can enhance or lower the worth of their constructing by adjusting the lease they pay to themselves. All of that may change as a part of a personal fairness transaction.

Now, lease will likely be paid from the non-public fairness backed observe to the physician-owned actual property entity. It’s typical {that a} new lease will likely be struck as a part of the deal, formalizing the landlord-tenant relationship, together with the obligations of the 2 events. On the similar time, the property worth turns into fastened and is extremely depending on the phrases of the brand new lease that has been negotiated. Correct lease structuring throughout a personal fairness transaction is paramount to protect and maximize (or, no less than, not impair) actual property worth. This may be achieved with fundamental preparation and little to no influence on observe valuation.

So what goes into maximizing property worth?Considerate lease structuring, together with the next:

1. Honest Market Lease – May be established via a assessment of market comparables or by partaking an actual property advisor specializing in well being care properties. Medical property are completely different than different actual property, so additional care should be taken to determine properties which are really comparable.
2. Lengthy Time period Lease – A minimal of 10 years, however 12 or 15 years is right, serving to create a safe stream of rental earnings for the foreseeable future.
3. Annual Rental Will increase – Sometimes within the vary of 2-3% per yr, with exceptions in inflationary durations the place annual progress within the CPI exceeds the fastened will increase.
4. NNN Phrases – Along with base lease, the observe/tenant must also accountable for paying property taxes, insurance coverage, constructing upkeep, repairs, and replacements.
5. Company Assure – As an alternative of sustaining the observe because the tenant entity, the owner advantages from having the bigger company entity (i.e., the private-equity backed platform) because the tenant or a guarantor of the lease.

Along with the monetary issues, there are additionally authorized and tax implications to think about in relation to structuring a lease throughout a personal fairness transaction. It is vital to work with skilled authorized and tax advisors to make sure that the lease is structured in a manner that maximizes worth whereas additionally complying with related rules (together with, if relevant federal and state fraud and abuse legal guidelines governing physicians) and minimizing tax liabilities.

So why is it so vital to correctly construction a gaggle’s lease as a part of a personal fairness transaction?The reason being as a result of as soon as the deal is closed and the lease is executed, it’s tough to barter and alter the phrases afterwards. As well as, it makes monetary sense to restructure the lease earlier than a personal fairness transaction as a result of the numbers are enticing too as a result of whereas all of us can agree that actual property has some intrinsic worth, property valuations are completely different in comparison with medical observe valuations. Because the diagram beneath outlines, medical practices are valued as a a number of of EBITDA whereas actual property is valued as a a number of of lease.Usually talking, except for very massive practices, multiples on actual property are nearly all the time greater.In consequence, restructuring the lease as a part of the non-public fairness transaction is a worthwhile endeavor.Whether or not you intend to promote your observe actual property instantly or not, a well-crafted lease ensures you’ve gotten the optionality to take action in some unspecified time in the future sooner or later.

One other vital consideration is the influence of the lease construction on potential consumers. If a doctor group decides to promote their observe and actual property sooner or later, a well-structured lease could make the property extra enticing to potential consumers. Patrons will likely be extra keen to pay a premium for a property with a long-term lease and steady rental earnings. This may finally end in a better gross sales value for the property.

In conclusion, a personal fairness transaction can considerably influence the worth of physician-owned actual property, making it essential to correctly construction lease agreements. By working with skilled advisors and taking the time to develop a well-crafted lease, doctor teams can maximize the worth of their actual property holdings and be sure that they’re well-positioned for the longer term.

Collin Hart is the CEO and Managing Director of ERE Healthcare Actual Property Advisors. Anjana Patel is an legal professional with Epstein Becker Inexperienced.