Avoid real estate hiccups when buying a clinic

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Problems involving the real estate where the clinic operates can set the hopeful purchaser’s head spinning at any point in the transaction. Most commonly they seem to happen at the worst time possible—when bank commitments are set to expire, when the buyer’s resignation notice period is about to start and other nifty times like that.

We counsel practice-buying clients to do their level best to predict issues that might pop up as a sale transaction progresses. But there are limits to a person’s imagination and experience.

Because some snags are virtually impossible to foresee, it’s important for both the buyer and the seller—as well as their legal representatives—to monitor closely everything that is happening as the property sale moves from letter of intent through the close of escrow.

And realty troubles can pop up even in practice sales that do not involve a real estate purchase. When the clinic being sold is located in a shopping center or when the seller is only willing to part with the practice but not the building, lease terms can get sticky during negotiations and occasionally even scuttle the sale of the practice itself.

We have found that if the parties, especially buyers, can look past the mere terms of the real estate lease or purchase contract and investigate potential trouble areas as they may arise, they will likely be able to predict clinic cash flow accurately, close the sale earlier and see through a smoother transition than would be the case if issues are confronted on a crisis-by-crisis basis.

Premises costs as a financing hindrance

Often, when a potential practice buyer looks into the cash flow of an interesting clinic, he merely accepts the rent or mortgage service costs as an immutable reality. These buyers look at the business’ income and expenses—but not occupancy costs—with an eye toward coming up with a realistic price to offer a seller. But looking only at the cost of inventory, number of transactions and personnel expenses to the exclusion of the real estate’s current and future carrying costs can be a big mistake.

Instead of ignoring the “occupancy overhead” of a potential practice acquisition, it makes far more sense to look at real estate cost and to evaluate that parameter in a non-emotional way. A property’s price, upkeep (or common area maintenance), depreciation, neighborhood quality and “highest use” characteristics are essential things to be aware of. These need to be considered objectively as they exist, and their future predicted to the extent possible. Remember that taxes, assessment, insurance and value acceleration (or deterioration) are hard and fast realities that can impact business profits far into the future.

Real-world examples are instructional

But anticipating neighborhood growth or the risk of tax increases that might result from lousy municipal management are only part of the realty Rubik’s Cube.

Regular readers of this column know that I am a big believer in learning from the mistakes and oversights I’ve made myself and seen lots of others make. In veterinary real estate, there are plenty of both, so here are a few of the scenarios that have worked their way across my desk:

Lease goblins

• Corporate consolidator gets blindsided. About six months ago, one of the largest venture-capital–driven “roll-ups” ran into an 11th-hour snag that nearly collapsed the acquisition. Literally hours before a closing at which the practice seller was to sign a long-term lease on his building and take home a seven-figure check, he inadvertently mentioned that he only owned the clinic building. The land underneath was leased property, and nobody involved had arranged to include the landowner in the negotiations. Clearly a potential deal killer.
• Awesome location, rent increases eclipse practice growth. A young veterinarian invested substantial capital obtaining a professional appraisal of a veterinary practice in a super-popular tourist area in a state with outstanding population growth. The bank evaluated the business financials and agreed to the loan, contingent on the buyer obtaining a 15-year lease on the practice building. Uh-oh! Turns out the landlord was waiting for the existing lease expiration 2 years hence so that they could raise the rent by double digits. The bank could no longer justify the loan based on historical profit figures once the new anticipated rent was factored in.

Building-purchase goblins

• Sale near closing, buyers reveal demo plan. A trio of entrepreneurial veterinarians we worked with recently had identified a great practice in a growing commercial area. The land and building titles were clear, and practice finances added up pretty well, too. The bank signed the initial commitment and the closing was scheduled. Oops! During a meeting with the bank, one of the partners mentioned that they “weren’t concerned” about some roof leaks identified by the bank’s inspector because they planned to tear the building down in six months and replace it. Deal on indefinite hold while the bank re-evaluates the borrowers’ ability to finance a new building once the original building’s demolition slashes the property’s value as collateral.
• Veterinarian discovers he doesn’t want to be a landlord. One of our very good associate clients started hunting for a profitable practice to buy and found a thriving clinic in a nice building, both of which were fairly priced. One problem: The building’s taxes, insurance, mortgage and upkeep costs were only affordable if the new owner-DVM was willing to manage the upstairs two-bedroom apartment and the CPA office in back, both of which were part of the facility. And a bonus: All the electric and gas to the entire building was handled through single meters in the veterinary clinic. I asked my client if he had any experience being a landlord (i.e. backed-up toilets, repainting commercial space and long, unanticipated vacancies). I didn’t mean to be a naysayer, but I know that landlording just is not everyone’s cup of tea. Our client decided to pass on what would otherwise have been a no-brainer purchase.

Problem properties can be profitable—for clever doctors

My final suggestion is for you “outside-the-box” thinkers not to be discouraged by my litany of unanticipated real estate debacles. “Problem” properties associated with solid practices can prove to be good opportunities—with some creative footwork. But be sure to listen to other, more experienced property owners and veterinarian-tenants and take their stories to heart.

There are numerous clever “overlooked” routes to making what might at first appear to be a lousy practice buy into a diamond in the rough. I will be presenting some creative solutions to real estate problems in an upcoming column. And if you can, please join me in September at the Southwest Veterinary Symposium in Fort Worth where I will be discussing veterinary real estate in much greater detail.

Christopher J. Allen, DVM, JD is president of the Associates in Veterinary Law P.C., which provides legal and consulting services exclusively to veterinarians. He can be reached via e-mail at info@veterinarylaw.com. Dr. Allen serves on dvm360 magazine's Editorial Advisory Board.