What Vet Practice Owners Should Know About Animal Hospital Real Estate Sale-Leasebacks
Oftentimes veterinarians own not only their practice, but the real estate as well. And equally as often, the owners do not realize how valuable their real estate has become.
Jon Vick, the founder and president of Vet Asset Advisors, Inc., (www.vetadvisorsinc.com) and medical property expert and broker Jason Winokur answer questions on successfully selling animal hospital real estate and leasing it back.
Questions and Answers
What is a Sale-leaseback?
A sale-leaseback is an arrangement in which the vet practice owner sells their real estate and the practice simultaneously leases it back from the purchaser. With a sale-leaseback, the details of the arrangement, such as the purchase price, lease payments and lease duration, are negotiated as the terms of the sale. In a sale-leaseback transaction, the seller of the asset becomes the lessee (tenant) and the purchaser becomes the lessor (landlord).
A sale-leaseback enables a vet to sell their real estate to a purchaser, and the practice leases that asset back from the purchaser. In this way, the vet can get both the cash and the property he/she needs to continue to operate their business. The cash can be used for any purpose, including buying other diversified assets.
Example: A veterinarian owns a 10,000 square foot animal hospital on an acre of land, and is paying rent of $22/sf or $220,000 a year. This is considered income, so the vet is paying ordinary income tax on $220,000 a year. In a sale-leaseback transaction, a buyer pays the vet a cash purchase price of $3.1 million (using a 7% CAP rate) and the practice signs a 12-year NNN lease at $22/square foot, plus annual 2.5% rent increases, with four or more options to renew, tying up the real estate for 30 or more years. The vet thus retains control of the property with a NNN lease.
Why would a vet want to sell their animal hospital real estate when they are paying themselves rent and getting a good return?
There are four important reasons:
- High Value: Animal hospital real estate has become very valuable, selling at higher multiples than vet practices have been selling for previously. The owner can sell at a high price, take the money off the table, and leaseback at the same rent as before the sale.
- Good timing: There is currently an excellent market for animal hospital real estate and a scarcity of good properties for buyers to bid on. Due to the current extremely low interest rates, the prices being offered are at the top of the market.
- At market rate rent, your real estate is fully valued. The increase in rent, or your annual ROI, is only 2% to 3%. The ROI from alternative investments ranges from 6% to 12%.
- Rent is considered income and you are taxed at a 30% to 37% tax rate, greatly reducing or eliminating any profit from rent. In most cases you are not getting a “good return” on the value of your real estate assets.
When does it make sense for a vet to consider a real estate sale-leaseback?
When the vet practice owner wants to realize a profit from real estate and take some money off the table. In most cases, the owner has greatly increased the value of the real estate by operating a successful animal hospital. The real estate value is based on rent and rent for successful animal hospitals can be at the maximum fair market value, thus maximizing the value of the real estate. However, the only way to unlock the value and the profit is to sell the real estate.
The owner can sell his/her real estate, realize a significant profit, and lease back at the same rent. The owner will have cash to diversify investments while impacting neither the value nor profitability of the animal hospital business.
If you are considering selling your practice, what steps should you take to protect the value of your real estate?
Prior to a sale, you have full control over your lease. You will lose this control once you sell your practice, so you want to have a saleable lease in place prior to entering into negotiations with a buyer of your practice. This will help you avoid any future real estate/tenant conflicts with the future owner of the practice. To maximize the value of your assets, you should have a long-term lease that maximizes the value of both your practice and real estate before entering into negotiations with any buyers. After the sale of the practice, you will not be able to change the lease.
If a vet has already sold their practice to a consolidator, does it make sense to now sell their real estate as well?
Most consolidators don’t buy real estate – they raise their capital to buy veterinary businesses. Therefore, vets who have sold their business to a consolidator, or who are thinking of selling to a consolidator, and who also want to sell their real estate will need to find another buyer. The decision to sell the real estate depends on the practice owner’s goals – for example, are you seeking an exit strategy? – and timing. The best time to sell is when interest rates are low, because most buyers finance their purchases and offer higher purchase prices when their borrowing costs are low. The market for selling animal hospital real estate is very strong right now due to the current low interest rates and there being more buyers than sellers. Competitive bidding among buyers pushes prices up to their highest level.
If a vet has not yet sold their practice to a consolidator but may want to in the future, how would a sale-leaseback of their real estate impact their ability to sell their practice?
