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Critical Medical Lease Negotiation Points

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supportEvery element of a medical office lease can be negotiable.

For the benefit of both the landlord and the tenant, we have highlighted and defined the most frequently negotiated items within a medical office lease.

Alterations: The degree to which the tenant make make physical changes to the premises.

Assignment: The right to transfer the lease to another entity.

Buyouts: A concession where the remainder of the lease is bought out in consideration for tenant to move into another facility.

Common Area Maintenance (CAM): Extent to which tenant is responsible for property upkeep.

Condition of Premises: Repairs to the condition of the property prior to or during the tenants term; what the tenant agrees to change, pay or maintain.

Default and Remedies: Performance of contract and remedies for satisfaction; key areas are property condition, rent payment, and insurance policies.

Deposits: Security for right to use premises; provides financial requirement and interest.

Expenses and Stops: Operating expenses the tenant pays; typically plays role in complete occupancy costs.

Free Rent: A concession typically offered in a challenging market; a discount off of the aggregate lease amount.

Grace Period: Time of consideration of rent payment for purposes of grace, redemption and default.

Hours of Service: Schedule of building hours where tenant will benefit the greatest; access, lighting, HVAC, security and parking.

Lease Term: Determines length of liability, commitment, amortization schedule for both tenant and landlord.

Maintenance: Ongoing repairs or responsibilities.

Measurement: Determination of rentable area vs usable area as well as load factor; used competitively within marketplace to maximize space usage and compare amenities.

For the second half of our post, please visit our website at MREA | Medical Real Estate Advisors or call Kayla at 713.701.7900. For a highly specialized business and real estate platform to serve your unique healthcare-specific needs, contact Robert Lowery, Managing Partner, of MREA today.

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Overlooked Items in a Medical Office Lease

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As tenants of medical office buildings, medical users create unique leasing issues. They handle hazardous materials, produce biomedical waste, require confidentiality in patient recording, and are in the watchful eye of safety/regulatory bodies. While medical professionals are familiar with these inevitabilities, most of what makes their business unique are rarely found on a medical office lease.

After location identification, the majority of our time is spent negotiating the lease. It has been our observation that many physicians will negotiate and sign lease agreements without the benefit of educated real estate advisory or legal counsel. Commonly, this medical tenant is simply concerned with the general business terms (including the term of lease, rental rate and commencement date) and rarely gives the lengthy document  a second look.

While it is tempting to sign the lease to reduce the amount of time spent towards negotiating or communicating real estate interests, a few select studies have documented that tenants who solicit real estate advisors for their business negotiations tend to have greater business longevity. Because a medical office lease is an expense that often requires a multi-year commitment, tenants should not want to be party to any agreement that is not reflective of their own interests. Below are a few examples of where real estate advisors or legal counsel may be requested:

  • Medical office leases typically offer one of two approaches in which a physician can make improvements or alterations to the rented space. Either the tenant is required to remove all improvements installed during the lease term or all improvements simply become part of the property. While the lease may variably contain language that references one of these two approaches, the fact is, knowing additional expenses are tucked within the lease is unsettling to our clients.
  • Too often, physicians assume that a landlord will provide certain basic services for their tenancy. It should be known that landlords only provide the services that are expressly stipulated within the lease. Often, for example, landlords turn off a building’s air conditioning “after hours”, designated as evenings and weekends. If a medical tenant requires extended evening or weekend hours, advisors may assist, in the very least, by educating the tenant on what can be done to facilitate this request. Similarly, medical practices rely on certain types of equipment that consume significant electrical resources. In this case, an advisor should be able to make certain whether the landlord will furnish the necessary amount of electricity or will charge separately for such extensive use.
  • As a tenant, you want clarity for all financial obligations. Some medical office leases require you to simply pay the established monthly rental rate. Others require pro rata payments of some, or all, of the landlord’s operating expenses and real estate taxes associated with the property, in addition to the monthly base rent. In the past, we have noticed where operating expenses have been interpreted loosely by landlords, which may come as a shock to some. Overall, though, the majority of medical office landlords will adhere to the strict guidelines as set forth by educational bodies that attempt govern building use metrics. But, without proper advisory payment, especially the fluctuated amount, may easily become misrepresented. In order to minimize the financial responsibility for operating expenses, tenants should verify that the landlord’s operating expense calculations are correct and not being overcharged. If the operating expenses include real estate taxes, tenants should request an annual copy of the tax bill. In addition, within the lease, tenants may have the opportunity to verify that the operating expense charges have been accurately calculated.
  • Lastly, while you may think you will never default on your lease, it is hard to ignore default provisions. Remember, defaults may not necessarily be the result of bad faith or bad action. A non-monetary default may include failing to maintain the premises or violation of one specific clause within the complete document as written by the landlord’s counsel. Some leases provide a certain time period to “cure” the default, but some do not. It is necessary to identify the potential for violations or default and discuss each one.

