If given the opportunity to purchase space for your practice, are you better off owning that space or opting to lease an equivalent space instead? While there are many variables to consider, owning could generally prove to be a much less expensive option over the long run.
Paying rent, utilities, and repairs and maintenance are expenses all practices incur. These Facility Costs are often the second largest expense grouping of a practice after Staff Expenses.
Practices seem to pay on average between 5% and 7% of their collections on facility costs. Smaller practices, less productive practices, and newer practices can see a higher percentage of their collections going towards their facility costs.
So what’s better – owning or leasing?
Let’s first look at the cost of leasing your space. For starters:
- You pay rent every month you occupy the space
- Rent increases over time with inflation.
Many commercial leases are written as “Triple Net” leases, which means that you as the tenant pay the real estate taxes, insurance, and repairs and maintenance for the property you are leasing. Essentially, you as the tenant take on many of the financial risks of ownership. (This is very different from a residential lease where the tenant pays the rent and the landlord covers the various costs of ownership.)
Let’s assume that you will be in practice for 25 years, and enter into a lease with an initial rent of $3k per month that increases over time with inflation. If inflation runs at 3% per year, you’ll pay $3,090 in rent starting in year 2, $3,183 in year 3, $3,279 in year 4, and so on. In year 20, your rent will be $5,400 per month.
To be able to figure out whether leasing is less expensive than buying, we need to compare “apples to apples”. To do so, we need to calculate all the costs in “today’s dollars”, which removes the effect of inflation. It’s easy to understand the value of $3,000 today. Who knows what $5,400 will buy in 20 years?
For a practice entering into a lease for $3k per month over a term of 25 years that increases with inflation, that practice would spend $900k in today’s dollars for that lease. ($3,000 * 12 months * 25 years = $900k)
That’s a lot of money. Let’s now figure out the cost of owning in today’s dollars.
For this example, we calculated that you could purchase a $500k office space for a 20-years mortgage with a payment of $3k per month at a 4% interest interest rate. We also assumed that the value of the building will increase based on inflation of 3% per year, so will double in value over the 25 years you are in practice.
Here are the basics:
- Mortgage payments do NOT increase with inflation. Monthly payments on a fixed-rate mortgages stay the same over the life of the loan. (Remember, your rent in year 20 would be $5,400 per month, while your mortgage payment would still be $3k per month that year.)
- Unlike rent which continues as long as you occupy the space, mortgage payments end when the mortgage is paid off. In this example, you would have the final 5 years of your 25-year career with no payments for your space; money available to put away for retirement, pay for your kids’ education, or finally purchase that Tesla.
- The property is an asset available to be sold at the end of your career.
We then converted the 20 years of paying $3k per month to today’s dollars, and reduced that total by what $1 million dollars 25 years from now would be worth today, and came out with a total cost of owning this property, in today’s dollars, to be only $60k! That cost is essentially the real cost of the interest you will pay on the mortgage converted to today’s dollars.
In this oversimplified example, leasing your space over 25 years is 15 times more expensive than purchasing an equivalent space.
Please note, however, that there are a lot of variables to consider when trying to decide whether to lease or own office space for your practice. Your CPA or our friends at Carr Healthcare Realty can help you run these numbers. The Carr team can also help you negotiate the lease or the purchase price for your office space, and believe it or not, the Landlord or the Seller pays their fee. Yes, Carr offers this essential business service at no cost to the practice owner.