Managing Healthcare Real Estate Properly – Podcast #117

Intro: This is the White Coat Investor Podcast where we help those who wear the white coat get a fair shake on Wall Street. We've been helping doctors and other high income professionals stop doing dumb things with their money since 2011. Here's your host, Dr. Jim Dahle. Welcome to White Coat Investor Podcast number 117, managing healthcare real estate properly. This episode is sponsored by Alexis Gallati, of Gallati Professional Services.

WCI: Alexis is not your typical tax advisor. With over 15 years of experience, she's been helping physicians all over the country save money on their taxes. As the spouse of busy physician, she understands the burden of high tax payments physicians incur during their lifetime. Not only will she create a high level strategic tax plan for you, guaranteeing money in your pocket but Alexis will proactively work with you throughout the year to maintain your tax plan, prepare your annual tax returns and represent you in case of an audit.

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WCI: In fact prior to recording this podcast, we weren't even sure if we were going to run it at all, but it turned out to be pretty informative. So here we go. Our guest today is Collin Hart, MBA, the CEO and Managing Director of ERE Healthcare Real Estate Advisors. His company is a real estate brokerage that specializes in representing physicians in the process of selling and leasing back the practice real estate. They've done 180 plus transactions so far. I brought Collin on the show to talk about exit strategies surrounding practice real estate. Collin, welcome to the show.

Collin Hart: Jim, thanks for having me today. Happy to be here.

WCI: Great. Can you tell us about your real estate experience and particularly with regard to healthcare properties?

Collin Hart: Of course, I'll start at the beginning. I've actually been in the real estate world for about 12 years, primarily in institutional real estate investments. About five years ago, I worked for a REIT or real estate investment trust. We invested in retail, industrial and medical assets, all three of those but I took a specific liking to healthcare properties. About three years ago, we formed our company really to focus on healthcare properties and advising physicians on exit strategies. We've worked with physicians all over the country in 30 plus states, and typically we're helping them sell their practice real estate.

WCI: What's unique about healthcare properties compared to those other types?

Collin Hart: That's a great question. Whereas a lot of investors understand, let's say a retail property, you could say maybe a Burger King, it's easy to understand the underlying business. A Burger King makes hamburgers and sells them and that's how they generate their revenue. Obviously, the healthcare business is a little bit more complex than that, particularly with third-party payers. It's a more complex business and as a result, the fundamentals of the real estate are a little bit unique.

Collin Hart: Healthcare properties are unique primarily because they're special-purpose buildings. A lot of times we're working with clinical assets, oftentimes surgery centers, and so there's a lot of licensing or certification that's required in order to operate those properties. Having a detailed understanding of how the business operates, really helps us advise better on the real estate side.

WCI: What is it that attracts you to this particular niche?

Collin Hart: That's a great question. We found, primarily when I was working on the investment side that a lot of physicians don't have the detailed knowledge on the real estate side or could use some advice. We've carved out a niche where we're helping those positions really meet their objectives. A lot of times physicians invest in real estate because it's attractive. Obviously, you've talked about real estate a bit on your show and so there's some attraction to it, but there's limited knowledge we found from a lot of physicians in the real estate world.

WCI: The most basic question I tend to get on this topic is, when should a physician buy versus rent their practice space?

Collin Hart: Okay. That's a great question. As you can tell, we primarily work with physicians who own their practice real estate. Typically the profile of someone or a physician who owns their practice real estate is someone who has the financial wherewithal, and is determined that they're going to be in the same location or market for some period of time.

Collin Hart: A lot of our clients are attracted to investing in real estate and owning their practice real estate is a great way for them to do that. Then oftentimes, the groups who we work with are multi-provider practices, so there are multiple physicians under one roof. They've decided that they'd like to control their destiny and we're up to buying their building.

WCI: Obviously control's attractive but in the residential side, the typical rule of thumb is if you're going to be there for longer than three, four, five years, it usually makes sense to buy; less than that, it usually makes sense to rent. Is it more or less the same rule of thumb when it comes to owning your practice real estate, does it take longer to break-even, is the period shorter or how does that relate?