It is of great importance to seek the guidance of experienced healthcare real estate advisors or counselors to negotiate the lease in an effort to meet the tenant’s professional needs and insure the continued health of their medical business.

3 Development Strategies for Healthcare Providers

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Hospitals and physician groups are embracing third party ownership, management and development of real estate because it has the ability to preserve capital resources for acute care needs, eliminate the conflicts that arise in the landlord/tenant relationship and minimize the potential legal and regulatory challenges associated with leasing space to referring physicians.

Many partnership synergies and dispositions have been publicized through our organization’s newsletter, but a new trend is occurring in which small providers up to large systems are utilizing third parties to develop and own new medical real estate projects. This trend has the potential to have a significant impact on capital structure decisions for going forward.

The use of outside capital to fund non-core real estate assets has been used with improved adoption in corporate America to facilitate growth and expansion. Retailers such as Wal-Mart, CVS and Walgreens, which are becoming stronger competitors in providing healthcare, have all increased liquidity and implemented cost efficiencies using third party capital and development expertise to fund billions of real estate expansion over the last few decades.

As for the development of medical facilities, healthcare providers may choose a few approaches that have been highly successful.

One. Providers may select to develop a project internally using an owner’s representative in place of the traditional developer. The owner’s rep determines the size and scope of the project and works with architects, engineers and the general contractor to build the facility. The provider is responsible for procuring entitlements and utility easements and covering the costs for the site preparation process. In this scenario, third party consultants may be employed to assist with these individual processes. The hospital is also responsible for the leasing and management of the building, although it may appoint a property management firm.

Two. Another approach is through the use of a third party to develop the medical facility for a fee. The third party will receive a fee for its services. In this case, the provider is contracting the developer’s expertise, which commonly includes feasibility analysis, project guidelines, pre-leasing, management of the entitlement process, value engineering for the project, negotiating the contract with the general contractor, as well as project management.

Three. A third party developer and owner both develops and owns the building through its completion. The developer/owner performs all the same functions as the fee-based developer. The main difference is that the developer assumes all of the risks and benefits of the development process and the ownership. A fee-based developer may have an incentive to reel the project in at a contracted cost and within a specified timeframe. The developer-owner has the same incentive, but is likely to strategize on ways that will lower costs of the long-term ownership, because this will ultimately determine the owner’s total cash flow and return on investment. Furthermore, a developer-owner has an incentive to minimize the size of the building to assure high occupancy rates, which has the ability to create conflict with the providers longing for vacant space to accommodate future needs.

If you should have any questions or require a proposal for a medical development under one of these three proven commercial real estate development strategies, please contact MREA at 713.701.7900.

Common Real Estate Needs in Medical Tenancy

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ImageThe need for long term tenancy appears to be in its greatest demand in decades. This urgency will rise considerably over the next several years as investors continue to discount vacant property, rather purchasing through banks which typically transact without title objections or past, present or future litigation issues. Another factor that will improve the need for stable tenancy is that lenders are again beginning to support investors by reducing capital requirements in exchange for long-term leased, less risky investment real estate.

