Jay Holmes: Welcome to the Medical Management Podcast. A podcast focused on helping you level up your practice. Through interviews with some of the most successful leaders in the industry, we help uncover resources, tools, and ideas to help you level up your practice. Thanks for tuning in and we hope you enjoy today's program.
Jesse Arnoldson: Hello and welcome to the Medical Management Podcast. I'm your host, Jesse Arnoldson, and I'm joined by our co-host Jay Holmes. Welcome back, Jay!
Jay Holmes: Good to be back, Jesse!
Jesse Arnoldson: I'm excited for our listeners. Jay has spent the summer transplanting all over the West, you know, living a little bit in California, Arizona, and just got back from Montana. So we're excited to have him back. Today, I'm really excited because we're going to talk about an issue that comes up in most independent medical practices, and that's the idea of marrying the business of a practice with that of owning and managing real estate. Jay, tell me a little bit about why you think it's a good idea as a physician group or a practice owner to get into the business of owning your own real estate.
Jay Holmes: Yeah, well, let's put a gigantic asterisk next to that.
Jesse Arnoldson: Yeah.
Jay Holmes: Before we even jump in, you know, there are equally, if not, you know, unbalanced pros and cons list. And so, you know, the stance isn't that owning real estate is the way to go and you should do it. So that's really the, you know, the disclaimer of this episode here. So with that disclaimer.
Jesse Arnoldson: Gotcha!
Jay Holmes: Loud and clear.
Jesse Arnoldson: I like the disclaimer.
Jay Holmes: Let's start off with those things that are, you know, on the pro side of the list here. And buying real estate is an amazing way to build wealth. And, you know, you've really got two forces working for you. You've got this general assumption that real estate is going to appreciate in value over time, that's one assumption. You know, let's call it five to, five to eight percent appreciation per year. And of course, that's a number that you should not really hold on to, because every locality, every geographic region is going to be different. But.
Jesse Arnoldson: Right.
Jay Holmes: Let's just say that you're going to pay five percent, or your real estate's going to appreciate five percent a year, that's awesome. OK, because on top of that, what you're also doing is that you are paying down the loan that you used to purchase the property. You're gaining equity by that. And every practice has to, you know, I mean, they have to practice somewhere. And, you know, things are changing now. Obviously, you can practice medicine in your house with telemedicine, but generally speaking, right, you'd need an office location. You need a place where your practice is, and you're going to pay rent. And so why don't you pay rent to yourself, which means that those dollars are going to pay down your loan. So you've got this force that pushes the value of the property up, and you've got this mechanism by paying rent, by reducing the loan. So you've got this double, you know, this expanding equity going up in the equity that you're building by paying off the loan. So it's a really amazing vehicle to do that. You've got some good tax benefits with that, too. And in good tax benefits, you know, is maybe misleading. When you pay rent to yourself, you're deducting it on one end, and on the other end, you're picking up as income, right? But that income then gets offset by the interest that you're paying on the loan. It gets offset by the real estate taxes that you're paying. It gets offset by the, you know, the snow removal that you have to pay to keep the, you know, your parking lot clear. And so there are expenses that then offset that income. So while you might not see a gigantic tax saving, like difference, you get pretty neutral with it. So it doesn't actually harm you. And that's why I said it could be misleading with tax benefits, right, because it's not like you buy a piece of property and all of a sudden you're going to save a bunch on taxes. What you are going to save on is really reducing the revenue that you have to pick up. And so it really creates a more cost-neutral pathway to building that equity growth on both sides. And it's just you have more flexibility. You get to decide what you want to do and how to do it. And I think that's a big, big thing for a lot of us, is that you know, independent practices are independent because they want some autonomy in what they do and how they do it and being tied in, being told what to do or not, and if you want to knock out a wall and do something, go ahead and do it. If you want to lease the space out to a, you know, a complimentary business practice specialty, do it. You have a lot more flexibility in what you do. And so those are a handful of the reasons you should jump in and say, yes, this is for me and I'm going to do it, which are very strong reasons.
Jesse Arnoldson: I love it. I love it, you know, with all the positives. Why don't we jump in to maybe where some of your reservations lie, what's on the con list, Jay?
Jay Holmes: Well, this is where it gets fun and interesting.
Jesse Arnoldson: Yeah, it's complicated.
