Both doctors in a small clinic building are past sixty, and that changes how the deal should be priced

Question

Take a rural medical office building priced at a 9.1 cap on in-place income, which for that kind of market is not unusual on its own. The part that deserves the most attention is the tenant roster. Say a family practice occupies 4,400 square feet on a flat lease with four years remaining, no renewal options, and no notice language that helps a new owner, and the two physicians who own the practice are both somewhere north of sixty. A physical therapy operator fills the remaining 1,800 square feet on a three year deal, personally guaranteed by one owner. If the town has one hospital-affiliated urgent care forty minutes away and no other medical space nearby, the bull case is that the practice is the only option locally, whoever buys the practice or inherits the patient panel has to sit in that building, and regional health systems have been acquiring independent practices in markets like this. If that happens, the building ends up with a stronger credit tenant paying the same rent. The bear case is that both physicians retire during the hold, nobody buys a two-doctor rural panel, and the owner is left with a purpose-built shell with plumbing in the walls in a market with essentially no general office demand. Conversion cost would exceed the building's value at that point. A 9 cap is compensating the buyer for exactly one risk failing. Succession cannot be underwritten from the outside. Nobody puts retirement plans in writing. So the real question is what would make a deal like this ownable rather than a bet, and the answer usually sits in what the seller and the tenants are willing to document before close, not in the cap rate itself.

tashaford30 · Answer

The part to chase first is what a lender does with it. If a bank in that market will only go 60% on a four year lease with a retirement risk tenant, your real return is whatever you earn on a lot of cash sitting in one building with one point of failure, and the 9.1 becomes a footnote. Small lenders in that position will often say flatly that they underwrite to the remaining term rather than the cap rate, and you should get that in writing from yours before you put money at risk. Also, the flat rent is more worrying than the age. Four years at flat rent in a rural market means you cannot tell whether you are at market or 15% over it, and if they retire you find out the hard way.

renee_dubois · Answer

@tashaford30's point about term is the one that matters, and the release timeline deserves the same pressure. A small multifamily unit re-tenants in three weeks. A 4,400 sf exam room suite in a town of 9,000 sits. A building like that in a comparable market can sit 19 months and then lease to a chiropractor at about 60% of the prior rent, with the landlord funding cosmetic work. So underwrite the downside as roughly two years empty plus taxes, insurance and heat on an empty building, then a rent haircut. If the 9 cap still clears something you would accept after that, fine. If it only works with continuous occupancy, what you are buying is a guess about two people's plans rather than income.

Both doctors in a small clinic building are past sixty, and that changes how the deal should be priced

2 replies