Understanding the importance of medical tenancy, as it relates to the stabilization of an asset for purposes of a long term hold or investment sale, also requires a basic understanding of what is standard in its tenancy. This recognition, as well as access to professionals which support the healthcare profession, is key to preservation of a leveraged real estate asset or portfolio.

Tenancy items relative to medical professional are many; most outlined in a lease rider. To keep this blog passage succinct, we have outlined the most common needs below.

Utility expense can be one of the highest cost components of medical occupancy. Practice tenants often have higher utility usage than standard office tenants because many have equipment and hygienic requirements which consume large amounts of utility service. Medical professionals typically consume extra water from examining rooms with sinks. They also may utilize extra electricity from diagnostic or therapeutic equipment that requires more electricity than standard office equipment. Some medical uses, such as surgery centers, require the continuous use of uninterruptible power and, consequently, the extra expense of back-up power generation and data transmitters. Because of these items, it is best for the landlord to seek calculations relative to the variety of medical professionals that are considered for tenancy. 

Medical uses often will limit or require specialized janitorial and waste removal services. Special attention may be provided to medical and infectious waste maintenance and storage. These issues sometimes focus on the method for isolating medical waste and used equipment, the kinds and qualities of waste containers, and the process for removal and disposal of such waste.

Medical tenants will frequently have more intensive water and electric needs. Special machinery and furnishings may require special floor/pad accessories. Equipment may also require special fixturing and unique buildout. If the tenant expects to retain ownership of the equipment at termination of the lease, it be necessary to address this in the lease. Another consideration is to the waiver of lien or security interest in equipment which is owned or pledged, especially if there are hazardous materials involved, which is the case in laboratory and radiology services. The examination rooms in a healthcare facility may also be good only for the single use by the healthcare tenant, with no likelihood of a secondary need by a subsequent tenant. Equivalent issues apply to extra work needed to install and remove ADA accommodations.

Some special medical practices will may require special improvements. Ambulatory surgical centers typically require the need of the first floor. Maternity and birthing centers typically require the closest proximity to reserved parking. Psychiatric centers typically require separate and secured access. Plastic surgery clinics typically require separate and less visible access corridors.

The are just a few of the common needs relative to medical tenancy. For more information or submission of a request for our healthcare real estate services, please contact your MREA representative.

Ambulatory Surgery Center: From Concept to Reality

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In our continued expansion throughout the State of Texas, we are regularly posed questions pertaining to financial feasibility and cultivation of an ambulatory surgery center. We would like to respond by providing a few feasibility studies, to include financial summaries, in a later post. This post will be dedicated towards setting up the ASC entity, determining consultants, bidding to preparation for construction.

1.  Once you have determined that it is feasible to build an ASC, you must first consider its legal structure. Will you consider owning the ASC with partners outside of your medical practice? Many physicians adopt others when building an ASC. But, prior to making this decision, it is important to determine the legal risks associated with joint ownership of an ASC. Many are familiar that Stark Law has limited scope for operations within a surgery center, yet several other legal issues such as non-compliant physicians, indirect referrals, and billing matters may arise and should be considered and should be explained to avoid contagion within an ASC.

If the ASC is going to be built on existing land investment, it is important to determine how the land should be owned. Should it be in its own legal entity or part of the ASC entity? Will all of the owners of the ASC own the real estate? Owning the real estate in a separate entity may make the cost of the ASC more affordable for others. Separate ownership of the real estate may also provide an income stream for years to come. If your ASC is owned in a separate entity, you should consider the tax implications with receiving income from more than one employer.

Your legal counsel should review with you the issues surrounding the building of an ASC. They include, at a minimum, HIPAA, Anti-Kickback Statute issues, fraud and abuse issues, and antitrust considerations.

