You spend countless hours planning bank financing, personal investments, tax strategies, taking continuing education credits, learning treatment modalities, developing marketing initiatives, executing staff recruiting, retention and training strategies, but most tenants rarely look at their premises arrangements because it’s not an immediate concern.
Your practice is in a premises. No premises, no practice. Your premises is the foundation, the home of your practice. Your premises defines key elements of your practice including the location, shape, size, signage, parking, hours of operation, rent, use, leasehold improvements, and timeline. Premises defines the actual value of your practice. One of the most important and overlooked premises element is the timeline.
The timeline or length of time you expect to practice in your premises in the context of premises attributes is critical. You need to be aware, always, of what your timeline is and plan accordingly. You would not drive your car forever without checking the gas gauge every now and then and planning accordingly, because you would eventually run out of gas at an inconvenient time. Similarly, you need to check your lease timeline now and then and plan accordingly, so you don’t run out of time.
Consider your premises timeline a “premises planning event horizon”. Take a moment and think about the period from today until 10 years past the day you expect to sell. This amount of time is your “premises planning event horizon”. You need time to practice for the rest of your career, and then time for your successor to amortize the loan they borrow to buy your practice and fund your retirement. For example, if you are now 30 years old and plan to practice until the age of 65 and then sell, your premises planning event horizon is 35 to practice plus 10 years to amortize the sale loan or a total of 45 years.
Does your lease ensure your use for the next 45 years? You can check by adding the number of years in the current term plus all the years in each of the term renewal options. For example, if you are in year three of a five-year term and have two options to renew for five years each then you have 2+5+5 or 12 years ahead of you. The exceptions would be if:
1. You have a termination for demolition clause valid at any time on six months advance notice which effectively reduces your premises planning event horizon to six months, or
2. You are lucky, and the landlord agrees to delay the termination for demolition clause and give you a number of term renewal options.
If your premises planning event horizon is less than the time you need to practice and sell at full value, your practice value is potentially impaired by the cost to relocate. For example, if the relocation cost is $300 per square foot, then the cost to relocate and the impaired practice value is $450K for a 1,500 sq.ft. practice.
Consider two premises planning event horizon strategies.
A primary advantage to leasing includes the relatively low entry cost. Because your capital is not tied up, you can relocate from time to time and you can enter a market where there is no appropriate realty for sale. Ongoing rental payments approximate the cost of mortgage payments, and the cost of realty tax. Maintenance and insurance would apply in both owned and leased property.
Two disadvantages to leasing are that:
• The tenant does not accumulate any increase in realty value both in terms of market appreciation and mortgage paydown, and
• Most leases have a premises planning event horizon of 20 years of less, which is shorter than most occupants need.
You can manage your liability to a certain extent by choosing to locate in leased premises that are in a relatively new development, are unlikely to be re-zoned for an alternate use because of the neighborhood and making sure you have multiple options to renew for your premises event planning horizon, or plan to leave.
Consider ownership challenges. Many markets do not have any commercial real estate readily available for purchase at a financial or effort cost that makes sense. Purchasing ties up capital either as cash or borrowing power, requires a lot more administrative time than leasing, and is a long-term commitment. You cannot leave without selling. You will need your successor to remain as a tenant to protect your investment which means selling or leasing your property to your successor. However, the advantage is that you have a premises planning event horizon for as long as you want, your rent decreases the mortgage, your premises asset value floats up with the market, and you can sell your property or lease it to your successor.
Consider buying a condominium, a redevelopment property such as a house, or a small plaza. In each case you would want the cost to you and your practice to make sense. For example, at a 5% rate of return to buy a 1,500 sq.ft. premises, you could buy a condominium at $1,000 per square foot, or redevelop a house, or buy a small plaza (after collectively factoring in other tenants rent) for $1,500,000. A 5% return-on-investment equates to $75,000 per year or $6,250 per month for mortgage service. Remembering you would still need to pay realty tax, maintenance and insurance
If you are a tenant, look at your lease right now and determine the premises planning
costs, your ownership cost roughly approximates leasing expenses. Factoring in the cost of borrowing and the advantage of asset appreciation, over time you will generate equity and have a premises planning event horizon.
If you are a tenant, look at your lease right now and determine the premises planning event horizon. Compare the lease timeline to your premises planning event horizon. Define the difference. Then, develop a strategy to accommodate our plan. You might accept that because you are in leased premises with a premises planning event horizon shorter than you require, you may have to sell charts at the end of your career, or pay the cost of relocation, or hope that the landlord does give you additional options to renew as time passes. You might invest available cash as you go to offset
the decrease in expected practice sale value at the end of your career.
Alternatively, you could start searching for available realty to buy, factoring in the level of effort and time required to secure property and build your premises.
In either case, you need to be aware of the premises planning event horizon, schedule a consult with a capable advisor to help plan your strategy, and add planning for eventualities to your list of periodic projects.