Pitfalls to Avoid in Buying a Building
By Steve Kikikis, Vice President, Commercial Real Estate Broker
Money Pit or Cash Cow?
On occasion when a doctor purchases a practice there is also an option to purchase the real estate. Historically, real estate has been a good investment over time, but owning a commercial building has its own nuances.
There are a lot of similarities between owning a commercial building and a residential house. As the building owner or homeowner, you are responsible for paying the insurance, maintenance, and property taxes. Be sure to understand what your out-of-pocket costs are before you take on the responsibility of purchasing a property. Investing in a building or home inspection conducted by a reputable building inspector is always worth it.
Before you purchase a commercial building, know your demographics, and do your research. If a building is a steal, make sure you do some research to find out why. A commercial real estate broker that specializes in your industry can assist you in looking at the demographic information to fully understand the value of the real estate.
After you’ve purchased the practice, you are now the king of your castle and if you are business savvy, you can make a profit from owning your building. Having some knowledge of what to expect and what the pitfalls are of owning a building can save a lot of headaches down the road. For this article, we will consider that you are the owner and sole tenant of your building.
Maintenance – You’re now responsible for everything from the leaky roof, sweeping the parking lot, HVAC systems, lighting, ADA compliance, security systems, plumbing, and possibly the water and sewer mains underneath the property. The best advice is to adhere to a schedule with regular and preventive maintenance. Don’t skimp on issues that may seem small but that can turn into a bigger safety issue (both expensive and potential lawsuit if hazardous) in the long run.
A lot of potential challenges are dependent on the age of the building and how the previous owner took care of the property. You can hire a property manager to be the point of contact so you’re not distracted and can concentrate on your work. Some owners like to be involved in every decision, while others don’t want the hassle of being contacted for leaky pipes, clogged toilets, etc.
Insurance – a commercial building policy will differ from a residential homeowner’s policy on your home. A commercial policy will also have coverage for the business operations, its products, and operations liability. Much like homeowner’s insurance, the age and construction type of the commercial property will determine the premiums. Commercial insurance is also based on the neighborhood where the building is located.
Although chances are slim, some policies cover loss of income in the event of a fire or other loss of the building. These are usually additional policies that can provide peace of mind.
City ordinances – Although you may own the building, ownership doesn’t necessarily mean you can do anything you want. An example is a new building owner who wanted to utilize a specific size of a sign for his business, but the city ordinances stated a sign can be no bigger than 30 square feet. Be sure to reach out to the city before you decide to change or update the signage on your building and also verify if there are any restrictions for the exterior of your building such as signage, color, material, etc.
Taxes – There are two points on the taxes. First, for the building taxes, make sure your ownership is properly transferred to you during the purchase, and make sure that you keep up-to-date on your taxes. Set up an account directly within the municipality you are located or make sure your loan program is paying it directly. For your business taxes, owning your own commercial real estate has many tax advantages. Connect with your CPA, make sure you’re paying your real estate entity as a business expense, and more.
Money Pit or Cash Cow? There will be costs to owning your own commercial real estate, but taking the proper steps and working with an experienced commercial real estate broker that specializes in medical/dental purchases will save you time and a lot of money. Just think, if you are leasing a space, after 10 years you will be signing up for paying the landlord another 5 years of income. If you own, after 10 years, you will be working towards paying that building off and have the equity in the building.
Read More5 Considerations when Buying a Veterinary Practice
How many years you should have under your belt before you own a practice? Typically, the number is five years, but that the number really depends on the doctor. We’ve had doctors who were able to purchase a practice after three years and do quite well. A lot depends on your comfort level, skill set and experience.
Here are some things to consider before you buy:
- Are you comfortable with your clinical skills? If you have been out of veterinary school 3 to 5 years, you should have a feel for where you are with your skills. A lot depends on the clinic(s) or hospital(s) you’ve been working. Some may limit what you’re doing and others just may not be busy. If you’re in a location that’s given you a variety and volume of experience, you should be getting a good amount of experience.
- Have you seen a good practice in operation? Sure, you’ve been working in one or more clinics, but are they well run? Or, if they’re not, you know the difference. If you are in a well-run practice, you should be observing how the doctor and/or office manager treat the staff. Whether a veterinary assistant, office manager, or veterinary technician, they should all be treated well. How about the patients and clients? They should be given good, Nordstrom-like treatment. They pay your rent and you want them coming back.
- Do you know how to read financial statements? Most veterinarians in the early stages of their career don’t know what a financial statement is let alone how to read one. There are on-line courses such as accounting for non-accountants and other courses on financial statements and bookkeeping that can fairly quickly teach you what the financial statements are and how to read them. Understanding them is imperative in running any business.