Collin Hart: Yeah. I think that a lot of physicians that we work with, they're focused on a market. Obviously, healthcare is kind of a local business and so they get to know their patients. If they're independent and they're growing their practice, then we found that they liked to own it. Even if it's an individual provider or sole provider, if they have the financial capability to buy a building, they're probably going to stay in the community and it would make to buy that building.

Collin Hart: Usually we found that it's a great investment for them, I can't really talk to you about breaking-even. That's usually an internal calculation but as you know, it makes sense to put rent in your own pocket or build equity in your property, and owning real estate is a great way to do that.

WCI: When it comes time for a doc to sell, they're selling the practice, they're selling the real estate. What's typical for how much of the value there is in the real estate versus the practice?

Collin Hart: Sure. I'll break it down; real estate and practices are valued differently and I'm certainly not an expert on the practice side, but I can relate the two. The value of a physician's practice is typically calculated as a multiple of EBITDA or earnings before interest, taxes, depreciation, and amortization. Then real estate is valued according to a multiple of the annual rent. Oftentimes what we've seen in practice valuations is anywhere from let's say five to eight times EBITDA, sometimes it's lower, sometimes it's higher.

Collin Hart: Then on the real estate side, we've seen that valuations are anywhere from let's say 13 to 15 times annual rent. If you picked up on that, you can tell that the multiple on the real estate side is usually higher, oftentimes double. But typically the rent associated with a facility is lower than a practice's EBITDA. Oftentimes what we see is that the value of the real estate might be equal to, or slightly lower than the value of the practice, but still, it's a substantial asset and so specific attention should be paid to that. Does that make sense?

WCI: It does.

Collin Hart: Okay.

WCI: It sounds like typical cap rates if you turn that 13 to 15X around or in this six to 7% range there. Is that fairly accurate to say or no?
Collin Hart: Yeah. A good calculation. I oftentimes speak in multiples just because a lot of our clients are familiar with EBITDA multiples and so it's easier for them to compare. A lot of our clients don't understand cap rate, cap rate's kind of a real estate jargon word, obviously, you're familiar with it. Let me break down cap rate for your listeners just so that they have a better understanding.

Collin Hart: In simple terms what I like to say is, let's say you invested in a rental property, let's say it cost you $100,000 and then every year you're collecting $7,000 of net rent. Each year you have $7,000 in profit. You invested in $100,000 to buy the property, so you're getting a 7% return. You follow me?
WCI: Absolutely. Thanks for the explanation.

Collin Hart: Sure. That would equate to you getting a 7% cap rate. What I did to convert it to a multiple, as I just said, one divided by 0.07, which is a 7% cap rate and that'll give us a 14.28 multiple. In general to answer your original question, typical cap rates for healthcare properties are anywhere in the range of let's say 6% to 8%; and it depends on location, size of practice, size of building, et cetera.

WCI: Okay. That's helpful. Let's talk a little bit about the business of selling practice related real estate. What are the typical commissions when you go to sell your property, is it the same on the residential side where you're paying five to 6% to sell it?

Collin Hart: Sure. We get asked that question a lot as you can imagine, and it really depends on the complexity of the transaction and the size of the transaction. Primarily we focus on sale and leaseback transactions, so there's a lot of complexity, there's lease negotiation, et cetera. It's a little bit different than just selling a house. Obviously, there's a huge market for people buying homes, but it's a much smaller buyer pool when you start talking about selling an institutional quality asset, like a medical building.

Collin Hart: We'd done transactions, so a couple of years ago we did like a $60 million transaction and our commission on that was 1.5%. We've also done transactions that are two, three, $5 million and our commission is up to 5% there. I would say it's generally in that range and usually the larger the transaction, the smaller the percentage. Does that make sense?

WCI: That does. Now on the residential side, there's lots of downward pressure on those commissions. You have these online companies, the local one in my area is called Homey, and they got a billion billboards up around the city where they're basically saying, “Get rid of the commission, sell yourself online, et cetera.” Is that even a possibility when it comes to practice real estate or is pretty much everybody using a broker of some kind?

