BLOG: Being a physician landlord to your private equity buyer
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Key takeaways:
- Selling physicians will retain ownership of the real estate after the sale, making them the “physician landlord.”
- Physician landlords should expect to negotiate a new lease as part of the transaction.
In our prior blog post, we discussed the frequent need to separate, from a legal and financial perspective, the real property from the practice in order to consummate a practice transaction with a private equity buyer.
At the closing of the practice transaction, the physicians (or more likely, their real estate entity) will retain ownership of the real estate, while the practice’s nonclinical assets will be acquired by the private equity buyer.
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The practice will almost certainly remain at its current location, at least for some years in the near term. This means that the physician real estate entity will become the landlord to the private equity buyer that is now managing the medical practice. The “physician landlord” (as we will call the physicians here) and the private equity buyer (now the tenant) will need to come to an agreement on the terms of the real estate lease.
A new real estate lease
In some instances, the private equity buyer will become the tenant by simply assuming the existing lease, without modification. (It is imperative from a regulatory compliance perspective that there be a lease in writing between the physician landlord and the tenant in the first place, which we will discuss in a future blog post.) In other instances, a new real estate lease will need to be negotiated as part of the practice sale transaction because one or both parties demand it. The lease terms will become part of the broader negotiations in the sale of the practice.
For example, the private equity buyer, who is becoming the tenant, may seek favorable rental terms and flexible lease periods as part of a new lease; on the other hand, the selling physicians, who are remaining the landlord, will want to ensure the rental rate reflects the fair market value of the property and that the lease terms are at least as favorable as they would be if the tenant were a completely unrelated third-party tenant and that they provide longer-term assurances that property will be leased.
Like any other commercial real estate lease, the lease should clearly outline the terms of rent, annual rent increases, maintenance responsibilities, duration and any options to renew. In the midst of negotiating the overall practice transaction, two key issues that some physician landlords might overlook are rent and its impact on the practice purchase price and the terms of lease and how it can impact your ability to sell the real estate in the future.
Rent and possible impact to practice purchase price
If you are a physician selling your practice, the amount of rent that the practice historically paid to a landlord was factored into the buyer’s purchase price, which is usually based on the practice’s earnings before interest, taxes, depreciation and amortization (EBITDA). When you are the selling physician but also the physician landlord, when negotiating a new lease with your private equity buyer, you need to be mindful of material changes in the rent payments in the new lease because the changes impact the practice’s EBITDA and therefore can impact the purchase price. If the rent is increased substantially, then the buyer might require a reduction in the practice purchase price, and if the rent is decreased substantially, then you should likewise request an increase in the practice purchase price.
Separate from the practice purchase price, the rent and the other lease terms can have a significant impact on the value of your real estate should you ever want to sell your real estate in the future.
Your ability to sell the real estate in the future
Another key consideration is that you as a physician landlord will want to ensure that you can sell the real estate in the future should such an opportunity arise. While your intent may be to retain ownership of the real estate indefinitely, circumstances change, and you want to preserve the flexibility to sell the real estate at a later date.
Physician landlords should negotiate for the lease agreement to include language that explicitly allows the landlord to sell the real estate without obtaining the tenant's prior consent; otherwise, you might face obstacles in selling the real estate. Your tenant (who, as a reminder, is the private equity buyer that is now managing your practice) may attempt to block the sale or demand concessions, such as rent reductions or lease modifications, in exchange for consenting to your sale of the real estate. This can delay the sale of the real estate, reduce the value of the real estate in the eyes of a potential buyer or even turn off real estate buyers entirely.
Of course, most private equity buyers (or at least their lawyers) are sophisticated enough not to agree to completely waive all tenant rights on a sale of the real estate, so you can expect that they will require written assurances in the lease that any new owner of the real estate is financially qualified to own the property, will honor the lease terms after the sale and will assume all of the landlord’s lease obligations.
If you are a physician selling your practice but also the landlord to your practice, then you should expect to negotiate a new lease as part of your practice transaction. Your legal team should include experienced real estate lawyers and real estate advisors who are thoughtful about these legal and business issues and the impact on the practice transaction and the impact on a future sale of your real estate.
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