Commercial Real Estate Investments - clinics - Recommendations / Pitfalls?

[SeattlePilot]

Some of the members of my practice are looking to invest in commercial properties. The idea would be to buy a few buildings that our practice can operate out of, with additional space to rent to other specialties. These would be clinics and not ASCs. The tenants would have NNN leases (including the practice) with almost no hands on management from the owners. Some of the other docs have done this before and have been successful. The idea is to have positive rental income within a few years, and obviously the equity in the building/land.

In exploring the options, I wanted to know if anyone else has done something similar? Each property would have its own LLC and the individual investors would be members of that LLC; the rental income would be treated as partnership income and we would receive K-1s. What would the tax implications be for the individual investor? If we have multiple investment properties (all with separate LLCs) would it make any sense for me to have an individual LLC that can hold my interest in all of the other properties? Any pitfalls to watch out for?

[EntrepreneurMD]

I've done about 20K sq ft but am the only owner and "partner". NNN leases are the way to go. My setup is simple, I have an employee with property management experiences that manages the rent, contractors and accounting spreadsheets (with some oversight) but it's been rather straightforward.

I am not sure from your intro why you would need separate LLC's but I'm sure there may be reasons to do so. Those are questions for your CPA's and attorneys, not so much here unless those in these respective professions want to weigh in. My properties are under one LLC but my situation is clearly different.

The group I was with in a former life had a building partnership set-up. The group, I believe, simply withheld the associated business income taxes from the K-1 distributions so the individual investors didn't have to worry about that, just their individual K-1 income taxes.

Not sure if you're a multi-specialty or single specialty group or primary care vs. specialty. As primary care, I of course don't lease to competitors but to complimentary specialties for secondary benefit above and beyond lease income and that seems to enhance benefit quite a bit.

Location is important. I went for a major epicenter and have received tenant demand above what I can accommodate. While the land was more expensive, the property commands better lease rates to offset, difference can be quite significant. I say this about location also because I know others who have also built very nice buildings but off the beaten path and have struggled to find/retain tenants. Of course if many of your docs spend time at local hospital proximity to hospitals is an important consideration and seems to also enhance investment value.

Interview multiple builders, engineers, architects, etc. Make sure they have good experience building what you need especially if there will be surgical suites, MRI/x-ray imaging rooms, significant OSHA considerations, etc.

Look at financing options and consider what monthly mortgage payments the group can manage. I did a 10-year fixed (no balloon) commercial (construction) loan at 3.5% (I actually negotiated better than the best rate quoted). Your stable business is valuable to lenders needing to make good loans. I put down a large down payment and to pay all the debt off within 3 years of moving in but again my situation is different. It did however optimize annual profits with no mortgage interest to pay.

Ideally the group would have a healthy down payment and would of course not need to funds allocated to the project for business expansion. It's a balancing act to a degree.

[SeattlePilot]

I've done about 20K sq ft but am the only owner and "partner". NNN leases are the way to go. My setup is simple, I have an employee with property management experiences that manages the rent, contractors and accounting spreadsheets (with some oversight) but it's been rather straightforward.

I am not sure from your intro why you would need separate LLC's but I'm sure there may be reasons to do so. Those are questions for your CPA's and attorneys, not so much here unless those in these respective professions want to weigh in. My properties are under one LLC but my situation is clearly different.

The group I was with in a former life had a building partnership set-up. The group, I believe, simply withheld the associated business income taxes from the K-1 distributions so the individual investors didn't have to worry about that, just their individual K-1 income taxes.

Not sure if you're a multi-specialty or single specialty group or primary care vs. specialty. As primary care, I of course don't lease to competitors but to complimentary specialties for secondary benefit above and beyond lease income and that seems to enhance benefit quite a bit.

Location is important. I went for a major epicenter and have received tenant demand above what I can accommodate. While the land was more expensive, the property commands better lease rates to offset, difference can be quite significant. I say this about location also because I know others who have also built very nice buildings but off the beaten path and have struggled to find/retain tenants. Of course if many of your docs spend time at local hospital proximity to hospitals is an important consideration and seems to also enhance investment value.

Interview multiple builders, engineers, architects, etc. Make sure they have good experience building what you need especially if there will be surgical suites, MRI/x-ray imaging rooms, significant OSHA considerations, etc.