Once you have evaluated the legal considerations and determined the structure of the organization, your legal counsel should prepare a number of organizational documents. Within this packet, you should have an Operating Agreement which details how the business of the ASC will be run. The Operating Agreement will clearly define the initial and supplemental capital contributions of each member of the ASC as well as how contributions will be required. The Operating Agreement may also contain a non-compete provision prohibiting investors in the ASC from owning an investment interest in a competing ASC within a specific geographic area. You should consult with your attorney regarding the enforceability of non-competition covenants. The Operating Agreement will also determine how new partners are admitted, and the buy-out of existing partners. A valuation formula for the Member’s ownership interest should be included in the Operating Agreement. The Operating Agreement should also contain a conflicts of interest provision which requires members of the ASC to disclose potential conflicts or business opportunities to the ASC.

2.  Moving forward, now that a viable project exists, it is time to turn the attention towards the next step, which is to contact the state where the facility will be constructed to determine the steps necessary to complete the project and comply with the necessary state and federal requirements. Texas will send you a packet of information detailing this process and advising you of the significant building requirements.

In conjunction with this, it would be advisable to interview architects. In the process of interviewing candidates, be sure to qualify each one based on their experience designing ASCs within Texas. ASCs can be complex structures with significant engineering involved. Do not proceed without a qualified architect and engineer who commit to providing you with a fully engineered plan. As a caveat, if the architect advises you to proceed on a “design build basis” where the contractor and his subcontractors provide the engineering, you may be inviting delays in getting the center built.

The basic decision of what is to be built is largely based on what procedures will be performed at the ASC. If a constructing a single specialty ASC, it is common for physician to assist in direction for the layout of the ASC. Certain spaces are required inside the ASC to support the surgical procedures you intend to provide. The list of all of this space is called the program. Once a program has been developed, the floor plan layout can be done.

For purposes of certification, Texas requires floor plan review prior to proceeding with formal construction planning. Once the floor plan has been approved, your architect can proceed with the construction drawings. A significant period of time for this should be alotted, as most projects sit in idle during this phase.

Most owners want control of bidding for their projects. However, because the industry is seeing a greater number of projects moving forward, some are being performed within a construction management agreement. The advantage to construction management is that if you have advisory through experienced general contractor, or knowledgeable advisory, the process can ultimately save money within in the design process. The contractor can provide a valuable engineering function by recommending less expensive ways to construct the building or less expensive materials for the project.

3.  If you decide to bid out the ASC project, we recommend you get bids from multiple contractors. Your architect and consultants should make a recommendation as to which bidder wins the contract. Ultimately, it should be the owner’s decision, although the architect and consultant’s recommendations will remain of serious consideration.

Once the contract is awarded, be sure to sign a contract for the construction of the project. Also be sure to set out expectations for payment to the contractor at the start of the project so everyone knows what is expected of them. You should expect multiple requests for payment during the project based on a percentage of the project that is completed.

The architect and consultants should provide regular onsite visits. A report should be available on a bi-weekly basis to keep the owner apprised of the progress being made. Construction meetings with the subcontractors, general contractor and the owner’s representative should be held along these same scheduled intervals.

Please look forward to subsequent posts regarding feasibility studies, equipment, or licensing of an ambulatory surgery center.  Contact Robert S. “Bob” Lowery of MREA for any questions during any part of the planning or implementation process of your Texas ASC.

Fundamental Differences Between Commercial Real Estate and Residential

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Our broker brethren on the residential real estate have opened doors to excellent opportunities for our group to capitalize.  Working within our 28-person commercial real estate brokerage office that covers entire Houston area, we are fortunate to have residential offices disbursed throughout the community.  Our continuous feedback with approximately 10 Coldwell Banker residential agents, provides us with invaluable data and significant advantage for our clients who are searching for growth or upside in a commercial property investment. We regard this residential data as absolutely essential for future, telling real estate trends in the Greater Houston area.  It is important to recognize that if not for residential real estate stability, commercial real estate would cease to function properly.

