Financing a medical condo

April 2014
By Lisa Wood, MBA, Senior VP, Medical Industry Specialist IberiaBank

Establishing a new medical practice or expanding a successful one can be a challenge − not the least of which is acquiring a suitable location that provides the space, facilities and amenities required with terms that make economic sense.

For a growing number of individual doctors and physician groups, the answer is the medical condo. These facilities typically offer greater flexibility and lower entry costs than new construction or acquisition of an existing building, but offer the economic advantages of ownership compared to renting or leasing space.

Technically speaking, condo ownership refers only to the interior air space with the boundaries of the unit itself − bordered by the walls, floor and ceiling. The building itself, common areas and the land on which it sits are owned by separate entity or corporation representing all owners.

A condominium project can include individual units in a multi-floor building or single-story, freestanding structures in a complex. The owner controls the physical space within the structure; the driveways, elevators, hallways, recreation and landscaped areas are the responsibility of the overall corporation of condo association representing all owners. The corporation holds this property in trust on behalf of the property owners as a group.

Medical condos offer an expedient way to relocate a medical practice or open a satellite office in a new location quickly and more cost efficiently. This can be important as the demographics of a market area change over the course of time. Condos also allow the clustering of different practices within a given area, providing ease of access to patients and referral benefits for physicians.

Because of these benefits, the interest in professional condominiums is growing. Projects have been developed throughout urban and suburban areas, offering buyers greater opportunities to acquire the space they need in a location suitable to their requirements.

Purchasing a medical condo is similar to any other real estate purchase, although there are a number of issues that should be carefully considered with input from one’s legal and financial advisors.

In a typical new construction acquisition, the purchase price applies only to the space itself − not a build out of the space. The builder will bring the space to a status of “substantial completion,” meaning the shell of the space is complete, but it is the responsibility of the buyer to address interior walls, floor coverings, fixtures and other structural or design elements.

In some cases, developers offer a build-out allowance, which is negotiated as part of the sales agreement to defray the cost of finishing the condo interior. It’s a good idea to check into this before finalizing the sales contract.

Once the developer provides notice that the condo is substantially complete, the buyer has a predetermined period of time to close the purchase transaction. Once that is complete, the buyer can begin the build-out process, using the original builder or outside contractors.

While medical condos offer significant economic advantages, there are issues than can affect their use. Condo associations have conditions, covenants, restrictions and special rules that govern how individual unit owners may use their unit and how they share space with other owners. This can mean that, unless the condo association bylaws specifically authorizes it, approval must be secured from the condominium board in order to make changes to either the office’s physical structure or the operation of the practice.

There are also likely to be monthly fees to cover insurance, maintenance and other periodic expenses associated with building upkeep. The insurance a condo owner carries provides coverage only for the amenities within his or her space—not common areas.

The loan agreement on a condo is often a two-step process. The first phase covers the cost of the condo unit itself. The second installment covers the cost of building out the space and making it available and usable for professional services.

In the typical loan agreement for a medical condo for a group practice, a separate entity is formed to hold the property, which then leases the space to the practice. The borrower in such a scenario is the real estate entity created to acquire the space.

Loan terms on a medical condo will vary based on a variety of factors, but, generally speaking, bankers will want a higher down payment than a traditional real estate purchase. This is because the borrower is paying property taxes, insurance, maintenance and other fees to a separate entity and relying on them to make those payments appropriately.

Documentation required as part of the loan process will include financial statement for the past several years and guarantor personal statements and tax returns. As the loan will be repaid by the rent paid to the real estate entity, the loan is typically guaranteed by the practice or physician partners and secured by a deed of trust. In most cases, financial institutions will require a mortgagee to take out a title policy as well, so it is important for potential buyer’s to consult their CPA and attorney, to make sure the terms of the agreement are clear and in their best interest, before the closing at a title company.

For group practices, the financial arrangement can be complicated, especially if not all of the physicians involved in the practice choose to be part of the purchase of the condo. In such cases, the physicians participating in the condo purchase will again form a separate corporation or entity which in turn leases the space to the overall members of the group practice—though members not participating in the original condo purchase do not share an equity position.

Professional condos make sense for a number of practices seeking to relocate or expand into a new market area. Unlike a lease agreement, medical condos can appreciate in value over time, providing the owners with investment opportunities.

Bankers and lending institutions are well versed in the potential benefits of business expansion and will be interested in working with qualified physicians and group practices.

But, like every real estate transaction, buyers should do their due diligence, consult with tax, finance and legal experts, make sure they fully understand all aspects of the transaction and confirm that the decision is appropriate for their particular situation.