Collin Hart: There are some commercial real estate platforms that have popped-up, that focus on trying to provide a wider marketplace and allow people to sell properties on their own. But at the end of the day, our specific transactions are really nuanced and it's not as much just a property sale as it is a succession planning tool. We really come in as advisors, it depends on the objective of the practice, of the partners, who the partners are, how the number of partners in the real estate compares with the number of partners in the practice, are their interests aligned, et cetera.

Collin Hart: Hopefully what you took from that is that every situation is very different. It's hard to make that a mass appeal or fit that in a specific box, because every transaction really is different. The answer to your question is, we haven't seen a lot of competition from online brokerages in the commercial real estate space just because the transactions are so specific.

WCI: All right. Let's talk a little bit about exit strategies. For some reason, a doc doesn't want to own his practice real estate anymore. What are his options?
Collin Hart: Sure. I was thinking about this before our call and I would say there are three different exit strategies. The first and probably the most basic is, let's say you have a sole provider, he owns his building, maybe it's a couple thousand square feet. He decides he's going to retire, he doesn't have anyone to take over his practice and he wants to get out of his building.

Collin Hart: What he would do is then sell his building vacant to another, what's referred to as an owner-user. It could be another physician, it could be someone who wants to own the building as their own office building. Really he's just going to sell it probably with a local real estate broker to try and find someone local to buy and occupy the building. Are you with me?

WCI: Yes.

Collin Hart: Okay. Then the second option would be to sell to an incoming partner. We see this a fair amount, I think it's a typical exit strategy for multi-provider practices. Let's say there are four real estate and practice partners, you have one of the partners retiring but you have a junior or associate physician who is on the track to partnership. The outgoing partner would negotiate a sale of his real estate shares within the operating entity of the real estate ownership, and he would sell those shares to the incoming real estate partner. In a transaction like that, you're usually going to need to go through some sort of valuation process.

Collin Hart: A lot of the operating agreements for these real estate partnerships govern how real estate's valued. We've seen some problems in that. Sometimes there's an appraisal that's required, sometimes it's determined by market value, sometimes it's just kind of arbitrary what the incoming and outgoing partner agree to. Most often we've just seen that it's based on an appraisal of the building and then that appraisal is applied to the shares that the outgoing partner owns, and then the incoming partner pays that amount. That's the second exit strategy.

Collin Hart: Then the third is to structure a sale and leaseback transaction, which again is primarily what we do. In those instances, you have physicians who maybe are looking at retirement in the next five or 10 years, but they're thinking about what is their exit strategy. They don't want to sell their building vacant whenever they retire because they realized that the value of a vacant building probably is not as great as the value of a cash-flowing asset.

Collin Hart: They say, “Hey, I'm going to be practicing here for the next five, 10, 15 years. We're recruiting new partners who are going to continue practicing here and continue on the legacy of the practice.” But maybe they don't want to own the real estate and so now's a perfect time for us to do a sale leaseback. At that point, they sell their property and simultaneously will lease it back, and there's no interruption to the practice. Typically we found the highest value being in this third exit strategy, which is the sale leaseback.

WCI: Now, what about some other options? For example, holding on to the real estate while selling the practice and then having the new practice owner rent from you. Do you see that happen very often, and what are the pluses and minuses of that?

Collin Hart: We see it very often. When you're selling your practice, so we've seen a lot of consolidation recently in the specialties. A few years ago dermatology was big and it still is, ophthalmology is on fire right now. I would say half of our transactions are in ophthalmology and the real estate sale is driven by a practice sale. We've seen a lot in orthopedics as well. There are some physicians who say, “Hey, I'd like to own the real estate and continue cash-flowing it even after I've sold my practice.”

Collin Hart: What it does is that changes the dynamic of the real estate investment. You can imagine that if Dr. Dahle, you bought your building and you were the tenant in the building, you're basically in control of your investment, right? But if you now sell your practice to a new entity or a third-party company or private equity, you're now beholden to that tenant.

