Real Estate Advice For the Investment-minded Physician

Physician's Money Digest, July 2007, Volume 14, Issue 7

“People are living longer than ever before, a phenomenon undoubtedly made necessary by the 30-year mortgage.” —Doug Larson

34%–Percentage of homeowners who don’t know what type of mortgage they have. (Bankrate.com, 2007)

For many, owning a home represents the American dream and, according to some analysts, the timing might be right to make that purchase. Chief economist of the National Association of Realtors, David Lereah, says, "…it appears that buyers are becoming more comfortable, sensing the timing is good and that their local market has bottomed out…2007 promises to be the fourth best year on record."

Robin Wilson, founder and CEO of Robin Wilson Homes, agrees. Wilson explains that while many people are still waiting for the housing bubble to burst, there's a general concensus that the market may have already bottomed out.

If that's the case—if sales are slowing and prices are weakening— it might be an excellent time for buyers to obtain some leverage in the market.

The Allure of Commercial Property

Many doctors want to invest in real estate to build personal wealth, but they do not want the management headaches that come with many types of investment real estate. For the doctor who never owned investment real estate before, the natural inclination is to choose a type of real estate that is most familiar or perceived to be easy to understand. For this reason, many first–time physician investors choose apartments to purchase. But, according to Mark Alexander, CCIM, senior medical office advisor for Sperry Van Ness Real Estate Advisors, this type of investment is highly maintenance intensive, so they will need to hire a local real estate firm to help them manage the property.

"First–time apartment owners often cut corners on operating expenses in an effort to save money and don’t realize the need to maintain the property in top condition to insure high occupancy and high rental rates," Alexander explains. "So, when management starts cutting corners on the property condition, that often starts the slow spiral downward toward deferred maintenance, which causes tenant turnover, higher vacancies, and a lower return on their investment."

The easier solution for the first-time investor, Alexander says, is to purchase triple net lease income properties like office or medical office properties.

"With a single tenant, triple leased property, there is no need to hire a management firm because the tenant takes care of all maintenance issues and property expenses such as insurance and real estate taxes. The investor just gets a check in the mail each month so this investment resembles a bank CD. That is why this type of single tenant, triple net lease investment is called a coupon clipper, and it is the investment of choice for physicians heading into retirement who need safe income from their property investments during retirement when they are no longer earning a paycheck."

Being Aware of the Snags

Wilson is an advocate of commercial property purchases, but he cautions that today there are more issues of concern, caused by overbuilding of commercial property in many markets, which can lead to vacancies.

"Many sellers are savvy and want the maximum revenue without thinking about the fact that the new buyer may not be able to cover debt service with existing tenants unless rents are raised," Wilson explains. "Always look carefully at the sales ads that tout 'long-term leases' in place, which may translate into an inability for the new investor to dislodge a tenant who is receiving a very low lease rate."

A long-term tenant may produce stabilization in your space and will ensure that your investment begins to pay for itself. On the negative side, a nonpaying tenant with a long lease can create eviction issues that are quite expensive and time-consuming.

Investing Trends to Consider

An investment in a condo-hotel conversion property is another way to maintain value, lower maintenance costs, and have a residence in a second city, but also to receive "hotel" income when not in the location. This can be quite advantageous, Wilson says, but it is important to understand the rules for the property and to calculate wear and tear on your personal belongings.

Location is, as always, a key factor in selecting this type of investment property. However, you should determine if your goal is cash-flow or appreciation.

"If you seek cash-flow, but appearances are not important, you may wish to pick a high-transient location such as a college campus, hospital, or low-income community," Wilson suggests. "If you want to see appreciation, then we suggest making a purchase from a developer at the lowest negotiable price during the preconstruction phase. Then, as the development sells, you may be able to put your property back on the market to see a gain."

But there is a risk, Wilson cautions. For example, people who made an investment in 'hot' markets such as Las Vegas were unable to place their investment spaces on the market with a gain because the market plunged as the area overbuilt. Keep in mind that commercial property is drastically different from residential, and should be purchased only after thorough investigation of the financials associated with the selected property. Make sure to do the research before speculating.

In addition, Wilson believes that physicians should select a space for investment that will be in a low-tax community so that no matter the rental income, the gains will not be taken away. And it is always a good idea to ensure that maintenance is a priority because you don't want to retire and wish to rely on the income, only to be faced with making significant repairs.

Alexander adds that while location is always important, its degree of importance varies between property types. "For example, if you are buying an industrial warehouse property, you want to make sure the building is located on a street with good access to the nearest Interstate and airport," Alexander says. "Conversely, when buying a triple net lease property like a CVS Pharmacy or Good Tire Store, location will have less importance because you are really buying the strength of that tenant and its ability to pay you rent over its long lease term, which typically ranges from 10 to 25 years."

Sticking with What You Know

One aspect of real estate that the housing bubble does not affect, Alexander says, is medical office sale/leaseback transactions. He explains that doctors who get within 5 to 7 years of retirement are using the sale/leaseback to create "above appraised value" sales for the medical office building they own and occupy with their medical practice.

"After the sale/leaseback transaction closes, the trend is for doctors to roll their sale proceeds into buying a triple net lease income replacement property as part of a 1031 exchange to save tax dollars on their sale and to provide secure income for retirement," Alexander explains. "Separating their medical office property value from their medical practice value allows them to secure a property value that is 20% to 30% higher than they could get if they packaged the medical building together with the sale of the practice. Investors seeking a good return will always pay a higher price than an incoming doctor who wants to use the property for his or her business."

After the sale/leaseback closes, Alexander says, it becomes easier for the doctor to retire and sell the practice to another doctor who will need to come up with much less cash because he is just buying the practice and taking over the existing lease. Because most medical practice buyers have not been out of residency very long and they tend to have hefty school debt outstanding, this arrangement helps these doctors buy practices.

The sale/leaseback "enables them to create top-ofthe- market sales prices for the property and makes it easier to retire when they are ready to sell their practice," Alexander says. For more information on sale/leaseback, contact a CPA who is experienced in this type of investing.