Office condos prove to be good Rx for doctors
Posted Thursday, September 06, 2007
San Antonio's office market has been relatively flat in recent years, but one segment is seeing some sparks. Office condos, the latest trend in commercial real estate, are selling well.
“It was the smartest thing I ever did,” says Dr. Lane Walsh of his decision to buy office space for his dental practice rather than continue to rent.
Walsh bought his property on Sonterra Boulevard more than a year ago when rental costs and lease negotiations became unacceptable.
“I started out with an office where the rent was $1,600 for about 2,100 usable square feet,” he explains. “After seven or eight years, my rent was up to $3,550.”
Walsh adds that he’d been trying to negotiate a new lease for more than a year but kept being put off.
“The leasing agent was playing the waiting game – waiting until I was near the end of my lease and out of time to look for another place before it ran out,” he says.
Walsh is one of a growing number of professionals, primarily health care providers, who have decided to become their own landlord. One of the factors driving that decision is the cost of retrofitting office space for medical usage. Physicians, dentists, and other health care-related businesses have specific and extensive electrical and plumbing needs. Doctors are often willing to put up with rent increases and additional pass-through costs because they’re reluctant to leave an office once they’ve put several thousand dollars into making it fit their needs.
“Now any improvements I make belong to me and not the landlord,” Walsh says.
“When you put $40,000 into customizing a space you’re renting, the landlord will usually amortize it over the length of the lease,” explains Dr. Craig Kuebker. “Then they’ll want you to sign at least a five-year deal to make sure they get their money back.”
Kuebker, a family practice physician, shares his recently purchased office on Huebner Road with Drs. Frank and Cheryl Mueller, a husband-and-wife team. Monthly expenses were a factor in their decision to buy as well.
“This was one of the few overhead expenses we could do anything about,” he explains.
Sharing ownership of their building wasn’t a risk for Kuebker and his partners.
“We share a waiting room in our rented office for about 15 years so we knew each other pretty well. We get along fine so there was no problem making the commitment to own our office space,” he adds.
Jim Ploetz, marketing director for Huffman Developments, says the main reason professionals are buying their offices is because they can. “Previously, doctors who wanted to own their own office space would either have to buy, or at least buy into, an entire building. That leads to another entire array of investments. Now, in a campus setting, they can buy just the space they want to occupy. If they want to buy 3,000 square feet, now they can. At the end of the day, they want to have a hard asset that they can say, ‘this is not only my office, it’s an investment.’”
Not all owners are single tenants. Brian Harris, vice president of transaction services and a partner at REOC Partners Ltd., says many owners find tenants to lease any spare space they have in order to cover their mortgage costs.
“Doctors and dentists see this as an income source too,” he explains. “Say they’re in their 30s or 40s. They can easily go to a bank and finance this. They tend to be good risks and real estate tends to appreciate so the bank may lend them a higher percentage.”
Investors buying multi-tenant buildings are usually able to finance about 70 percent of the purchase. As a single-tenant owner or majority tenant, Harris says buyers can finance up to 95 percent of the building’s cost through the Small Business Administration (SBA) and as much as 80 percent through a commercial bank.
“So a doctor buys a building and he occupies it for 10 or 15 years and decides to retire. He can sell his practice to a young doctor and retain the real estate and lease it to his new tenant or he can sell them the practice and the building and walk away.”
Value added
Having a hard asset like a building to include in the deal may make it easier for a retiring doctor to sell his practice. Kuebker says times have changed in the 15 years since he bought his practice after retiring from the Air Force.
“Practices aren’t really worth anything when you retire anymore, especially among primary care physicians. Most people belong to PPOs (Preferred Provider Organizations) now so they don’t get to choose their doctor. And patients have gotten used to switching doctors so I can’t tell a young doctor that I have 3,000 patients to turn over because they might not stay. The facilities are something tangible that comes along with the practice.”
So far Huffman is building two developments: The Villages on Sonterra with three buildings, which are occupied by physicians, an attorney, a mortgage company and insurance agent; and The Villages on Huebner, with two buildings up and another set to open in July. That location is being acquired by dentists and physicians.
Other developers are entering the office condo market as well. Local developer Efraim Abramoff is building condominium offices at the Huebner Town Center, located at the corner of Huebner Road and Churchill Estates Boulevard. Last year, Alcar Construction began working on a 10-acre development at Huebner Road and Stone Oak Parkway targeting health-care businesses that want to own their own offices. Earlier this year, TC Austin Properties and Alfra Development of Laredo teamed up on a project that includes office condominiums.
Not for everyone
But buying office space isn’t a no-brainer for everyone. Steve Nathanson of the Nathanson and Nathanson Accounting Firm says every situation is different.
“It’s a matter of what you can afford. If you pay $500 a month rent now, can you really afford to pay a $2,000 mortgage in order to own your own building? You have to paint a worst case scenario. ‘If I have no business and no tenants, can I afford the mortgage?’”
He also advises potential buyers not to assume there will be tax advantages to owning their office. Commercial property is depreciated over a period of 39 years, according to Nathanson and a portion of the cost of the space is allocated to which appreciates.
Business people should also be aware of the lifespan of their business. Short-term businesses, likely to last less than five years, will not be able to fully depreciate the cost of a building and are advised to rent space.
“I own my own building,” Nathanson explains. “And I’m glad I do, but it’s not right for everyone. I basically stole my place at an auction and I also have a couple of tenants, which helps. But this is a third-generation business. We’ve been in business since 1953 and I expect to be here for a long time to come.”
Another factor Nathanson tells potential buyers to consider is the cost in dollars and time of property management. Huffman Developments uses professional maintenance services at his properties paid for through association dues.
“It’s like being in a homeowners’ association,” says Walsh. “You’re responsible for your office but the grounds and the parking lot and any common areas like sidewalks, they belong to the association. You pay your dues and the association manages all that.”
Ploetz says that most office complexes, such as the Villages on Sonterra, which has just begun construction on its second phase, hire association management companies although its possible for building owners to manage the property themselves.
“We offer a turnkey operation,” Ploetz explains. “We sell our office space in two phases. We sell the office as a shell and then we sell the interior. It’s like a custom home. I can tell you what the outside is going to look like, but it’s up to you to decide where you want the interior walls and the plumbing.”
Ploetz says business people have the option of building their own offices. “I’ve had people tell me they can do it themselves and why should they pay me. I tell them, good luck. Call me for the grand opening. I know what it takes to do this. I know what it takes to buy land, make sure it’s zoned properly, get it platted. Then they have to come up with an architect and builder, develop plans, etc. You can see the hours invested. If I’d spent all that time and money to become a doctor, that’s not where I’d want to spend my time.”
“Regrets?” asks Walsh after being in his office for more than a year. “Only that I didn’t do it sooner.”
“We’re still grinding out the punch list,” laughs Kuebker, “like any new owner. But we’re happy with the space. I wish we had done this long ago but it was just so much easier to rent 10 or 15 years ago. Today, even after you negotiate a lease you’re not sure what you’re going to be paying because of the pass-through costs. This is the right thing for us now.”
RANDY LANKFORD is a San Antonio-based free-lance writer.
Commercial Real Estate Journal – A supplement to the San Antonio Business Journal
2nd Quarter 2005