Collin Hart: If something ever happened to that tenant, then your investment in the real estate is potentially in jeopardy. There are folks who say, “Hey, I'd like to hold onto my building and cash-flow.” I would say they're an equal number who decide, “Hey, this is a great time because I have a new lease and we happen to be at a good point in the real estate market, so I'm going to sell my building.”

WCI: What about exchanging the building for some other investment real estate? You want to buy into apartment building syndication or something using the money that was locked in your practice. Do you see that very often where people try to do an exchange?

Collin Hart: We do. I have a client actually in the Northeast who did that exactly. He sold his building about a $5 million transaction and he did 1031 exchange. Which is, I guess you could say IRS regulation or IRS statute that allows you to reinvest proceeds of a real estate sale into a like-kind property. If you follow the rules and timing for doing that, it allows you to defer the capital gain that you would have received or would've had to pay rather on the sale of your property. Does that make sense?

WCI: Yes. Of these strategies, three, four, five strategies, whatever, which one do you think doctors actually end up doing most often?

Collin Hart: It's funny, there were folks that we started talking to two or three years ago, who maybe weren't interested in selling and leasing back their property. Who are coming back to us now and saying, “Hey, we'd actually like to consider this.” I'm obviously biased but I would say that we've seen more and more people opting towards a sale leaseback primarily for value reasons, right? Or succession plan reasons. If you're a smaller practice, then you're probably going to take advantage of sell your building vacant to another user.

Collin Hart: If you are a multi-physician practice and you have the ability to either sell your real estate to an incoming partner or do a sale leaseback, you'd probably opt for sale leaseback. The reason for that is number one, because of value and generally will get a higher value than just an appraiser would give you. But number two, we're finding that a lot of the younger physicians are not interested in buying into the real estate.

Collin Hart: A lot of our clients say, “Hey, we have an associate on the track to partnership. He's going to buy into the practice but he doesn't want to lock up a lot of money in the real estate, doesn't have the money to invest in the real estate or doesn't want to get any more debt to buy into the real estate.” As a result of that, we're seeing more people opt towards the sale leaseback.

WCI: Okay. Now there's lots of healthcare consolidation going on in the industry. A lot of times your practices are being bought by the local hospital or are being bought by a private equity group. Are they usually interested in the real estate as well or do you end up having to sell the real estate out separately, and how does that affect the value you get for the real estate?

Collin Hart: Yeah. It's a good question. Sometimes we found that the hospital is interested in owning the real estate. We were working with a client in Oregon, an orthopedic physician. He had a building right across from the hospital and the hospital was kind of strategically buying up real estate all around them. As a result, I think he's in the process of selling to the hospital.

Collin Hart: Obviously healthcare is highly regulated, so the hospital has to go through an appraisal and make sure that they are doing everything by the book. It's a slower process and he'll get an okay value, I think out of the building. Private equity firms, we've seen are generally not interested in owning the real estate. As we talked about earlier, they're usually going to the value of practice according to a multiple of EBITDA.

Collin Hart: I think why private equity is interested in getting into the healthcare space is because there's the opportunity to grow EBITDA, and then eventually sell these practices and make a handsome profit. On the real estate side, there's less opportunity for growing rent. As a result, I don't think the profit that private equity investors could make off of owning real estate is as great as if it were deployed into other practices. We've just found that private equity is not as interested in the real estate.

WCI: Okay. Clearly, your main interest is in this buying and leasing back strategy. Let's talk about that and when a doctor would want to do that.

Collin Hart: Sure. As I touched on earlier, we're seeing some kind of practice factors tie into this and demographic factors. Again, growing practice, but younger physicians coming in who don't want to buy into the real estate. Obviously, if you were going to sell your real estate, but you have your practice operating there, you can't sell it as a vacant building so that option is out. If you have incoming partners who you would consider selling your real estate shares to, but they are not interested in selling or in buying into the real estate, then that option is out as well.

