Doctors Investing : Real estate option

Doctors normally start their practice and the money starts coming in – first in trickles and then as a flood. Over enthusiastic accountants and ignorant doctors are a dangerous combination – they keep the doctor’s income low so that lesser tax can be paid.


Suddenly if the doctor wants to set up a bigger practice, buy some property, or employ some juniors, the doctors suddenly start wishing that they had showed more income. One thing doctors can do is to invest in commercial property – for his / her own practice and for renting out.


Doctors should invest in commercial property because it is an asset class generates good inflation adjusted returns with relatively low risk. This risk can be diversified down by investing in a mix of commercial properties, whether by owning multiple properties.


Over the last 20 years commercial property returns have averaged more than 12% per annum, and in the last ten years it has been the second highest performing asset class, second only to the index of equities. The returns from commercial property is surely superior to residential property especially from a cash-flow point of view. Read on, it is not difficult to understand, even if you are a doctor! If commercial property comes ahead of residential property, then why own any residential property? Why not only own commercial property?


Residential property buying is far more emotional than commercial. It is a social and emotional need, and it surely generates some capital gain for doctors over a long period of time.


One reason is that commercial property usually generates higher income yields than residential property. Rental yields of 7% or more are not unusual, and rental yields of 10% are encountered as well, whereas residential property yields are normally closer to 3% (with occasional exceptions in less popular areas).


And with commercial property the tenant pays the outgoings (rates, repairs, society charges etc), not the owner, so there are lower cash outgoings as well. Higher yields and lower outgoings mean cash flow being positive even with high levels of borrowing. That is more cash comes in than goes out, even before the tax advantages are considered. Many leveraged commercial properties cover the interest on the loan and also leave a surplus. This is better than a residential property, where the cash flow effect is usually negative.


So for a new doctor it makes more sense to buy a commercial property and put it on rent, while for an older doctor it makes sense to buy residential property! Soon after the doctor buys a residential investment property, cash flow is down compared to what it was before; whereas in case of a commercial property, cash flow is up comparatively!


Each purchase of a residential property reduces the doc’s ability to service the loan on the next residential property investment; whereas each purchase of an industrial property increases his ability to service the loan on the next commercial property.


This of course ignores capital gains: historically residential property has achieved significantly higher capital gains than commercial property. Obviously investors buy residential property with medium and long term capital gains in mind: why else would you borrow at 13% to buy an asset earning 3% rent? The answer has to be an expected capital gain in five, ten and twenty year’s time.


But expected capital gains are far away if the doctor cannot meet the loan repayments in the meanwhile. And for doctors whose cash flows are not guaranteed always, this is a risk to worry about.


Another reason why doctors should consider owning commercial property is diversification. Studies show that diversifying across asset classes reduces risk. It boils down to not putting all your eggs in one basket: if you have all your wealth in say equity only – through a mutual fund or an unit linked plan, your fortunes are 100% determined by that asset class’s performance.


However, diversification is a two edged sword: it reduces up-side risk as well as reducing down-sized risk. It all depends on the individual doctor’s risk profile, and most prefer some diversification.


Commercial property usually has much longer leases than the residential property. Lease terms of five years, with options for a further five or ten years at the end are not at all unusual. This creates more security than residential property, where terms are

usually for no more than a year. Most residential property tenants see themselves as renting short term, whereas a business in a well located retail shop, or an ATM of a bank, will want to secure their own goodwill by obtaining security of tenure.


This means they want the certainty attached to a long term lease.

Diversification from residential property to commercial property makes particular sense when the cash flow of commercial property is considered: this creates a cash flow buffer that takes away some of the stress of residential property prices falling.


My suggestion to a doctor is to build a portfolio of 2-3 residential properties, plus their own home, and then diversify into commercial property. Another residential property may have created too much strain on the practice’s cash flow, whereas a commercial property instead adds to cash flow and reduces some of the strain caused by the existing residential properties.

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2 Responses to “Doctors Investing : Real estate option”

  1. Valencia Mortgages » Blog Archive » California Commercial Real Estate Rates on September 29th, 2008 at 3:15 am

    […] Doctors Investing : Real estate option […]

  2. Brady Bryant on May 24th, 2010 at 1:18 pm

    Investing is my way of earning money both online and offiline, right now i am into venture capital.;-*

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