Should You Rent or Own Your Medical Office Space?

If you own or operate a medical practice, the first check you cut every month is probably the rent—and it is often one of the largest. Real estate is usually the second-largest expense in most practices. Only payroll is larger.

Thankfully, this is an expense you can control, and that makes it an opportunity—perhaps the best opportunity—to impact profitability over the life of your practice. But it requires you to answer a major question: Should you own or lease your office space?

The answer requires you to address other important factors such as your proximity to retirement, exit strategy and financial position. Where you want to be located and the availability of real estate options are also important.

The reality is there is no single right answer to the question of purchasing versus leasing. Leasing can offer flexibility and financial concessions such as free rent, a tenant improvement allowance, a free built-out period and more. Ownership brings equity, which can increase both your net worth and the value of your practice. If you want to take a deeper dive into the benefits of purchasing, keep reading.

The Benefits of Ownership

Most practices are interested in increasing revenue. For example, a doctor might bring in a specialist, purchase a new piece of equipment and offer new services.  That’s a great option, but it requires the practice to increase overhead.

Real estate ownership involves taking a payment you already make every month and adjusting it to work harder for you. Rather than paying rent to a landlord, you accrue equity as you pay down principal on a commercial real estate loan. It is similar to the buy-versus-rent decision you make on residential real estate. Over a 10- to 20-year period, the difference can be hundreds of thousands—even millions—of dollars in your pocket.

While most doctors understand the equity benefits of ownership, the tax benefits are less well known.

Typically, the real estate is owned by an LLC, which is formed by the practice owner(s).  Rent and operating expenses are then paid by the practice to the LLC.  The practice can write off rent and operating expenses on its taxes, the same as it would if the real estate were owned by an unrelated landlord.

Given that the doctor owns both the real estate LLC and the practice, do the taxes on the rental income paid to the LLC negate the practice's write-off benefits? In short, no, but a Certified Public Accountant should be consulted to evaluate the precise implications. Speaking generally, here’s how that works.

It is true that the LLC will be taxed on rental income. However, the LLC also has a number of additional write-offs that substantially reduce that tax liability. In addition to the mortgage interest deduction, the LLC can depreciate the building and land improvements. The standard straight-line deprecation for commercial property is 39 years, and some property improvements can also be accelerated. For example, while the land itself isn't depreciable, the land improvements can be depreciated over 15 years or less.

Put in simple numbers, if $1.25 million was paid for a property, and the land was worth $250,000, then the remaining $1 million could be written off over 15 to 39 years.  That's a minimum of an additional $25,000 of tax deduction annually. By leveraging depreciation timelines, known as “cost segregation,” a CPA can often dramatically reduce tax liability on rental income.

In short, tax advantages provide a compelling reason to own.

Boosting Your Retirement Strategy

Owning office space can bolster your retirement strategy. In fact, in a practice sale, it's very common for the real estate to be worth more than the practice. This presents options that can help provide retirement income in a number of ways.

When you're in a lease and are ready to retire, it's a simple exit. You close the practice or assign the lease to the buyer and you're done.  The value of the practice you have spent your life building is the only item you have to sell.

If you own your real estate, you have a number of options to consider. You can sell it to the practice buyer and either cash out or exchange it, increasing your real estate investment portfolio. You can sign a long term lease with the buyer and receive the additional cash flow of thousands per month. Or, you can enact a combination of the two, leasing it to the new practice owner and creating an annuity, and then selling it and cashing out years down the road when the new practice owner is ready to buy the real estate.

Options for Ownership

Of course, ownership depends upon having viable options in the marketplace. Variables such as location, square feet and the type of building can limit—or even eliminate—the possibility of ownership in a specific market. For those reasons alone, it is vital to have expert representation to fully vet all options.

It is also important to complete due diligence on your top three to five retail and office space options before you take action. You can't make an informed decision if you don't know your options. Ownership can be an opportunity to maximize profitability, increase net worth, boost retirement income and end tense lease negotiations. But the numbers have to be favorable.

CARR is the nation’s leading provider of commercial real estate services for healthcare tenants and buyers. Nitra cardmembers get a free lease evaluation.  Visit CARR.US to learn more.

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