The administrator of a large specialty practice once shared that she had 50 priorities in her field of vision and real estate was not one of them. Unless there is a pending lease expiration or strategic initiative to open a new site, real estate strategy was not top of mind.
As most medical practices will eventually confront a lease expiration or a strategic initiative, it is essential they establish a defined set of real estate principles to avoid becoming a passive player in an important decision that will have significant financial implications for a decade or more. All groups should develop an organized framework to best ensure real estate decisions align with the practice’s strategic, operational and financial objectives.
When it comes to real estate, medical groups typically fall into one of three categories:
Owners
Practice owns all its real estate either directly or through a real estate partnership. Motivation is generally financial as practice views the real estate as an investment opportunity with good short-term returns and as part of the physician owners’ retirement plan.
Renters
Practice rents all its real estate from third parties. Common reasons include:
• a larger group size where real estate returns aren’t material to individual partners
• recruitment concerns about requiring multiple buy-ins
• location constraints in mature markets where ownership options are limited
Opportunistic Investors
Practice is agnostic in terms of real estate ownership, looking at each opportunity through a lens of what best decision aligns with the business plans and goals of the practice.
The 15-Year Rule
From a financial perspective, ownership is attractive if the group has a high degree of confidence that the building will serve its needs for 15 years or more. Most analysis suggests that it takes at least this length of time before ownership is financially advantageous over leasing. Deciding to own requires a trifecta of confidence: in the market, building location, and building size. If any of these factors are uncertain, the practice would be better positioned to lease so that it could relocate, consolidate, downsize or expand if the need arises when the lease term expires.
In addition to long-term confidence in the real estate investment, groups should have full buy-in from all physician partners. Practices that have different ownership structures between the clinic and the real estate partnership may encounter conflicting interests. The practice could want to pursue a strategy that is not advantageous to the real estate partnership such as downsizing or relocation. Best practice to avoid such a scenario is to only allow active physicians to be in the real estate partnership and require all physician partners to be equal investors in the real estate partnership.
Collaborative Planning
Groups intending to be real estate owners generally start the process one of two ways: on their own or in partnership with a real estate professional. Although certainly not required, partnering with a healthcare-focused real estate professional is highly recommended for transactions of this scale. Buying and/or developing within the medical market is a multi-million-dollar transaction requiring a high degree of sophistication, so collaboration is often a strategic necessity.
The real estate professional will facilitate:
- Due diligence
- Governmental approval process
- Financing
- Legal documentation
- Consultant engagement (architect, contractor)
Although these services can be contracted on a fee basis with a developer, partnering with the developer on ownership affords the clinic with the optimal financial structure. The developer will deliver both cash for the equity investment and banking relationships that bring much more favorable terms than if the clinic were to finance the real estate on its own.
The Davis Approach
The key to successfully implementing a real estate strategy is partnering with the right real estate professional. With a focus only on healthcare real estate and an approach that optimizes the objectives of its clients, Davis is positioned to be the ideal real estate partner for a variety of healthcare organizations and specialty medical clients.
Davis has completed 40 medical outpatient developments (from 10,000 to 150,000 square feet) and 65 healthcare-related investment/acquisition transactions (totaling $989M in value). Davis shapes its role around the objectives of its practice clients—developing for the client, in partnership with the client, or providing its expertise on a fee basis for the client.
Ready to make real estate a strategic advantage instead of an afterthought? Email Michael Sharpe at msharpe@davishre.com to start the conversation.