Diagnosing the state of health care investment property

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KesterSmoak

As the U.S. economy continues to strengthen following the Great Recession, increased opportunities have arrived for building owners to monetize their assets through a robust commercial investment property market.

After the significant stock market devaluation of 2008, many investors have become wary of the volatility of the equity markets, choosing instead to put their cash into real property yielding a passive income stream. The last few weeks of August 2015 further highlighted the potential for volatility that is inherent with traditional investment in equities.

Investors looking to place capital in commercial real estate have historically targeted buildings occupied by national credit retailers, with recognizable tenants such as Walgreens, Starbucks and a host of fast food restaurants. As the market for these opportunities has tightened, the investor community has turned its attention toward medical and dental offices as an opportunity to capture higher returns. These properties are typically owned and developed by the practice founders or owners, and can be a source for a substantial windfall for these individuals.

Below are some common questions and scenarios that property owners encounter when considering selling a building as investment property.

 

Q: Our physician group sold the practice to a hospital system that now leases the building to us, as we still own the real estate. What opportunity exists for us to sell the property to an investor?

 

Every day, investors are scouring the Upstate, looking for opportunities to purchase the income stream from fully leased medical buildings. Depending on the terms of the lease with the hospital system, the sale of a practice can create a significant spike in the value of the underlying real estate. We recommend consulting with a trusted real estate adviser, who can assist with packaging the building for sale as an investment grade asset.

It is important for the building owner to understand that the sale does not result in any changes or disruption in the day-to-day operations of the practice. The existing property owners often enjoy realizing a valuation that is significantly above the building’s original cost, and the new building owner is inserted in place of the previous landlord.

 

Q: I am a dentist or a physician and I developed the building in order to have a place to operate my practice. Does it make sense to consider selling the building, considering that I still own the practice as well as the real estate?

 

Yes, as a matter of accounting, many physicians or dentists who own their building already lease the property back to the practice. This a common way of accounting for office lease expense, as well as increasing business expenses with respect to offsetting income for tax purposes. An investment sales broker can assist with the coordination of creating a triple net lease document, drafted and reviewed by an attorney. The lease terms in this document will dictate the valuation of the property, and as such, this is a critical component of the process.

 

Q: Our ownership group currently enjoys the income that is generated from the practice ownership paying rent on the building. Why would we want to sell the building and give up this cash flow?

 

 

If the building is owned by a partnership, the structure of the ownership group has likely changed over time. Some of the partners may be approaching retirement (or have already retired) and there may be variations between what is important to each member of the ownership group. This is referred to as partnership stratification, and has the potential to create a significant rift within the ownership structure. Many times, selling the building emerges as the most prudent path to a resolution.

 

Q: Assuming that I am interested in selling my building as an investment property, how is the value determined?

 

For an income property, the valuation is determined by the capitalization (“cap”) rate, which is derived from a relationship between a tenant’s credit, the length of the lease, the landlord’s responsibilities, and the underlying quality of the building. Once a cap rate is determined, this factor is applied to the net operating income (sum of the gross lease payments less any landlord expenses), and a property valuation is produced. Current cap rates for medical investment properties range from 6 percent to a high in the low teens, with property value being inversely related to the cap rate.

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Ross Kester and Tyson Smoak, CCIM, are members of the Investment Division at NAI Earle Furman LLC Commercial Real Estate

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