Collin Hart: I would say that the folks who are in a position for a sale leaseback are those who have strong growing practices, who are recruiting physicians who maybe are not interested in buying into the real estate and who are in a position where they can sign a long term lease. Which for most of the groups we work with, they're dominant in their area, their geography, they're in a position to do that.

WCI: Who are they selling to, who are the buyers, who wants to buy my building that I'm planning on practicing in for five or 10 more years?
Collin Hart: Yeah. That's a great question. I was hoping you would ask that. The buyers of healthcare real estate are typically institutional investors. There are kind of some buzzwords, there are REITs or real estate investment trusts, there are real estate private equity funds, there are family offices and a variety of other buying entities. They all have fancy names but ultimately they all do the same thing.

Collin Hart: Which is, buy real estate or lease to strong practices under long term leases. These investors are going to pension funds, they're going to registered investment advisors, they're going to high net worth individuals and they're raising money. I think you've even invested in some entities like that who raise money maybe 50 or $100,000 at a time, and they pull the capital and invest in assets, right?

WCI: Yes.

Collin Hart: Right. REITs or these other healthcare real estate buyers do the exact same thing. They raise the money and then they'd go out and deploy the capital. What they're looking for is, they're looking for a secure stream of income because investors like secure income so that would be cash-flowing real estate. Typically they're looking for properties in strong geographies, buildings that are difficult to move out of, which again creates more security.

Collin Hart: Then long term leases because they don't have to go in and renegotiate the lease two or three years from now, they have the practice operating there and just paying rent, and continuing to do their business. Does that answer your question, was that clear?

WCI: I think so. The idea when you sell the real estate, especially if you're planning on practicing for a few more years, is to maximize that real estate value.
Collin Hart: Right.

WCI: Which presumably the value is tied to how much you're paying in rent.

Collin Hart: That's right.

WCI: In order to maximize your real estate value, you got to jack up the rent on yourself.
Collin Hart: Right.

WCI: Then once they buy it, you're stuck with this high rent payment. Are you really coming out ahead and doing that, or what's really the proper way to set up leases in order to maximize your real estate value?

Collin Hart: That's a great point, and I'm glad you brought it up. You would say, “Hey, is this an opportunity to jack up our rent?” But let's not forget that the practice is continuing to operate there, and a lot of times you have the older physicians retiring and new physicians coming in. You can imagine that if there are new partners coming in, they're probably not going to be happy to be saddled with a huge rent payment. Would you agree?
WCI: I think so. I think everybody would agree with that.

Collin Hart: Okay. Good. This is where we come in and kind of help get an understanding of the practices' objectives and setting their rent to a fair market value. I would say establishing a fair market value rent is more art than science. It's maybe easy to figure out what houses are renting for on your block and you can say, “Hey, if I buy this rental property, I can rent it for 1500 bucks a month or $1,000 a month, or what have you.”

Collin Hart: But healthcare real estate is a lot more nuanced. You can imagine that any of your friends who own their practice or surgery center real estate probably aren't publishing their rental rate all over the Internet, so there's less transparency. That's where you would work with an appraiser or an advisor to help to figure out what your fair market rent should be. I'll kind of give you some guidelines. Generally, what we've found is clinical rents could be in the range of, let's say 15 to $25 per square foot.

Collin Hart: That's just clinical space, like medical office space. Again, we're talking a broad range just because you have listeners across the country. Then surgery center rents, we've seen anywhere from let's say 25 to $40 per square foot. You can imagine that ASC space is a lot more specialized, it's more expensive to build and so that's the justification for there being a higher rent on that space.

Collin Hart: To be honest with you, what we've found is that when we come in and help a partnership or a real estate partnership evaluate their rent, a lot of they're not that far off. They might have younger people in the practice who aren't owners in the real estate, so there was some pressure on the real estate centers to set a rent that was fair and sustainable. Does that make sense?

WCI: It does.

Collin Hart: Okay.

WCI: I presumably, the longer the lease and the higher the rent, the more value the real estate has.