Jay Holmes: Yeah, it was complicated. And there's two big ones. You know, generally, when you own something, it's, you're accountable for it. And so there's always that, you know, you own it. If something goes wrong, you don't have a landlord to call to say, hey, come and fix us. If the roof starts leaking and it turns out the roof's old enough and you have to redo the roof, that's a, you know, it could be 50.000, 100.000 dollars that you have to come out of pocket with to fix that. And it's not something that you just get to pass along to someone else. And so there's just more responsibility and accountability. And depending on where you are, you have to ask yourself, do you want to increase the stress in your life to make a little bit more money, or do you want to decrease the stress in your life? And I think that's a very viable decision factor into the decision that you make is this stress, because certainly having, you know, and I've gone through this where I've owned a building and it's all great, but that leak happened and that AC, that HVAC unit on top of the building went out and we had a decision to replace it in one year, we didn't because we opted for the, you know, the Band-Aid. And the next year, the HVAC system costs 30 percent more. And, you know, these are just the added stressors of your life that you can either say, you know what, it's worth it because I want to accumulate more wealth faster or you know, what I'm doing all right in other avenues that are a lot less involved or stressful.
Jesse Arnoldson: You know, we talked on the last episode about most issues being people problems. And I can see a big people problem at the core of this issue, even though it's something I would think would be miles away from it. But having, looking at the business of physician groups, I've never seen more partnerships made up of completely incompatible people, if that makes sense.
Jay Holmes: Yeah!
Jesse Arnoldson: You know, you come across two docs and you're like, how in the world did you guys become partners? Because this is a weird marriage right here, right?
Jay Holmes: Yeah.
Jesse Arnoldson: And then you, you know, and so all of these real estate issues have to pass through the filter of your physician partnership and whether that is a functional relationship or not, can you maybe talk a little bit, Jay, to not necessarily the pros and cons, but just the ins and outs of what that filter does? You know, what does a physician partnership, how does that affect owning the building itself?
Jay Holmes: Yeah, and you're reading my mind here because that was the second, and, you know, let's not take order as an indication of relevance here, because this is the biggest issue. The biggest challenge is having multiple owners in the group, in the building. And just like a practice having, you know, the, just anytime you add owners to a business, you're basically adding a spouse to your life. So anytime you add another owner to a business entity, you're adding a relationship and you're exponentially increasing the complexity. It's not that it's a square rather than at times. And that's very, very important to understand. But the building, having multiple owners in a building is actually more complicated at times than a medical practice, OK? Because oftentimes when we get into agreements with medical practices and different owners, you know, the value that you bring to a medical practice is really the patients. And that's, sometimes you can sever that and move away or, you know, it's a little bit more tangible, and it's a little easier to separate in cashflow any separation. And so let's, let's kind of understand the challenges with multiple owners on top of your just adding complexity at a really, really increasing rate with a more owners you have, OK, because to your point, Jesse, it's the well, we're going to have to replace the HVAC that costs 20.000 dollars. OK, well, there's not a reserve in the entity, so we're all going to come out of pocket. OK, well, we could do that, or we could fix it for a thousand. And the vote is we fixed it for a thousand. And the next year it goes out, now it's 40.000 or 30.000, whatever, right? And so now we start to come out of pocket. So all these factors and it just adds complexity. There's decisions that may need to be made, and they generally are made by the group, by the owners. OK, but most of the pain is due to a member leaving, all right? And that's where the challenges really come in, all right? And so when someone leaves and remember what you're doing is you're building equity, the whole point of owning a building is that you get these two opposing forces to build equity, appreciation, and then debt payment, all right. And so then if someone wants to leave, they're, you know, entitled and desiring that share equity. Well, how do you determine that? Well, generally, you go get an appraisal. Well, business appraisals for commercial properties are four to five times the cost of a residential appraisal. So residential appraisal might cost you four, five hundred bucks. Well, commercial space, you know, it could be four to five thousand dollars.
Jesse Arnoldson: Okay.
Jay Holmes: And as we know, appraisals are somewhat subjective. And so in your mind and I think 99 percent of the time, they're going to be less than what you think it's going to be. Which creates contention. So my buildings were two million and the appraisal comes in and it's like, well, actually, right now it's worth about one point five. So you thought you were going to get about four thousand dollars out of it, but you really only get about 200.
Jesse Arnoldson: Right.