- Now that you know how to read a financial statement, do you know what the numbers should be? What percentage of collections should your payroll numbers be? What about rent? Etc., If you don’t know, there are resources you can look at on-line where you can learn. Watch all of the White-Board Wednesday videos from Joel Parker, DVM that are on line. They are great in teaching you numbers as well as other aspects.
- Practice Management – Learn as much as you can with the free stuff on-line. From the White-Board Wednesday videos to other on-line courses, you can learn a lot for no cost to minimal cost. This will quickly help you grasp the key concepts of managing a practice.
These are just a few things you can do to prepare you to own a practice. Keep in mind that practice owners typically make 20% to 25% more than an associate veterinarian. In addition, the equity you build in a practice is a great source of retirement.
If you’d like to talk to us about your individual situation, contact us and we can help!
Where to Own a Dental Practice?
The question we often get from potential practice buyers is “Where is a good spot to own a dental practice?” There are a lot of factors that contribute to answering that question. But first, let’s discuss the reasons why you want to own a dental practice.
If you are in it because you love dentistry and love helping patients and you are not necessarily in it to make the big bucks, you can really own a dental practice almost anywhere. A lot of buyers seem to want the downtown metropolitan practice thinking it’s a great place to practice since there are so many potential patients and you can live the urban lifestyle. I’ve helped doctors who absolutely wanted to be in a metropolitan area, even though the demographics made no sense whatsoever, who then started a practice and did quite well. One doctor that I helped always dreamed of owning a practice in a particular city. He went for it and is successful. And I have seen others want a practice in a certain area, and although the numbers didn’t make sense, they did it anyway and were successful.
Some of you are buying a practice because you want to make a lot of money, in which case, further analysis and discussion are needed. The failure rate for dentists is infinitesimal – somewhere around .0125%. If you’re buying an existing practice and you have identified that the practice already has good cash flow, you can purchase the practice and have success almost no matter where it is. If it’s a poor performing practice, you would need to examine if the poor performance is because of the location, the management, or something else. If you want to buy an existing practice and are looking for an opportunity to grow and have lower overhead, I would suggest looking outside of the metropolitan areas. Practices outside of metropolitan areas have less competition, wages and rents are lower, and it’s easier to grow those practices. And if you are considering doing a startup practice, the same rules apply. Look for a location with good demographics outside of metropolitan areas. Of course, if you absolutely want to be in a metropolitan area, don’t be afraid to go for it. Just look closely at the numbers and hire a good dental practice or real estate broker to help you out.
I do recommend that you do a bit of demographic analysis on the locale. See how many dentists are currently practicing in the area. A good ratio is 2,000 daytime population for each doctor. There is a difference between the daytime population and the regular population. The daytime population includes the workforce. For example, if you look at the population of South Lake Union during the day vs. the nighttime population, you would see a big difference. Another demographic to pay attention to is the age of the population. For a general practice, a good mix of young and old is best. If you want a high cosmetic practice, but the average age is 28, you might need to consider another area. Homeownership is another good indicator of practice success. You want to have more homeowners than apartment renters. You can obtain detailed demographics either through a company that will charge a fee and provides data such as the average annual dollar amount spent on dentistry per person within a zip code and other more granular items. Or, Omni has information that we can provide.
One of the advantages of working with Omni is that we have both dental practice brokers and real estate brokers to help you traverse the ownership trail in any way we can. Just give us a call at 877-866-6053 or email us at info@omni-pg.com and we’ll be happy to help get you started. Contact us today!
Read MoreWhere to Own a Practice?
The question we often get from potential practice buyers is “Where is a good spot to own a practice?” There are a lot of factors that contribute to answering that question. But first, let’s discuss the reasons why you want to own a practice.
If you are in it because you love being a veterinarian and love helping patients and you are not necessarily in it to make the big bucks, you can really own a practice almost anywhere. A lot of buyers seem to want the downtown metropolitan practice thinking it’s a great place to practice since there are so many potential clients and you can live the urban lifestyle. I’ve helped doctors who absolutely wanted to be in a metropolitan area, even though the demographics made no sense whatsoever, who then started a practice and did quite well. One doctor that I helped always dreamed of owning a practice in a particular city. He went for it and is successful. And I have seen others want a practice in a certain area, and although the numbers didn’t make sense, they did it anyway and were successful.
Some of you are buying a practice because you want to make a lot of money, in which case, further analysis and discussion is needed. If you’re buying an existing practice and you have identified that the practice already has good cash flow, you can purchase the practice and have success almost no matter where it is. If it’s a poor performing practice, you would need to examine if the poor performance is because of the location, the management, or something else. If you want to buy an existing practice and are looking for an opportunity to grow and have lower overhead, I would suggest looking outside of the metropolitan areas. Practices outside of metropolitan areas have less competition, wages and rents are lower, and it’s easier to grow those practices. And if you are considering doing a startup practice, the same rules apply. Look for a location with good demographics outside of metropolitan areas. Of course, if you absolutely want to be in a metropolitan area, don’t be afraid to go for it. Just look closely at the numbers and hire a good veterinary practice or real estate broker to help you out.