Collin Hart: Yes.

WCI: The less freedom and the higher costs you're going to have going forward continuing to practice in the building is. It sounds like it's mostly a balancing act between those two and just trying to get it to a fair market rent.

Collin Hart: That's exactly right. It is a balancing act again between the objectives of the real estate partnership and the practice. I guess what we've found is that most practices, and I think you would be aware of this and kind of the legal structuring of businesses, but what we found is that most practices already have a lease in place.

Collin Hart: Really what we're doing is kind of modifying the terms of that lease and setting the rent to something that is sustainable on a going forward basis. But effectively what changes in a sale and leaseback transaction is who you pay your rent to. Now instead of the rent moving from the practice entity to the real estate entity, it's just being paid from the practice entity to a third-party landlord.

WCI: A lot of people would point out your conflict of interest, anytime you're a broker and you're paid commissions for a sale, the goal is to sell early and often.
Collin Hart: Yeah.

WCI: Because it'll generate more commissions. How would you respond to that criticism of your recommendation to sell earlier than maybe a doc would otherwise, and do at least back?

Collin Hart: Sure. One of our core values of our company is that we are trusted advisors, and that means looking out for our clients. As licensed real estate agents, we also have a fiduciary responsibility to our clients to help them meet their objectives and look out for their objectives first. There have been clients who we've sat down with and they were considering a real estate sale and we evaluated their situation. We said, “Hey, now's probably not a good time to sell.”

Collin Hart: Maybe it's because they have new physicians who want to buy-in, maybe it's because the physicians who are there are on the younger side and they're going to be practicing for the next 20 or 25 years. Maybe it's because they sold their practice and they're just getting a really nice rent, and their initial investment in the building was so low that their return is irreplaceable. I think there are a variety of reasons why it would make sense for someone not to sell. We get a lot of our business through referrals, so our job is to be open and honest with our clients.

WCI: What are the tax implications of a sale and how does that change when you do a sale and leaseback?

Collin Hart: I'm not a CPA and I would tell your listeners to all talk to their CPA. But in general, the way that we interpret how rent is taxed is that in a real estate partnership, rent is brought in. Then it's distributed through the LLC to the partners underneath the LLC, so that rental income is taxed as ordinary income. Most of our clients are in a pretty high tax bracket as you can imagine.

Collin Hart: When we move towards a sale, now what we're doing is basically capitalizing that rent, we're going back to that discussion of a cap rate. We're now selling that stream of rental income and basically getting a lump-sum today. What we think is attractive about a sale leaseback is that, that lump-sum is now more tax efficient, because it's taxed as a capital gain. If we talk about multiples a little bit, we said, “Hey, you can get anywhere from 13 to 15 times annual rent in the sale of your real estate.”

Collin Hart: Again, that's the multiple. Effectively by selling your building and capitalizing it at a six and a half to 8% cap rate, you're getting the next 13 to 15 years of rent today. But instead of being taxed at ordinary income, you're taxed as a capital gain. Not to mention the time value of money, which is to say a dollar today is worth more than dollar 10 years from now.

WCI: Have you had run into a lot of docs that kind of regretted doing a sale and leaseback, they wished they'd held onto the property and maybe let it appreciate a few more years, and then had the option to sell it together with the practice a few years later?

Collin Hart: Not recently. I would say that's because we're at a peak in the real estate market. I know you're up on a lot of business news and so I'm sure you've heard that interest rates are at an all-time low. There was some chatter a few months back that interest rates might go up, but they've been okay recently. As interest rates remain low, values remain high.
Collin Hart: We're at this peak in the real estate market that happens to coincide pretty nicely with where a lot of our clients are in their career, and maybe again, they're looking at retirement on the horizon. As a result, it's kind of a perfect storm, if you will. Values have lined up nicely with where people are in their career.

WCI: Do you think that a lot of them are selling kind of for a market timing reasons or reducing the risk because they're worried the value of the real estate will go down between now and when they formally retire and sell the practice, or what do you think drives most of them to really look at the leaseback option?