These two cousins (residential and commercial) appear to be similar from the standpoint of a lay person, yet as any seasoned investor or broker will tell you, they could not be more different.  The easiest way I can explain this difference is that a residential investment transaction tends to rely more on investor/buyer emotion and ability to move a tenant in quickly, whereby the commercial real estate transaction is closer in similarity to any large business transaction with several moving parts and people.

We have highlighted 5 advantages and 5 disadvantages when purchasing a commercial property over residential.

The advantages:

  1. Longer Leases and Peace of Mind

Unlike a residential rental agreement, which might be as short as 6 or 12 months, commercial leases can be anywhere from 3 to 20 years in length. And, they are typically secured by bank guarantees when/if default occurs.

  1. Commercial Tenants are Responsible for Minor Repairs

Within the majority of commercial leases signed today, tenants are footing the bill for repairs within leased spaces. As a bonus, they need the property to be in the best possible condition for clients and employees, as the bar is set high. So, not only do commercial tenants save you time and money, in some cases they will improve and add value to your property.

  1. Strong Return on Investment

Commercial property returns on invested capital is typically somewhere between 7% and 10% after expenses.  Deductible items are also attractive because of favorable depreciation rates.

  1. Regular Rent Increases

Commercial rents are reviewed every year and increased in line with inflation, or by 4%, whichever is more.  Many commercial leases that we see are offered at a certain price for the first year, but escalate by 25% within a 5 year period.

  1. Tenant Mix

To reduce the risk of being stuck with excess space in the building, most educated investors maintain a blend of stable long-term leases and short-term, placing less secure tenants on higher rent.

The disadvantages:

  1. Finding Replacement Tenants Can Take Time

For the most part, it’s a much larger decision to move an entire business than it is to move into a new rental home.  So, while commercial tenants can be with you for many years, it can take many months to find a replacement to fill space. Investors will need to allocate resources for this expectation.

  1. Prices are Typically Higher

Generally, commercial real estate is a larger purchase than residential, especially in prime locations.

  1. Larger Down-Payments Required

To protect against the risk of losing a large tenant and not having that replacement, lenders will require the investor to place a larger down-payment.

  1. Risk of Loss

Although most commercial tenants are responsible for repairs in their space, the larger items are the responsibility of the investor. It is also common for the building to have ongoing maintenance and security issues so hiring a management company becomes an absolute must and is factored into most property investments.

  1. Barrier to Entry

Banks and other lenders are more rigorous in their lending process for a commercial property investment than for residential and building owners are more selective when choosing a tenant.

Please contact Robert S. “Bob” Lowery for any commercial real estate related questions.

What Is Wrong With Commercial Real Estate? Part 2

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As most are familiar by now, the banks have not dared foreclose commercial real estate simply because it would devastate their balance sheets.  The way the value of real estate is determined plays a significant part in the calculus of whether a bank will or will not foreclose. For instance, when foreclosing a residential property, the bank has an abundance of comparable sales of which to utilize, thus, they foreclose on a property with the simple understanding that one bad apple will not spoil the whole bunch.  In commercial real estate market, there are far fewer sales and considerably less volume, so there is a lack of ability to obtain a price point.

Or, to put it another way, commercial real estate is a relatively illiquid asset, and if banks foreclose in any volume, their worst fear is that “fire sale” prices will be set and will determine how other assets are “marked to market” (that is, using an asset’s actual market value on the bank’s balance sheet), which would devastate all banks balance sheets.

Sound familiar? You may recall when the banks worked so diligently to eliminate “mark to market” accounting for the various collateralized debt obligations, mortgage backed securities and other “complex illiquid assets” on their books. And just as with those assets, regulators accommodated the banks on commercial real estate accounting, making it easier to implement this “extend and pretend” policy.

