Throughout the State of Texas, MREA has assisted practice groups and healthcare professionals make the best real estate and space planning decisions for their organizations. Medical space is uniquely separate from traditional office space offering unique challenges that require professional guidance.
While we prefer to remain positive and energetic in our quest for our clients interests, what follows are a few mistakes that are made when signing a medical lease. Our tenant representative team not only helps to avoid such mistakes, but guides our clients through every step of the leasing process to help procure the ideal opportunity. To request the entire list (seven other items), please contact a healthcare real estate representative at 713.701.7900.
The Personal Guarantee
Medical landlords are apt to require personal guarantees. A personal guarantee is a legal contract between a landlord and an individual to guarantee a specific obligation of a business, usually the remaining rental obligation under a lease. Personal guarantees provide the landlord with additional recourse in the event of a default on a lease agreement. The implications of a personal guarantee are significant because personal assets (e.g., house, cars, retirement funds, etc.) are at risk if the party defaults on the lease.
The landlord commonly advises that to hedge against the high cost of the tenant improvements, personal guarantees are required for medical space. Due to this additional risk, a personal guarantee is instituted to provide additional security for the tenant’s full performance of the lease.
While any landlord that chooses to own a medical office building should expect high build-out costs, they should also be familiar with the lower risk associated when leasing to medical tenants. Furthermore, and as a rebut, the rental rate for medical office space is commonly higher to offset the higher tenant improvement contribution by the landlord. For example, the rental rates for medical space are far greater than those of traditional office space.
- So, if the landlord wants to reduce risk by requiring a personal guarantee, is it fair to suggest there should be a corresponding reduction to the rental rate?
- Will the interior improvements be specialty or generic? How does this factor into the decision for a personal guarantee as one size doesn’t fit all.
- Is the medical group a newly formed entity or is there a solid history of financial performance to ease the landlord’s concerns? What role does this play in the landlord’s decision?
If some form of personal guarantee is necessary, there are steps to take to protect oneself and/or limit a group’s exposure. For example, if you are in a partnership with multiple physicians, limiting a guarantee obligation to a specific percentage ownership in the practice is reasonable. Also, one should be have the capability to structure the guarantee so that it declines each year as the landlord’s risk exposure is reduced.
Additional items in negotiation may include a release of the guarantee based on the percentage of the lease or loan paid off, a specific end date for the guarantee, exclusion of certain personal items from the guarantee, and in some circumstances, personal guarantee insurance.
The Cost of Tenant Improvements
Tenant improvements for a medical space can be very expensive. Building out a space to cater the unique spatial needs of a healthcare group can range anywhere from $50 to $250 per square foot, depending on a myriad factors such as:
- What is the current condition of the existing suite (warm or cold shell)?
- What is the level of specialized requirements for the group (e.g., plumbing in exam rooms, lead walls for x-ray units, surgery components, etc.)?
- What are the groups decision for improvement finishes?
It is keenly important to comprehend the current condition of the space and how this will affect the purchasing power of each tenant improvement dollar going forward. A $25-per-square-foot allowance for a second-generation dental practice may be adequate, but the same allowance will barely get you started if you are building out from a “cold shell.” The point is to understand what is present before signing a lease.
The Timeline and Complexity of a Build Out
Just as the cost for tenant improvements varies by practice specialization and current condition of the space, so does the project’s complexity, and ultimately, the timeline for delivery of the finished space. For example, a practice requiring surgical space and digital x-ray units will take substantially longer to design, redesign, permit and construct than a family practitioner’s office which may simply require individual exam rooms.
We typically advise our medical clients to plan for a minimum four-month build-out period in order to design, obtain the appropriate permits, and construct the suite. For expensive and complex medical projects, the build-out period can be closer to one year — some longer. So, it is crucial to deploy the right team of experts from the outset.
Time happens to be the best leverage for a real estate negotiation. If it is not utilized effectively, things will get expensive — FAST.