I do recommend that you do a bit of demographic analysis on the locale. See how many veterinarians are currently practicing in the area. A good ratio is 2,000 daytime population for each doctor. There is a difference between the daytime population and the regular population. The daytime population includes the workforce. For example, if you look at the population of South Lake Union during the day vs. the nighttime population, you would see a big difference. Another demographic to pay attention to is the age of the population. For a general practice, a good mix of young and old is best. Homeownership is another good indicator of practice success. You want to have more homeowners than apartment renters. You can obtain detailed demographics either through a company that will charge a fee and provides data such as the average annual dollar amount spent on veterinary services per person within a zip code and other more granular items. Or, Omni has information that we can provide.
One of the advantages of working with Omni is that we have both veterinary practice brokers and real estate brokers to help you traverse the ownership trail in any way we can. Just give us a call at 877-866-6053 or email us at info@omni-pg.com and we’ll be happy to help get you started.
Read MoreInterest Rates Affect on Practice Values – Why now is a good time to Buy!
By Rod Johnston, MBA, CMA
Owner and Principal, Omni Practice Group
Some of you may remember, others were not born yet, but back in October of 1981, interest rates on home loans were 18.91%. Over the years, interest rates have gone up and they have gone down. In the early 2020s, we saw some home mortgage rates go as low as 2.81%. If you were wise, you borrowed as much as you could at that time and bought a house, even though you may already have one. Coincidentally, home prices typically do not follow interest rates. In fact, there have been periods of time over the past fifty years where interest rates have gone up and the average house price also went up. The same isn’t true for the value of practices.
When I first got into helping doctors sell their practices in the early 2000s, interest rates for practice loans were about 7.5%. Most of the terms on those loans were 7-year terms. Meaning you had 7 years to pay off or amortize the loan. What does that mean for practice values? Banks determine how much they will lend based on cash flow after debt service. Debt service is the amount of your monthly loan payments.
To calculate cash flow, you start with the net income on last years’ tax return. Banks typically use 2-years tax returns, brokers when valuing a practice use 3 years of tax returns. I’m using one year’s tax return to keep it simple. You take the last year’s net income of the practice and then add back the non-operational expenses. Those expenses are those that may not be necessary to run the practice. Expenses could include gifts to employees, a continuing education class a seller took in Hawaii to get a vacation along with the CE, or meals they expensed for practice. You can stop those expenses and still run the practice.
This gives you an adjusted net income for the practice. You then subtract your annual debt service to get the cash flow number. The banks then divide the cash flow after debt service by the annual debt service to get a debt service ratio number which should be above 1.2 times the debt service. So, if your cash flow is $120,000 and your debt service is $100,000, your debt service ratio is $120,000/$100,000 = 1.2 times your cash flow. Anything lower than that and the loan would be rejected, or you would need to figure out how to make the numbers work to get the debt service ratio up.
What does this have to do with practice values? Well, if interest rates go up, that’s going to cause a buyers debt service payments to go up. An increase in debt service will result in a decrease in cash flow after debt service. This will result in the debt service ratio going down and possibly dropping below the threshold of 1.2 times cash flow after debt service. The same goes for the term of the loan. Some banks now have 15- or 20-year terms on their practice loans. This reduces the debt service payments as the loan is spread out over more years. The result is a decrease in annual debt service payments which improves cash flow. A bank with a 7-year term may not get the loan approved, but a bank with a 15-year term may be able to do it.
Brokers know all this stuff. When good brokers do their valuations, they’ll do a check to make sure the bank will be able to finance the practice at a certain value. So, they’ll do a debt service ratio calculation and if it falls below 1.2 times debt service, then they should lower the value to price it correctly.
The good news is that there was a recent drop in practice loan interest rates. Interest rates on practice loans are between 5% and 5.5% at the moment. As a buyer, this means the cash flow after debt service is improved with lower interest rates. Because the lower interest rate resulted in lower debt service payments which helped increase the debt service ratio. In addition, lower interest rates will lower a buyers’ monthly payments as well. This may help you get into a practice that you may not have been able to purchase in the past as the ratio now works with the lower interest rate. This can be especially good in a startup scenario or in larger practices.
In summary, remember that when interest rates are low, which they are at the moment, it’s a good time to think about buying a practice. You may be able to get into a better cash-flowing practice with the same or lower payments than when you buy when interest rates are higher.
If you would like a free consultation on buying a practice, please contact one of the Omni brokers. We are always glad to help. Phone calls are always free. We are also having a buyer’s webinar on October 10th, 2024, and a seminar on November 1st, 2024, in Bellevue, Washington, where you will be educated from beginning to end on how to purchase a practice and why you should buy a practice.
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