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With prices low, it may seem like a great time to buy your office space. Be wary; the advantages to ownership, while real, are balanced with disadvantages and risk. Make sure your eyes are open.
Buying the building that houses their practice has been one of the savviest moves some physicians have made to build personal wealth. But such a purchase is risky, and often not a large enough advantage over renting, experts say.
To lease or to own: How do you decide which is right for your practice?
Ronald Groat, a psychiatrist in Edina, Minn., decided he wanted to own. Sensing an opportunity during the 1990-91 recession, he bought the nine-suite office building that houses his practice for about $300,000. He estimates the property has roughly doubled in value since then, even after the market corrections that have stung real estate the last 18 months. And because he rents part of the building to other physicians, he’s able to collect rent and share some professional services costs.
There are tax advantages to ownership, as well, and some down-the-road income potential. Groat, for example, could sell the building when he retires, or continue to own it and collect rent from younger physicians.
“At first the building had a pediatrics practice, a weight-loss service and some other things, but over time it became all psychiatrists,” he says. Groat and his tenants share call and overhead expenses in a co-op arrangement.
“It’s nice to be able to develop and manage a property as you wish,” he explains. “And despite a market that has peaks and valleys, real estate is always worth something.”
And considering the real-estate slump that began last year, there might never be a better time than now to buy.
But has the real estate ownership equation changed? Some experts say the tax benefits don’t live up to their billing, credit for doing deals has been hampered, and uncertainty about the future direction of healthcare delivery makes betting on a long-term real estate strategy risky.
“Prior to the downturn we saw a lot of physicians looking at buying buildings as an option. With the current credit markets, we see it a lot less,” says Steve Warner, partner in the healthcare resources group at Katz, Sapper & Miller, an Indianapolis accounting firm.
“Real estate in general is difficult,” he says. “Even in fully leased buildings, lenders are less willing to do deals. And physician groups have been trying to delay capital-intensive projects.”
There are some nice tax benefits to owning, says financial adviser Ross Levin, who has counseled several physician clients through office building purchases. One is the ability to take advantage of depreciation as a tax deduction, he says. Businesses can deduct the depreciative value of real assets, including real estate. He typically guides clients toward setting up a separate legal entity that will own the building and rent it to the medical practice. The practice can deduct the rent payments, while the partnership takes in rent as taxable income and can use depreciation to offset profit that exceeds operating costs, said Levin.
Still, says Levin, “there are a lot of reasons why buying would be a bad idea.” For example, “if your practice isn’t stable, the costs are too high, or the doctors are in specialties that tend to have high turnover rates.”
And depending on your own set of circumstances, even the tax strategy may not work.
“You may or may not get a tax benefit from depreciation, so the deal has to stand on its own to be worthwhile,” says Douglas Rutherford, an accountant with Rutherford, CPA & Associates in Lilburn, Ga., and president of LandlordSoftware.com, a tool that helps buyers evaluate and manage property deals.
Don’t be swayed by the reasoning that the tax benefits will make up for negative cash flow resulting from the purchase.
“If you can lock in a long-term lease today at very low rates, it might make more sense just to lease,” Rutherford argues. “If you’re considering buying, and the property doesn’t cash-flow right away, you paid too much.”
That said, losses from real estate activity can be used to offset your income for tax purposes, though such losses are only acceptable up to $25,000 and using the provision requires that the individual participate significantly in the management decisions of the property, says Mark Luscombe, principal tax analyst with CCH Inc., a tax information publisher in Riverwoods, Ill. Larger losses potentially could be used to offset real estate gains when a building is sold, he adds.
Owning a stream of rental payments also provides some flexibility for income reporting, Luscombe notes.
“If you have two streams of income coming out of the practice, one being rent and the other being compensation subject to Social Security tax, then there is some ability to play around with what is compensation versus rent,” he explains.
Beyond the tax implications, prospective owners need to think about the exit strategy before entering into a deal, says Levin.
“Medicine is changing so fast,” he says. “You might have a group that owns their building today but the practice is shrinking and the remaining doctors are discovering they have divergent [personal finance] needs. What used to be forever isn’t anymore.”
Even with strong buy-sell arrangements, having partners buy in and out of the property frequently can cause problems as different owners will have divergent views on how aggressively to take care of repairs or upgrade the facility, he notes.
When it works, though, it can be a beautiful thing.
As he gets closer to retirement (which is still a long way off), Groat says he’ll let market conditions determine the end game in his real estate venture. For now, though, he’s quite pleased with his purchase.
“I may continue to rent to other physicians to generate income after retirement, or I would even consider selling sooner to a developer and finding a place for my group to move if the deal was right,” he says.
With all the business and tax challenges and changes predicted in healthcare management, those are nice options to have these days.
Janet Kidd Stewart is a freelance writer based in Marshfield, Wis. As a contributing columnist for the Chicago Tribune, she writes a weekly, syndicated retirement column called “The Journey” that appears in Tribune newspapers across the United States. She holds a bachelor’s degree and master’s degree from the Medill School of Journalism at Northwestern University. She can be reached via firstname.lastname@example.org.
This article originally appeared in the July/August 2009 issue of Physicians Practice.