Often, veterinary practice owners are counseled to retain the real estate and lease it to the buyer of the practice after the sale. They are told that there are tax advantages, they will be able to receive rental income, and that there is less risk if they first sell the practice and then sell the real estate. Finally, they are told that the package will be more affordable without the real estate. Let’s examine each of these.
Rental income: It is true that by retaining the property, rental income will be available. However, there are probably other, less specialized rental properties that would provide a better return than a veterinary hospital. The sellers could receive the same or more rental income from one of these.
Growing investment: Although the real estate is likely to increase in value, so would other properties in the same area. In fact, because a veterinary hospital is a special-use building, it is likely to appreciate slower than comparable multi-use properties because the resale market is much smaller. Using a tax deferred, 1031 Exchange, the real estate can be sold along with the practice, and all of the taxes can be deferred if another investment property is purchased within a certain timeframe. This strategy is not widely known, but any accountant should be able to obtain the rules. It is an extremely useful strategy, and we see it used commonly with the sale of veterinary practices.
Selling practice first: There is a misconception that if the seller retains the real estate and sells only the practice, if the buyer defaults, the real estate can be easily resold. That may or may not be true. Again, this is a special use building and likely would have its very best value as a veterinary hospital. So, to resell might require the seller to go back in and rejuvenate a practice which has been run down. The reality is that DVMs are very low-risk buyers. In fact, the SBA has named veterinarians the best profession for NOT defaulting on SBA loans, an admirable “feather” in our profession’s cap.
Too much cost: Owners often think that if they do not sell the real estate, it will make the purchase more affordable, when in actuality that is untrue in today’s aggressive lending market. The buyer will need to pay either rent or a mortgage and today, for the same piece of property, the mortgage payments are usually less than rent payments would be. With aggressive lending for the practices, it is not uncommon for a buyer to be able to purchase both practice and real estate with little or no down payment.
Finally, buyers almost always want to purchase both practice and real estate (you did, didn’t you?). If the seller is able to offer that as an option, it expands the market of interested buyers considerably.
Let’s have a look at a couple of what I call “trainwreck scenarios” to illustrate the logic of keeping real estate and practice ownership together.
Trainwreck Case #1
This practice was situated in a standalone facility built to be used as a veterinary hospital. The buyer, Dr. A, wanted to buy the real estate along with the practice, but the seller, Dr. B, refused. So, they agreed to a five-year lease with renewal options. In the end, the buyer was not satisfied, leading to several disputes between Dr. B (now landlord) and Dr. A. At the end of the five-year period, Dr. A moved the practice out of the building to a nearby location, leaving an empty space. Of course, Dr. B couldn’t realistically rent to a new veterinary hospital since there was now a new practice just down the street. The cost to remodel would have been at least $100,000. So, the building has been vacant for almost three years at this point.
Trainwreck Case #2
Both husband and wife were DVMs and owned a standalone building, again, built for use as a veterinary hospital. They decided to divorce and the judge, in his infinite wisdom, awarded the practice to the husband and the building to the wife, forcing the husband to be the tenant of his ex-wife. As you can imagine, things did not work well. The ex-husband purchased the property next door, built a new hospital, and moved the practice into the new building, leaving his ex with the empty special-use building. Of course, it would have been difficult to sell to another DVM, and she did not want to pay to have it remodeled. Eventually, her ex-husband made a low-ball offer and purchased it from her at well below market price.
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