Is it always worth buying the freehold?

08 Oct Is it always worth buying the freehold?

When we speak to clients who are purchasing a dental practice, one question that often comes up is whether they should also purchase the freehold of the property.

We understand why.

Owning the freehold means, you are building an asset alongside the business. Instead of paying rent to a landlord, you are making mortgage payments and once the borrowing has been repaid, you own an unencumbered commercial property.

There can also be an attractive option further down the line. If you eventually sell the practice but retain the freehold, you could continue to receive rental income from the new practice owner.

So, on the face of it, buying the freehold can make a lot of sense.

But is it always the best use of your borrowing capacity?

It depends on your plans

The answer will be different for everyone, and a lot depends on what you are trying to achieve with your practice.

If your plan is to purchase one practice, grow it and remain there for the long term, buying the freehold can provide a great deal of comfort and control over the future of your business.

You are not exposed to future rent increases in the same way as a tenant and you have greater control over the property, subject of course to the usual planning and legal restrictions.

You are also building an asset outside of the goodwill of the practice itself.

However, if your strategy is to buy and build, the decision becomes more complicated.

Purchasing a freehold also means taking on additional borrowing, which can use some of the borrowing capacity you may otherwise have available for future practice acquisitions.

For someone following a buy-and-build strategy, this is an important consideration. It is not necessarily about whether you have the cash to buy the freehold, but whether taking on that additional borrowing could affect how much you are able to borrow for your next acquisition and ultimately, how quickly you can grow.

This leads to another consideration:

Where could that borrowing capacity be used most effectively?

The opportunity cost of buying the freehold

There is nothing wrong with investing in commercial property. In fact, for many practice owners, owning the property will be an important part of their long-term strategy.

The point is that taking on additional borrowing for the property could affect what else you are able to borrow for.

For an acquisitive buyer, the borrowing used to purchase a freehold could potentially affect their ability to finance another practice acquisition.

If you can acquire another practice, improve its performance and increase its profitability, the additional goodwill created could potentially be more valuable to your overall strategy than the capital growth achieved by the property.

That doesn’t mean one investment is better than the other. It simply means there is an opportunity cost to consider.

What about the future?

One of the strongest arguments for buying the freehold is the flexibility it can give you when you eventually come to sell.

For example, you could sell the practice goodwill but retain ownership of the property, with the new owner paying you rent.

This could create an ongoing income stream after you have exited the practice.

Alternatively, you may decide that owning the property is part of your long-term wealth strategy and choose to retain both the practice and the freehold.

There is also something to be said for the security of controlling the premises from which your business operates.

But what if you want to build a group?

This is where we think the conversation becomes particularly interesting.

If your ambition is to acquire several practices over the next few years, your borrowing capacity becomes increasingly important.

Every acquisition needs to be considered alongside the existing borrowing within the business. Taking on additional borrowing to purchase an expensive freehold may therefore affect the amount a lender is prepared to offer you for your next practice acquisition.

Buying the freehold may not stop you from growing, but it could affect the pace at which you are able to make your next acquisition.

On the other hand, if you lease the property, you retain more borrowing capacity for acquisitions, but you take on a landlord relationship and future rental costs.

There is also another point worth considering.

Some lenders are able to offer up to 100% finance on the purchase of a freehold, subject to the lender’s assessment of the transaction, the property and the borrower.

This can make buying the freehold particularly appealing. You may be able to purchase the property without putting down a significant deposit, while also securing ownership of the premises for the long term.

However, 100% finance does not mean the borrowing has no impact on your future plans. The additional debt will still form part of your overall lending position and may need to be taken into account when arranging finance for future acquisitions.

Neither approach is automatically right or wrong.

It comes down to what you are trying to build.

So, should you buy the freehold?

We are certainly not saying that you shouldn’t.

Lenders can be very supportive of clients looking to purchase the freehold alongside a practice, and the ability to obtain high levels of finance can make the proposition particularly attractive.

The important thing is to look at the whole picture rather than viewing the freehold in isolation.

If your plan is to buy one practice, grow it and stay there for the long term, owning the property could be an excellent fit.

If your plan is to acquire multiple practices, it is worth considering how the freehold borrowing could affect your ability to arrange finance for the next acquisition.

Taking on additional borrowing for the property may reduce the amount a lender is prepared to offer you for future practice acquisitions. This doesn’t necessarily mean you won’t be able to grow, but it could affect the pace at which you are able to make your next acquisition.

Although past performance is not a guide to future growth, property values have been relatively subdued in recent years, while dental practice goodwill has continued to show more consistent growth.

So another question to consider is:

How do the annual rental costs compare with the cost of borrowing to purchase the freehold, and what could that borrowing capacity achieve if it were used for another practice acquisition?

Ultimately, the business you are buying is what generates the cash flow that repays the borrowing and creates the opportunity to grow.

If you can improve a practice, increase its profitability and create additional value, having greater borrowing capacity available to acquire further sites could potentially accelerate your overall growth.

The freehold is an asset. The practice is an asset. The question is which combination of assets best fits your plans.

There isn’t necessarily a right or wrong answer, but it is a question worth asking before you commit to the property.