Look at financing options and consider what monthly mortgage payments the group can manage. I did a 10-year fixed (no balloon) commercial (construction) loan at 3.5% (I actually negotiated better than the best rate quoted). Your stable business is valuable to lenders needing to make good loans. I put down a large down payment and to pay all the debt off within 3 years of moving in but again my situation is different. It did however optimize annual profits with no mortgage interest to pay.

Ideally the group would have a healthy down payment and would of course not need to funds allocated to the project for business expansion. It's a balancing act to a degree.

This is great, thanks! The reason for the separate LLCs is for liability protection and there would theoretically be different members investing in different properties. Some docs want to invest in certain properties and not others, hence the reason one LLC wouldn't work. We are a specialty group and would rent to complimentary specialties.

As far as the separate LLC for myself I was just wondering if that would make it easier from an accounting and estate planning standpoint to have all of the properties I invest in owned by a single LLC I am a member of, rather than me being an individual member of a bunch of separate LLCs. It would also seem cleaner from an estate planning perspective to be able to transfer one membership interest rather than 3-5 separate ones.

[CREGuy]

There's no need to go to a course for what you're trying to do. A good RE attorney, RE CPA, and commercial real estate broker will provide better insight, especially on your specific project/scenario than any course would. Really what might be worth considering as well, would be to partner with a developer. They'll have much more experience in the process (which can be complicated and full of potential pitfalls), and it could be arranged as a partnership structure or fee based. While it seems relatively simple on the front end, you're going to need a full financial analysis, feasibility studies, leasing, then go through site selection, the entitlement process, architects/design, engineering, and then oversee a construction project of fairly significant magnitude (obviously you would hire a GC, but I can assure you, you're going to need to manage the GC too). At the very least it would be something to strongly consider on the first project or two until you've gained some experience with it yourself. If you didn't want to bring them on as a partner or pay a full development fee, even a more limited role as a consultant may be worthwhile.

Bottom line is that you need to seek out professionals that deal with CRE whether in advisory roles or as partners rather than paying for a class. Like anything, who do you think is going to provide better insight and knowledge, someone teaching a class (and ultimately you with nothing more than said class on your resume) or the people who have been doing it every day for years?

[jacoavlu]

this type of stuff can get messy and complex quickly.

Investors are to be you and some of your partners, but not the group as a whole? Then you have to have a well thought out and well written partnership agreement ahead of time. Anticipate problems and solve them ahead of time. What happens when one guy wants out two years later? What happens when one guy leaves your medical practice? Do they stay in the investment club? Or automatic exit? What if someone new wants in? What happens when one guy suddenly dies? Is his interest bought out by other members? At what price? Or are his heirs allowed to continue to hold the investment? Who makes decisions? What if there is disagreement? And on and on.

doesn't sound like much fun to me. This is different than your group owning a building.

[Kamban]

Entry and exit plans as jacoavlu mentioned becomes very messy. Many partners want to retire but want to hang on to the investment properties as passive income. New partners cannot get in and ask why they should be paying high rents and not be able to get in that share of income. Forcing former partners to give up on lucrative income can lead to legal battles. What happens when one is forced out of the group or relocates. Does he sell immediately or later and at what price and what happens if non one wants to buy him out.

The picture is not as rosy as it appears.

[Tim]

"Some of the other docs have done this before and have been successful."
Were they silent partners just writing a check or were they actually involved? One would hope they learned what they were investing in.

[EntrepreneurMD]

Our group was structured in such a way that a partner was automatically bought out of the building partnership when they left the group (voluntarily or fired, became disabled, lost license, etc.) or passed away, at the appreciated property valuation over the given time frame since your initial investment (which was a one-time buy-in). No one can just choose to extract their investments in the meantime. Nor could an individual partner choose what portion of the RE they would invest in. Not saying you need to do it this way, but it works around some of the pitfalls discussed above.

If not the board of directors of your group, a master LLC board of the real estate investment would be necessary to centralize decisions and vote for final resolution of disagreements.

It can and should be structured to enhance the cohesiveness of your group rather than cause rifts. Generally a reasonable buy-in that would grow in value to minimize group turnover, like what 401k vesting does for employment longevity. Actually new hires were required to maintain employment for 2 years prior to being eligible for building partnership, and at that point it was optional for the physician to join. A high buy-in may mean less takers.

Generally you cannot anticipate all of the potential issues and it's not your job. It's your RE attorney's job to produce a comprehensive contract. They see the problems for a living, so they are in a better position to anticipate.

There is risk because there is reward. It's not necessarily easy, but it can be made easier with adequate due diligence, probably for at least 12-24 months for what you are considering.