Jay Holmes: Because of the debt and all that stuff. And so that's a tough pill to swallow right there, OK? Now that you have the prices that's determined, where's the money going to come from? It's not like you have two hundred thousand or four thousand dollars just sitting in the bank account ready for whenever someone wants to leave. So then the owners either have to come out of pocket to say, I'm going to buy this owner out, which is a generally it's an event that's not planned for. So it's not like you're saying, hey, three years in the future, X-partner is going to leave and I'm going to buy them out. It's a, hey, something happened. You know, it's either personal life involved or, you know, I just, I want to move to a different place, maybe there's a divorce involved, maybe something else, it's unexpected. And all of a sudden, boom, we have to make a decision. And that timing may or may not be advantageous for everyone in the group to just step up. The other options, you get another loan, OK, but let's hold off on the loan just for a sec, because if you have partners or members in this entity and they're more than 20 percent owner, well, then they generally have to personally guarantee on the loan that you use to purchase the property. And if one of those personal guarantors leaves, then the underwriting of that loan becomes unstable, right? And so that creates a scenario where the bank says, whoa, time out, you've got to get a new loan because the loan that we gave you was on the premise that all four of you were involved in. All four of you gave us the confidence that you know, if there was a default, you personally would be able to fund it. So most of the time, you have to refinance that loan. All right. You either have to refinance it because there's a more than 20 percent owner or you have to refinance something because you need more money to pay that on their own, right?
Jesse Arnoldson: So you're needing, you're needing more money now on the loan with less people.
Jay Holmes: Absolutely!
Jesse Arnoldson: That is always the best argument to take to the bank, right?
Jay Holmes: Yeah! You know it, man! You know, the great thing about banks is when you need the money, they're not going to give it to you and when you don't do it they're going to chill it out. So you're in this situation where you don't get to plan and take advantage of what's best, right? So we've had unprecedented low-interest rates for a long, long time. And, you know, thankfully for human beings, we tend to forget things that happened, what, like a month ago and think that everything in the past will never happen again. But interest rates have fluctuated, you know, up to, what, like 20 percent in the past 40 or 50 years. And they've been held down for the last long time. I mean, really, it's been 10 plus years. I mean, more than that, right?
Jesse Arnoldson: Yeah.
Jay Holmes: It's probably been about 15 years of just this relatively really, really cheap money. And so, you know, what you do is you get put in a situation where your four percent loan or five percent commercial loan now has to get refinanced at seven or eight percent. And that is catastrophic to your plans. Now, you're 10.000 or 20.000 dollars a month mortgage payment, which is actually, was pretty close to what you would have been paying for rent becomes 40.000. And let's just say there's actually 10 grand a month you have to fork over for nothing more than the penalty for another owner leaving. And so that right there, you know, there's complexity with decision making and there's real complexity with how do you deal with someone leaving?
Jesse Arnoldson: Yeah. You know, our predecessor, Jim Trounson, CEO of MedMan, the founder of MedMan and CEO, he put out like, I don't know if you ever saw it, it was like the Ten Commandments of not owning real estate as a medical group. And they were a list out of like, you know, it makes it incredibly difficult to leave. And it had all these reasons that you and I have just talked about. And then it, you know, it makes it incredibly difficult for a new partner to buy in because you're not just buying into the practice, you're buying into the real estate group, too. And if you don't if you only buy into the medical group, are you then negotiating with your partners on a whole different level in a different business when it comes time to set the rent, pay for that HVAC, make decisions on TI, stuff like that? You know, it can be really difficult. I think his main problem, his main issue with medical groups owning real estate was everything that you and I just talked about had nothing to do with our core business, that of serving a patient, right? And it can be extremely distracting and pull away from what makes us great. Now, I've seen plenty of medical groups be very successful in owning their own real estate and managing that themselves, and so please don't take that, you know, but it's just one philosophy to take into consideration here. Jay, here at the end, tell me a group that's sitting here wondering if they should open up another practice, move theirs into a building that they own, maybe buy the building that they're in, whatever the situation looks like, what should you consider as you're looking at purchasing real estate as a medical group?
