Adding additional members to a property ownership group.
Hi All,

I am a commercial real estate broker and a friend of mine is a financial advisor. He asked me an interesting question and I thought I’d get this group’s thoughts. 

He has four clients who own a medical practice and the building which that practice is held. The building is fully leased, and the medical practice leases about 75%. The building is valued at about $12 million and the outstanding mortgage is about $4million. 

The four doctors would like to start some succession planning and bring on two younger doctors to be the partners and eventually exit the business. The four doctors would want the practice to continue to lease the medical building even through their retirement. But the younger doctors want some ownership in the building. However they lack the capital to buy their fair share in cash. Their alternative would be to buy a smaller building. 

What would be a fair way of structuring this? Some of the ideas I have are a little complex.
[{"id": "gps39lf", "text": "Following.", "replies": [], "depth": 1}, {"id": "gps3no8", "text": "You couod do a membership loan to those partners with an interest rate attached.  Then they can pay down that loan and receive more of the cash flow as it is paid down with the decreasing interest paid on principal.", "replies": [], "depth": 1}, {"id": "gps536b", "text": "This is a more and more common issue as baby boomers age and try to figure out what to do with their business. Current owners want to sell the operations but keep the real estate for residual income (and have new owners continue to build equity for them). Next generation doesn't want to continue to build first gen's equity after they ride off into the sunset having already cashed one check for the operating company. Realistically the current owners are the ones that have to compromise if they really want to retire. They are the ones that need new blood to continue the practice and keep paying rent.  Or they can look to sell to a chain.\n\nOne way to make it easier is to releverage the building and issue a distribution to the current owners.  Then the new doctors are \"buying into\" less equity which they might be able to get a loan for (doctor loan programs are nuts) or the practice or Gen 1 owners can hold a note.", "replies": [{"id": "gq9nxh2", "text": "&gt; Realistically the current owners are the ones that have to compromise if they really want to retire. \n\nthis is not at all my experience in this space.  The young docs are absolutely saddled with debt and have near 0 capital but are highly employable and valuable in that regard.  The existing patient flow and business structures are also worth a significant amount of money.  Its a bit like a law firm and new partners.  The old guys are basically offering a turn key job with a great future, but they have all the capital and if the new docs say no they will find someone else.", "replies": [], "depth": 2}], "depth": 1}, {"id": "gps7fyl", "text": "Approach the commercial banking rm. They should be able to form a new LLC to purchase the old building with a higher mortgage(say 6-8mm) and provide equity back to the existing 4 partners lessening the equity requirements for the new 2.", "replies": [{"id": "gq26318", "text": "That can get expensive. Resetting real estate taxes, recognizing capital gains, new loan means new associated expenses with the financing.", "replies": [], "depth": 2}], "depth": 1}, {"id": "gpsfjo2", "text": "Installment sale (aka seller financing). This is *not* a loan but allows the young doctors to pay in the required capital over time rather than in a single lump sum. The four doctors would be selling some of their interest, and spreading out the payments will also spread out their capital gains. They may or may not want to charge interest depending on their goals/tax situation.", "replies": [], "depth": 1}, {"id": "gpsyunp", "text": "In a similar issue. We buy hotels with our own equity and then after closing sell of our stake to investors. We sell it at the same value we bought in at, but still can get a bit confusing from a tax standpoint.", "replies": [], "depth": 1}, {"id": "gq26pgu", "text": "We are talking about $8 Million in Equity here. I think it would be best to separate the sale of the real estate from the participation of the new doctors in the practice.   \n\nThe building is probably held in its own real estate holding company, which means you can structure it as selling a percentage ownership into this Company. I would consult a tax attorney about the way to do this so that it is not a taxable event, maybe there is a way to postpone taxes until the underlying real estate is sold. Maybe calling the contributions convertible debt instead of equity.", "replies": [], "depth": 1}, {"id": "gq9ndc2", "text": "negotiate a purchase option for the re into the business partnership agreement.  If it goes fine for everyone they will have the capital at some point and that is the cleanest exit for everyone.", "replies": [], "depth": 1}]