Collin Hart: Yeah. I think it's really the succession planning. It just happens to be nice that a lot of these folks are at the point in their career where they will practice for the next five, 10, 15 years. But we're at a good point in the real estate market. I wouldn't say only driven by the market, I would say it's also just driven by personal objectives and wanting to get an exit strategy on their investment.

WCI: Any other tactics they can use related to a 1031 exchange that you've seen workout well, are people exchanging to residential properties? Are they exchanging to other healthcare properties, where do you see most of these exchanges going to and are they able to successfully complete it most of the time?

Collin Hart: Sure. We've seen it all. We've seen people 1031 exchange into funds, maybe like some of the stuff that you invest in. We've seen people 1031 exchange into real estate partnerships, maybe into an apartment complex or something like that. We've also seen people go into rental properties, we have some clients in Florida who did exactly that. Then we've also seen people exchange from their clinical real estate investment and then buy things like a triple net property, which you may have heard of as well; a property with a long term lease, leased to a retailer or something to that effect.

WCI: All right. I think we've covered most of the questions I had for you. Is there anything else my listeners should know about clinical and surgical center real estate that we haven't already discussed?

Collin Hart: I think we've covered a lot and I really appreciate your time today. What we're seeing a lot right now is that with a lot of consolidation in healthcare, there's focus on people selling their practices. We've run into a lot of clients who have already sold their practice and then as part of that practice negotiation, they signed a new lease with their private equity partner, or the hospital, or whoever bought their practice out.

Collin Hart: Oftentimes those leases are not ideally structured to the point where their building would be salable, and so now our clients are stuck and we can't sell their building. What I would encourage is that, if any of your listeners are looking at doing something on the practice side, that they should address the topic of real estate early. That means making sure they have the right rental rate in place. That means making sure they have the right lease terms. Even if they don't want to sell their real estate, structuring in their lease properly will ensure that they have that option in the future.

WCI: Yeah. What would be an example of a lease that was improperly structured, that really holds them from being able to sell their practice?

Collin Hart: Yeah. We didn't actually touch on ideal lease terms, but I'll go over them because it ties in with your question. Ideal lease terms in a sale and leaseback are a 12 to 15 year lease, annual rental increases. Usually, we see anywhere from one and a half to 3% rental increases per year, and then a triple net lease structure. Are you familiar with that, have you heard of that?

WCI: Yes. I'm familiar with triple net but many of my listeners may not be, so why don't you go ahead and explain it.

Collin Hart: Sure. Triple net just means that the tenant remains responsible for payment of real estate taxes, property insurance and property maintenance. In addition to base-rent, which again is what the landlord receives, the tenant is going to continue paying taxes, insurance and maintaining the building. We've seen clients who sold their building and they had a gross Lease.

Collin Hart: That means that they just pay rent to the new landlord, but the landlord is responsible for paying all those expenses we just discussed. It's not an ideal lease structure if you own hundreds of buildings. As a result in a situation like that, we don't get a lot of market interests because it's a much more hands-on investment. Whereas the large buyer pool is looking for hands-off investments that they can just collect a rent check from. Again, long term lease, annual rental increases, triple net lease structure.

Collin Hart: Then if they're selling their practice, they would typically want to try and get some sort of guarantee from the hospital, from the top level entity of the private equity company or something to that effect. One thing that we've seen as a trend in the industry is that maybe five years ago, if you were doing a sale leaseback and not selling your practice, just the practice stays on the hook. The physician partners might have to personally guarantee the lease. We're at a point today in the market where there's a lot of demand for properties like this.

Collin Hart: As a result, personal guarantees haven't been required in most of the transactions we've worked on recently. A lot of people say, “Hey, I don't want to personally guarantee a lease.” We say, “You don't have to.” It becomes attractive because they're trading, oftentimes a recourse loan and they're paying off that recourse loan, selling their building and then trading into what you could call a non-recourse lease.