Jay Holmes: Well, there's a few things. And let's touch on them real quick here. There's issues with related party transactions, OK, related party meeting that you're renting to yourself. OK, so you have to go into it thinking that you're not taking shortcuts. You had to make sure that all the I's are dotted and the T's are crossed. You need a lease agreement. You need to charge a fair market value of rent. You know, there's pressure to sometimes pay less. There's pressure to sometimes pay more. But at the end of the day, there are significant, you know, IRS court cases that have challenged and won the fair market value question. And you got to have some sort of assessment of that if they have some sort of benchmark and use that. And it doesn't mean that you can't push one direction or the other, because at any given time, you can pay 30 bucks a square foot or you can pay 10, right? And so doesn't mean that you don't have flexibility in what you set. But if you're going to pay three dollars a square foot or a hundred dollars a square foot, certainly you're increasing your risk, OK? And so the whole point here is that you don't want to increase your risk so much so that this great investment that you think you're investing in becomes unstable, right? The more you have, generally, the more risk-averse you are. That's just how it goes. Prevent defense is the worst, in my mind, play tactic in football, because once you're in the lead and all of a sudden everything that you did to get the lead, you just pull back. But that's generally what we do as human beings. The more we have, the older we get, we start diversifying, reducing our risk, right, certainly here It's a tactic that well, to say that you just need to do what you need to do. You need to treat it as though you're not renting to yourself. What would you do in a situation if you're going to rent to a third party? You need to do that, OK? You need to actually pay rent to this other entity and don't get in the habit of saying, well, you know, when cash flow is good every four or five months, instead of paying me, I guess I'll go ahead and pay the other entity for rent. Pay rent set it up again. It goes to the first point. And you have to always just communicate with your attorney and your tax advisor. You generally never want to hold an appreciable asset. What's an appreciable asset? It's not an x-ray machine because an x-ray machine in 10 years isn't going to be worth that it was worth when you bought it. But there are, you know, a building is an appreciable asset. It should be worth more in 10 years than you purchased it for. You don't want to hold appreciable asset in a corporation. C-Corp, S-Corp, and the reason is, is that there are specific rules on how to get that appreciable asset, how to get an asset out of a corporation. You cannot transfer out an asset without a sale in a corporation. So what that means is you own a building, you're building in your corporation as corporate C-Corp, and you just one day decide to sell your practice, but you want to keep the building because what a great idea. You sell your practice, the new provider comes in and pays you rent and you can continue to leverage those, the double-sided equity growth. Great idea until you have to separate the building from the practice. And to do so, you actually have to sell the building to yourself, right? What happens when you sell something yourself? Yourself doesn't give yourself money, right? It's a non-cash transaction, but tax purposes, you actually have to sell it for fair market value, and that triggers a taxable event. So you actually have to pay tax on the sale of the building yourself. You didn't get any extra cash by pulling it out of the corporation. And so at all, you know, and I say generally the majority of time you don't, there's certainly situations that would point that, but 99 percent time, you're going to do that. Generally, you know, it's an LLC that's formed as a partnership if there's multiple owners, partnerships are much more lax in how you can take.
Jesse Arnoldson: Things around.
Jay Holmes: Assets out. And so, you know, before you do that, don't just go down and file an LLC with the state and put it in there and then just go running. You really have to do your homework. You have to set it up right. You have to make sure everything's covered. The last thing you want to do as well is, again, have this asset and then have it at risk for liability. And so really making sure that you run the business as a business, don't pay things personally out of it and all that stuff, because you want to protect yourself. You don't go through all this extra work and take on the risk of extra complexity to then risk it all, because you're not treating it as a separate entity, as a business.
Jesse Arnoldson: And I thought this was going to be an easy answer, Jay. It was going to be like a simple, you know, three bullet point conversation for sure. No, Jay, this is super helpful, you know, I think it paints a picture that it can be a very worthwhile endeavor for a medical practice to own its own real estate or to be alongside an entity that owns its own real estate. It can also be extremely complicated. And that, I think, enforces the idea that you've got to do your homework. You've got to keep smart people around you, like your lawyer and your tax attorney. So before you just jump into it and, you know, with both feet, make sure you do those things. Make sure you do your due diligence. Jay, thank you for everything you shared with us today!
Jay Holmes: Hey, man, glad to be here. And hopefully, you know some of that insight is helpful for our listeners out there.
Jesse Arnoldson: Absolutely! And for our listeners, for transcripts and other episodes, please visit us at MedMan.com. And tune in next week! We'll be back with more impactful and applicable information that can help you level up your practice. We'll see you next time!
Jay Holmes: Thanks for tuning in to the Medical Management Podcast. We hope you enjoyed today's featured guest. For the show notes, transcripts, resources, and everything else MedMan foes it help you level up be sure to visit us at MedMan.com.
If you’re an independent practitioner and you’re wondering if buying or not your own real estate, this episode is perfect for you!
Jay and Jesse discuss this issue from different perspectives. They also ponder the pros and cons list of owning real estate for your practice. While you can have the autonomy to do things you like on the property, there are added tasks like fixing the building on your own. Also, having multiple owners may increase the complexity of procedures. These topics regarding real estate are way off of -what medical practitioners do-, but they affect the business.
Jesse and Jay dive deep into the considerations you might want to have before making a decision.
Pros and Cons list will sometimes be very unbalanced.
Buying real estate is a way to build wealth.
When you buy a property and use it for your practice, there’s a double-side benefit relationship in terms of payments.
Independent practices get the autonomy to manage their property however they like.
Adding an owner to the property is like adding a spouse to your life.
The more you have, generally, the more risk-averse you are.
Machines are not an appreciable asset, while buildings are.