The sale and leaseback of veterinary real estate should have no impact on the sale of the vet business to a consolidator. Consolidators typically do not want to buy the real estate but do want a fair market value lease. Thus, it is recommended that, prior to beginning discussions with a consolidator regarding the sale of the vet business, a lease should be put in place that is attractive both to the consolidator and to the eventual buyer of the real estate. These leases typically include 12 to 15-year terms, Triple Net (“NNN”) meaning that the tenant pays insurance, taxes and maintenance, 2% to 3% annual rent increases, and fair market value rent. With such a lease in place, the profitability and value of the vet business would not be impacted.
If a vet wants to remain independent, how does the sale-leaseback of their real estate impact their business?
Once again, with a fair market lease in place, the vet practice owner can sell and leaseback the practice real estate without impacting the profitability or value of the practice. An experienced broker can determine the best combination of rent and business profitability so as to maximize the value of both the vet’s real estate and the value of the vet’s business.
Who are the most likely real estate buyers?
There are many private investors, family trusts, and small real estate investment firms that are seeking passive investments and that are likely buyers of veterinary real estate. A growing number of real estate firms and private investors are diversifying from other assets such as retail and general office investments and seeking vet real estate. While some publicly traded real estate investment trusts (REITs) are also diversifying into vet real estate, a sale to a private entity is usually better for the seller as these buyers are looking for passive income and do not require onerous reporting, etc. Sellers should market nationally and not limit their buyer pool to local buyers who do not know the true value of vet property. Local brokers typically try to sell to local buyers. The national market yields more buyers, more competition, and higher offering prices.
How important is the lease in a sale-leaseback transaction, and what kind of lease is best?
The lease is the key element in a sale-leaseback transaction and should be thoughtfully written with a sale in mind, prior to engaging in discussions with potential buyers. The lease has to be attractive to the seller, the consolidators, and the buyers of the real estate. The value of the property is determined by the lease. Leases should be “NNN” leases, at a fair market value rent, with a term of 12 to 15 years, annual increases of 2% to 3%, and guaranteed by the business. For the guarantee by the business to be meaningful, the business must have a solid history of profitability, net profits that are at least 3 times the annual rent, and sustainability into the future for at least as long as the lease.
How can a vet practice seller ensure they are maximizing the value of their real estate?
The value of the real estate will be maximized by:
- Increasing the rent up to fair market value.
- Having a lease that is attractive to buyers.
- Having a long-term lease that is guaranteed by the vet’s practice.
- Soliciting competitive bids from multiple buyers.
- Using a broker with pre-qualified national buyers.
Are there any situations that could potentially lead to unfavorable lease terms? How can vets avoid this?
Many times a vet is leasing the real estate to the practice and charges below-market rent in order to maximize practice value. Because real estate sells at a higher multiple than the practice, this strategy devalues the real estate. The value of the real estate is dependent on the future stream of income from rent. So if you lowball the rent, you devalue the real estate. An experienced broker will forge a happy medium where the value of all assets is maximized.
What are the benefits of a sale-leaseback transaction?
The vet practice owner can sell the real estate, unlock the profits and diversify his/her investments while retaining the use, ownership and distributions from the practice. The rent they pay, which may be unchanged from before the sale, remains an expense to the business, just as before. The owner has gained from the sale of the real estate and retained all the benefits of the practice. Prices for vet real estate are at their highest as there is a shortage of good quality properties. Competition to buy pushes the prices up, and the current low interest rates enables the buyers to offer higher prices in this “seller’s market.”
Is there a way to shelter capital gains?
A tax-deferred 1031 exchange can eliminate capital gains taxes on the sales transaction. This entails buying another income producing property, such as an investment grade credit tenant bank or drug store, within a certain time frame after the sale. The seller can also potentially shelter a greater percentage of income on a new property than can be sheltered on their own vet property while indefinitely deferring capital gains taxes. Most brokers with access to national buyers for veterinary property can also arrange attractive 1031 exchange properties for the seller.
Jon Vick, the founder and President of Vet Asset Advisors, Inc., has assisted in development, merger, and strategic acquisition transactions for over 250 medical facilities and practices since 1998. He has extensive experience in real estate valuation, sales and leasebacks. He can be reached at 760-751-0250 or firstname.lastname@example.org.
Jason Winokur, a medical facility real estate expert and broker, is a principal of JH Winokur, Inc. and specializes in medical real estate sales and leasebacks, lease negotiations, property valuations and 1031 exchanges. Since 1998, he has transacted over $2 billion in medical and commercial transactions. He can be reached at 914-997-9200 or email@example.com.
More information can be obtained at: www.vetadvisorsinc.com
Copyright Vet Asset Advisors, Inc., 2020
The Vet Asset Advisors team has decades of experience helping the owners of medical and health care properties value their real estate before putting it on the market, and get the best results out of their sale or sale-leaseback transaction. We can provide you with greater exposure, a wider pool of qualified local and national buyers, and, most important, a much higher value on your property.