By Jon Vick and Jason Winokur • Vet Asset Advisors
Jon Vick, 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.
Q: What is a sale-leaseback?
A: A sale-leaseback is an arrangement in which the veterinarian sells their real estate and the practice simultaneously leases it back from the purchaser. In this way, the veterinarian gets the cash and retains control of the property he/she needs to continue to operate their practice. The cash can be used for any purpose, including buying other diversified assets.
Example: A veterinarian owns a 10,000-sf animal hospital and is paying rent of $25/sf or $250,000 a year. This is considered income, so the veterinarian is paying ordinary income tax on the rent received. In a sale-leaseback transaction, a buyer pays the veterinarian a cash purchase price of $3.5 million (using a seven percent CAP rate) and the practice signs a 12-year triple net (NNN) lease (meaning the tenant continues to pay the insurance, taxes, and maintenance) at $25/sf, plus annual 2.5 percent rent increases, with multiple options to renew, tying up the real estate for 30 or more years. The veterinarian stays in control of the property with a NNN lease.
Q: Why would a veterinarian want to sell when they are paying themselves rent and getting a good return?
A: There are four reasons:
1) High value: Animal hospital real estate has become very valuable, selling at higher multiples than veterinarian practices have been selling for. The owner can sell at a high price, take the money off the table, and leaseback at the same rent as before the sale.
2) 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.
3) At market rate rent, your real estate is fully valued. The increase in rent, or your annual return on investment (ROI), is only two to three percent. ROI from alternative investments ranges from six to 12 percent.
4) Rent is considered income and you are taxed at a 30 to 37 percent 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.
Q: When does it make sense for a veterinarian to consider a real estate sale-leaseback?
A: When the veterinarian-owner wants to realize a profit from real estate and take some money off the table. In most cases the veterinarian-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 real estate’s value. However, the only way to unlock the value and the profit is to sell the real estate.
The veterinarian-owner can sell his/her real estate, realize a significant profit, and lease it back at the same rent. The veterinarian will have cash to diversify investments while impacting neither the value nor profitability of the animal hospital practice.
Q: If you are considering selling your practice, what steps should you take to protect the value of your real estate?
A: Prior to the sale of your practice, 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. 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.
Q: If a veterinarian has already sold their practice to a consolidator, does it make sense to now sell their real estate as well?
A: Most consolidators don’t buy real estate—they raised their capital to buy veterinary practices. Therefore, veterinarians who have sold their practice 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 market for selling animal hospital real estate is currently very strong due to low interest rates and more buyers than sellers. Competitive bidding between buyers pushes prices up to their highest level.
Q: If a veterinarian has not yet sold their practice, but may want to in the future, how would a sale-leaseback of their real estate impact their ability to sell their practice?
A: The sale and leaseback of veterinary real estate should have no impact on the sale of the veterinary practice. 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 veterinary practice, a lease should be put in place that is attractive both to the consolidator and to the eventual buyer of the real estate. These NNN leases typically include 12- to 15-year terms with multiple options to renew, two to three percent annual rent increases, and fair market value rent. With such a lease in place, the profitability and value of the veterinary practice would not be impacted.
Q: If a veterinarian wants to remain independent, how does the sale-leaseback of their real estate impact their practice?
A: Once again, with a fair market value lease in place, the veterinarian-owner can sell and leaseback their real estate without impacting the practice’s profitability or value. An experienced broker can determine the best combination of rent and practice profitability so as to maximize the value of both the veterinarian’s real estate and the practice.
Q: Who are the most likely buyers?
A: There are many private investors, family trusts, and small real estate investment firms, as well as national real estate investment trusts (REITs), that are seeking passive investments and are likely buyers of veterinary real estate.
Q: How important is the lease in a sale-leaseback transaction? What sort of a lease is best?
A: The value of your property is determined by the lease. The lease is the key element in a sale-leaseback transaction and should be written with a sale in mind, prior to engaging in discussions with potential buyers. Leases should be NNN leases, at a fair market value rent, with a term of 12 to 15 years, annual increases of two to three percent, and guaranteed by the practice. For the guarantee to be meaningful, the practice must have a solid history of profitability, net profits that are at least three times the annual rent, and sustainability into the future for at least as long as the term of the lease.
Q: How can a veterinarian ensure they are maximizing the value of their real estate?
A: The value of the real estate will be maximized by:
1) Increasing the rent up to fair market value
2) Having a lease that is attractive to buyers
3) Having a long-term lease that is guaranteed by the veterinarian’s practice
4) Soliciting competitive bids from multiple buyers
5) Using a broker with prequalified national buyers
Q: What are the benefits of a sale-leaseback transaction?
A: The veterinarian can sell the real estate, unlock the profits, and diversify his/her investments while retaining the use, ownership, and profits from the practice. The rent they pay, which may be unchanged from before the sale, remains an expense to the practice just as before. The veterinarian-owner has gained from the sale of the real estate and retained all the benefits of the practice. Prices for veterinary real estate are the highest ever, as there is a shortage of good-quality properties. Competitive bids increase prices and the current low interest rates enable the buyers to offer higher prices in this “seller’s market.”
Jon Vick, founder and president of Vet Asset Advisors, Inc., has assisted in development, merger and strategic acquisition transactions for more than 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 by email at email@example.com.
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 more than $2 billion in medical and commercial transactions. He can be reached at (914) 216-3574 or by email at firstname.lastname@example.org.