Medical Office Space: Buy Or Lease? Practice Owners Need To Run The Numbers To Determine The Best Course

Doctors often ponder whether it is better to own their medical office space (MOS) or rent from someone else. Ownership can range from an office condominium to a multi-practice office building. This article will outline several factors that must be considered before making a decision.
Establishing clear objectives is the first step in the analysis. Keep in mind that this is strictly a business decision. It is not the same as buying a personal residence. This decision will impact your practice finances and may affect your relationship with associates. It is a significant long-term investment that can span several tenures of ownership.

Once you have compiled a list of objectives, you must identify and list the pros and cons of ownership or leasing. This may also bring out issues, not previously considered, that could weigh heavily in the equation.

Here are some common objectives of owning and the related pros and cons:

• Cost Control. This is probably the most common-sense reason for wanting to own your office space. Leasing to yourself puts you in control and can be a hedge down the road to skyrocketing increases due to market conditions outside your control if you were leasing. Most practices that have structured their real estate arrangements properly have saved money over the long run.

• Location. It may be that there is no rentable space available in the most desired location, in which case buying or building is the only way to situate your practice where the patients are.

• Expansion. Owning may make it easier to carve up or add onto existing office space to meet the growing needs of your practice. If you lease, you need permission from the landlord for substantive changes and may find the cost of additional space prohibitive, if available at all.

• Tax Advantages. The current tax laws significantly curtail the ability to shelter taxable income that was once enjoyed by real estate ownership. Write-off periods are now twice what they were in the 1980s, and annual operating losses from real estate can no longer be indiscriminately used to reduce other sources of taxable income. These losses, however, can be offset against income from similar real estate ventures or carried forward and deducted against future income or upon the disposition of the property.

Shifting income from your medical practice to your real estate entity can still save some taxes. Net income from real estate is not subject to Social Security, Medicare, and other payroll taxes that are payable on wages and self-employment income. Also, all or a portion of gains on the disposition of real estate may be taxed at capital gains rates that are lower then ordinary income tax rates. In short, there are still tax advantages to real estate ownership, but they should be a secondary consideration.

• Return on Investment. From a doctor’s perspective, this should be the least important objective of ownership. Although some doctors have amassed a large retirement fund from MOS ownership, they are the exception. Far more doctors have been very disappointed at retirement age to find that there is not only little or no equity in the MOS, but no market for it. This could be due to several factors, such as overpaying up front for the property, over-leveraging the property, failure to adequately maintain the property, or general market conditions.

Make inquiries of other doctors who own or have previously owned medical office space. You may benefit from their experience. Also, obtain information from commercial brokers and agents as to the market rate for leased office space and the per-square-foot costs of buying or building in your area.

Run the numbers. Have your accountant prepare a financial projection that will help you determine the costs and related rent structure that will be required to support the purchase or construction. This should show both the taxable income or loss that will be generated and a cash flow analysis of what level of rent is necessary to support the costs, debt service, and taxes owed, if any, on reportable income.

Consult with your bank or other financial lender on rates and terms for financing. Getting the lending institution involved early on is important. It may be able to assist you in obtaining information relative to market conditions, contractors, and other information that may be helpful in making your decision.

Obtain the consensus of the members of your practice. This may be one of the most significant and long-term financial commitments your group will ever make.

Obtaining a simple majority vote to proceed may not be enough. If you have partners that aren’t buying into this, you should understand their reservations and make every effort to bring them on board. Failure to do so could result in divisive issues resurfacing later on. For example, younger doctors saddled with educational loans and mortgage loans may not be able to afford the down payment required to finance the MOS. They may, however, desire to buy in at a later date.

In conclusion, ownership of medical office space is not for everyone. The adage ‘it is better to own than rent’ is not conventional wisdom as it regards medical office space. Establishing objectives, gathering information, and running the numbers will assist you in making an informed decision. In a follow-up article, we will discuss the entity structure, finances, and operational considerations of ownership.

James B. Calnan, CPA, is partner-in-charge of the Health Care Services Division of Meyers Brothers, P.C. in Longmeadow; (413) 567-6101.