Speaking with our banking contacts, they are readying our group, and others, for a substantial list of foreclosures. The greater question now is how will they be distributed? Will they go into the coffers of the big brokerage houses, never to be seen by the majority of the public, or will they be evenly distributed throughout the cooperating brokerage world, essentially creating another commercial real estate market for brokers and investors to play.

One thing is for certain, many of the larger banks will not just dump foreclosures onto the market because of the potential balance-sheet damage. In commercial real estate, banks can write down loan losses in smaller pieces over a longer period of time.

Who Is Representing Your Interests? 10 Reasons To Hire A Tenant Advocate

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As in all professions, specialists provide their clients with expertise and best practice techniques to make a difference to an organization’s bottom line. In commercial real estate, brokers with a focus on representing tenants can change both the fundamental approach and final outcome. Here are some of the advantages:

1. Tenant brokers understand how landlords think and the best way to leverage it.

Quality brokers understand the forces driving landlord decisions and can focus on the appropriate ones to gain the best deal for their clients. This process can encompass expertise with regional markets, competition with other landlords and the ability to present their client in the best possible light.

2. Tenant brokers even the playing field.

Typically, landlords gain the upper hand in the negotiating process when tenants negotiate a renewal without a broker. Landlords’ experience with multiple clients, knowledge of lease clauses and ability to wait out their tenants can create a significant advantage. Tenant brokers know how to separate nonnegotiable elements from a well-played bluff.

3. Tenant brokers avoid conflicts of interest.

Brokers who represent both tenants and numerous landlords are inevitably confronted with situations where they show space to tenants in buildings they represent, thereby creating a classic “conflict of interest.” Brokerage firms that represent none or only a few landlords avoid this situation and thereby create maximum leverage for the tenant.

4. Tenant brokers understand the impact of office layout, location and amenities.

Certain factors, unique to the corporate or medical tenant, must be considered when determining whether to renew your lease or explore new sites. For example, by relocating to another building, the benefits of the ease of your employees’ commute and/or building amenities (such as an on-site cafeteria, fitness center, patient or customer access and shuttle service to the rail) may be neglected by even the most beneficent company.

5. Tenant brokers can analyze your lease with a fine-toothed comb.

Tenant brokers understand the most important contingencies to include in any lease as well as the benefits accruing to both you and the landlord. Typically, an area where landlords enjoy the most advantage, lease clauses can be carefully examined by tenant brokers who close the knowledge gap and ensure their clients understand the document before they are bound for several years into the future.

6. Tenant brokers understand how tenants think.

Tenant brokers understand your needs and will bend over backwards to meet them. Their business model depends on your repeat business and referrals for continued livelihood.

7. Tenant brokers form natural alliances to help their clients.

In an effort to maximize the deal, tenant brokers will often consult with related professionals such as architects and real estate lawyers. They will form a “negotiating team” to ensure your interests are zealously protected.

8. Tenant brokers are experts in building assessment.

Thanks to their knowledge of the market and constant evaluation of sites, tenants brokers understand the pluses and minuses of your current or future headquarters. Items such as adequate parking, square footage loss factors and the design, layout and shape of the proposed office can be significant factors in comparing a renewal vs. a relocation .

9. Tenant brokers believe in what they’re doing.

The ability to advocate for the little guy and the feeling of shared purpose, often among entrepreneurs at a similar level of development, means your tenant broker will identify with your company, thus increasing the likelihood of a full-court press on your behalf.

10. Tenant brokers keep you informed.

Things change. The value of your location five years from today may decline due to industry developments, market variations, etc. Tenant brokers keep up-to-date with availability, infrastructure and many other factors affecting a renewal or search for a new site.

Tenants negotiating a renewal may encounter a number of complex decisions affecting their operation for years to come. A real estate broker focusing on tenant representation will offer a unique focus and expertise in these areas.