WCI: Now let's say you had some different lease terms, you only had a two year lease or a five year lease, or whatever. How much is that going to affect your ability to sell the property? Is that going to make it dramatically more difficult or just lower the value, 5% or what kind of an effect would that have?

Collin Hart: Dramatically more difficult. When you start talking about a property, let's say with a two year lease, we get back into that territory of maybe selling your building to someone as a vacant building or as something that a new person is going to or a new business is going to occupy. The interest from institutional investors, which are the folks who are usually going to pay the most amount of money will be zero. It's more of, you can't quantify it with a percentage decrease in value, I would more just say it's binary.

Collin Hart: Now instead of selling to an institutional investor who will pay the most amount of money, you're going to have to find some sort of a local buyer, someone who might occupy the building at some point in the future. As a result, instead of selling your building for let's say, capitalized value, which again is based on the rental income, maybe you're going to be selling the building for replacement costs. Which a lot of times we've seen is maybe 50% of capitalized value.
WCI: So rather dramatic difference, it sounds like?

Collin Hart: Quite dramatic, yeah.

WCI: Well, thank you so much for coming on. That's really helpful, I think to answer those questions about practice real estate and their values. For those who missed the beginning, this is Collin Hart, MBA that we're talking to. He's the CEO and Managing Director of ERE Healthcare Real Estate Advisors, that are real estate brokers, that you can easily find on the internet just by typing in that name. If you're interested in exploring the options of selling and leasing back your practice, and need some advice and some help doing that from people who've done it many, many times before. Thank you for coming on the White Coat Investor Podcast, Collin.

Collin Hart: Jim, thanks so much and have a great afternoon.

WCI: Thank you. Okay. I hope you enjoyed that interview. It's always fun to get something on there. It's a little bit of a niche topic, I'm sure. If you don't own any practice real estate, maybe it wasn't that interesting and you're not listening to this now, because you already turned it off. I don't know. But for those who are interested in owning their practice real estate or particularly interested in selling it, I think that will be a pretty useful podcast. As I mentioned at the beginning of the hour, if you have not checked out our student loan refinancing page, this should be a resource that should be at the top of your mind.

WCI: If you got student loans and you are planning to pay them back, you might as well cut a couple of the interest percentage points off there. If you've got a $200,000 loan and you're paying 8% and you can get that at 5%, that's basically $6,000 a year that could be going toward your principal instead of interest. This is as close to a free lunch as there is in physician finance. Check that out at whitecoatinvestor.com/student-loan-refinancing, and you can see the special deals we have there. Obviously, these are private companies, they are in it to make money.

WCI: If you've got a terrible credit score or a terrible debt to income ratio, they may not refinance. You don't refinance loans and you're planning to get forgiven through Public Service Loan Forgiveness. But if you're planning on paying these back, chances are you can decrease your interest rate significantly. The process usually only takes a couple of minutes to get a very accurate idea of what your interest rate would be. Then you can compare that to the other companies and take the one that gives you the best deal.

WCI: This episode was sponsored by Alexis Gallati, of Gallati Professional Services. Alexis is not your typical tax advisor. With over 15 years of experience, she's been helping physicians all over the country save money on their taxes. As a spouse of a busy physician, she understands the burden of high tax payments that we incurred on our lifetimes. Not only will she create a high level strategic plan for you, guaranteeing money in your pocket, but Alexis will proactively work with you throughout the year to maintain your tax plan, prepare your returns, and represent you in the case of an audit.

WCI: The investment in your tax planning services is a fixed price agreement and her tax maintenance package is at a flat monthly fee. If you're tired of complex tax jargon, giving away most of your paycheck to the IRS, visit Alexis's website at www.gallatitax.com today to schedule your free initial consultation. Head up, shoulders back. You've got this. We can help. I will see you next time on the White Coat Investor Podcast.

Disclaimer: My Dad, your host, Dr. Dahle, is a practicing emergency physician, blogger, author, and podcaster. He is not licensed to [countenance 00:44:56], attorney or financial advisor. This podcast is for your entertainment and information only. It should not be considered official, personalized financial advice.