The Impact of Real Estate on Clinic Valuation

It is common for practice owners to also own the clinic’s real estate (the land and the building). In these cases, the buyer will typically purchase this real estate as part of the overall practice purchase, or enter into a lease with the seller, allowing the practice owner to continue owning the real estate and benefiting from rental income for years into the future.

Sometimes a seller wants to sell both the practice and the real estate together, but the buyer does not want to purchase the real estate. In those cases, an experienced buyer can help arrange a third party to purchase the real estate and help meet the seller’s goals.

The Impact of Real Estate on Valuation
The practice’s real estate is an asset that can either be sold with or separately from the practice. Over time, the real estate can become a significant part of a practice owner’s investment portfolio. Therefore, it is generally preferable to own the real estate in a separate limited liability company (LLC), which allows the owner to easily keep both the real estate and the clinic at arm’s length.

If you own both the practice and the real estate, it is important to ensure that the clinic is paying appropriate fair market rent. It is best to think of them as separate businesses. Ask yourself these questions: As the owner of the real estate, what rent would you charge third party? How does that rate compare to the rent you are charging your own practice?

Charging below-market rent can hurt you when it is time to sell your practice. Here’s how.

• Real estate impact: Let’s say that the owner of both a practice and real estate is charging the clinic $10,000 per month in rent when the fair market rent is $15,000 per month. The owner obtains an appraisal on the building and is happy with the appraised value. However, the appraisal is based on the fair market rent, but the clinic is paying one third less ($10,000 rent vs. $15,000 fair market rent). It is unlikely that the owner will be able to sell the property for the appraised value unless he or she can raise the rent the clinic is paying.
• Clinic impact: A potential buyer will value the practice based on its current profitability. Since that profitability is based on below-market rent, any attempt to raise the rent will lower the clinic’s profitability and, consequently, its value. Let’s say that the owner of a practice and its real estate is charging the clinic $10,000 per month when fair market rent is $15,000 per month. The clinic is showing a $100,000 per year profit. When it is time to sell the practice, the owner tries to raise the rent to the fair market rate. However, the difference between the current rent and the fair market rent is $5,000 per month, or $60,000 per year. Suddenly the clinic’s income drops from $100,000 to $40,000 and its value drops dramatically.

The Take-Away Regarding Real Estate
The clinic’s real estate can be a profitable long-term investment for a practice owner. When it comes time to sell the practice, the owner can either sell the real estate with the practice, or keep the real estate and earn rental income for years to come. It is important to make sure that the practice is paying appropriate fair market rent.