SHOULD THE PRACTICE AND REAL ESTATE BE SOLD TOGETHER?

gerber_dave.jpgDavid B. Gerber, DVM, CVA
Simmons Northwest

This question commonly arises in practice sales with coincidental practice real estate ownership. Many owners do not think they should sell or can sell the real estate with the practice. We hear the following reasons:

They want the rental income,
Future investment to sell later at a higher price,
Defer taxes by not paying on the entire sale at once,
Sell later once they are sure the practice sale is safe under the new owner,
No one can afford to buy it all now.

Rental income may be a valid reason to hold onto the real estate, but there are likely better choices to accomplish the same goal. A veterinary hospital is usually a special use building, meaning that its highest value is as a veterinary practice. That is not always true, especially in some markets where real estate values are skyrocketing. Those excepted, special use rental properties carry significant risk. We could tell several horror stories in which owners refused to sell the real estate with the practice, but chose, instead to lease to the buyer of the practice. After the first lease period, the buyers vacated the buildings and moved into a freestanding locations, leaving the building owners with an empty buildings that required extensive remodeling. Leasing to another veterinarian is usually not possible in those situations because the previous tenant has opened a new facility nearby.

As to future investment, veterinary practice real estate has limited use and is probably not as good an investment as would be a sister piece of property nearby with a broader use. Moreover, the gain on the real estate sale is taxed as a capital gain. Unless there is a change in our tax structure, capital gain tax will always be with us and maybe at a higher rate. So why not take a 1031 exchange and roll over the real estate ownership into a more desirable property? This would defer the taxes and more effectively achieve the same investment goal. If you were unable to accomplish a 1031 exchange and you financed the real estate sale, you would pay a capital gain tax on the principal as you receive it over time. Rent is taxed at the higher ordinary income tax rate.

One of the reasons that the commercial lenders are so eager to make practice loans to veterinarians is that the loans “simply do not go bad, as one lender reported. In our experience, the great majority of practices take a strong double-digit jump in revenues the first 12 months after purchase. Additionally, we have seen only two sales nationwide go into foreclosure after the sale. Combine these favorable statistics with the seller‘s own intuition as to whether the buyer can follow in the seller‘s footsteps and be received by staff and clientele, and the long-term results following the sale are excellent. So after-sale security is not necessarily a valid reason to hold onto the real estate.

Probably the greatest fallacy is that the buyer “can‘t afford to buy it all now. While this was true a decade ago, it definitely is not today. There are many commercial lenders who are very aggressive in our profession, so that loan funds are readily available for buyers to purchase the real estate along with the practice, and usually with a very small or token down payment. Moreover, with the current interest rates and favorable terms available today, the mortgage payment on the real estate is typically about the same as a rent payment would be.

A major reason to consider selling the real estate with the practice is simply to accomplish the sale. Most buyers who are interested in purchasing the practice will insist on purchasing the real estate to avoid rent payments and to begin building equity from day one. We have seen several transactions fall through when the seller refused to sell the real estate.

Strictly from an ease of transaction perspective, the simplest and quickest way to close a transaction that includes real estate is for the seller to receive cash for the practice sale and finance the real estate himself or herself, perhaps with a balloon payment 5-10 years in the future.

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