Tag Archives: medical space

3 Items To Prepare For When Leasing Medical Space

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hammer cashThroughout 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.

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Locating Medical Real Estate: The Request for Proposal (RFP)

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searchDuring an organization’s planning process, a consideration of how medical space should be acquired will be determined. Whether by lease or purchase, via development or existing retrofit, the option selected should be derived by the real estate’s ability to provide the desired utility at the lowest cost. The financing function will determine how to fund the space acquisition, whether through existing capital, mortgages, or operating lease.

For reasons of flexibility, timeliness, economies of scale, and availability of funds, leasing is a better decision. Otherwise, when cash flows dictate the opportunity to purchase an existing facility, a simple step should be undertaken to diligently search for the property that best fits the criteria.

For the purposes of targeting existing facilities to meet the specified criteria, reduce time, improve clarity, as well as  bargaining position, it is important to utilize a document that is called a Request For Proposal (RFP). This, as a precursor to the landlord’s formal proposal, and which will answer the following general questions:

  1. Who will occupy the space or property?
  2. What type of space or property is required, leased or owned?
  3. What growth space will be required, now or future?
  4. When is space requirement needed?
  5. How long will the current need for such space last?
  6. Where should the property be located?
  7. What are special requirements?

For examples of purchase RFPs, please contact us here. As for acquiring lease space, items to consider in a Lease or Sublease RFP commonly are:

  • Premises requirements (rentable or usable square feet)
  • Term of the lease
  • Commencement date
  • Rent abatement (Free or deferred rent)
  • Rental commencement date
  • Rental rate
  • Escalations or adjustments
  • Improvement allowance
  • Space planning and design services
  • Expansion option(s)
  • Renewal option(s)
  • Property management and tenants
  • Operating hours
  • ADA compliance and access
  • Extended or after hours HVAC
  • Telecommunications
  • Security
  • Parking (# per 1,000 square of rentable space)
  • Asbestos
  • Nondisturbance
  • Response to RFP due date
  • Exhibits (if applicable)

Are you seeking an example of our Medical Real Estate Request for Proposal (RFP)? Require real estate guidance for a purchase or lease of a medical building in Texas?

Contact: 

Robert S. "Bob" Lowery 
Managing Partner
MREA Medical Real Estate Advisors
1200 Smith Street, Suite 1600
Houston, TX 77002

713.701.7900
office@mreausa.com

Issues That Can Arise When Leasing Medical Space

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ImageYou feel fortunate to have negotiated a favorable rent on behalf of your physician group, with free rent and options to renew, a generous tenant improvement allowance, and your contractor is ready to start building out the office. You have also negotiated with your contractor a reasonable price for the tenant improvements, and you have obtained a loan from your lender to cover all of your construction costs. The landlord quickly presents you with a lease which looks to be a  well-prepared document in which he/she requests that you sign it quickly to obtain the keys to the building / space. Should you sign the lease and expedite the process or should you consult with a leasing specialist to analyze?

This article is intended to provide an overview of some of the issues that MREA encounters when negotiating leases on behalf of physician practice clients. It is not intended to be comprehensive in nature, nor is it intended to replace the advice an attorney may provide.

Commencement of Lease

Once the lease is signed, your practice group and the landlord often have objectives that differ from one another. The landlord wants the lease commenced as quickly as possible so that lease payments begin, while your office seeks the completion of the build out to the agreed specifications with everything operational.

If your landlord is building out the office space, it is of vital importance to provide the landlord with the most detailed plans relative to your space and other details in an effort to guarantee that the office will meet the groups needs and expectations. However, it is important to ensure that the lease will not commence until the built out space has passed inspection by the local building authority. Most standard form leases provide that the build out will be deemed complete when the landlord or its contractor/architect certify that it is “substantially complete”. Usually this means that “punch list” items will be completed by the contractor after you have opened for business, and this isn’t the image you want to present to your patients.

Price Increases

Nearly all leases have rent escalation clauses that are either contractual in nature or are tied to an index, usually the Consumer Price Index (CPI) published by the U.S. Department of Labor. Contractual increases are what your practice and the landlord will negotiate regarding the life of the lease term. More common is a cost of living adjustment tied to the CPI. In recent years, CPI increases have averaged approximately 2% per year. However, historically the CPI has had periods of tremendous volatility. For instance, during the four year period between 1978 and 1982, CPI increases averaged over 10% a year.

We always recommend that they have a “ceiling” on CPI increases is necessary to protect them from unusual inflation occurrences. However, this is a highly negotiable item that will not gain consideration without compromise.

Rental Rate During Option Periods

When initially negotiating the lease, your group wants the option to renew the lease, which is very specific as to rent price. If you are using the typical standard forms as provided by the landlord, you will usually find one of two standards; either an increase tied to the CPI increase over the last adjustment date or an adjustment to prevailing market rent in the area. Many business people opt for CPI increases. However, there is a hidden trap here for physicians in that they typically spend a considerable sum on tenant improvements, and the landlord knows it is simply not economical to move an office if the CPI adjustment for the option period far exceeds the prevailing market rent.

Therefore, it is important to consider an adjustment to market rent, provided that it does not restrict the rent from being reduced in a soft rental market. Also, in order to ensure that a real market rate adjustment will occur, we recommend an arbitration procedure whereby the parties each choose one appraiser, and together the two appraisers choose a third appraiser, with the two closest appraisals being averaged to determine the fair market rent. Although this procedure is rarely used, it offers protection to a physician who has an arbitrary landlord unwilling to negotiate fairly.

Office Damage

A few years ago, we received a call from a client that they had moved from an office that had been destroyed in Hurricane Ike. Although the Hurricane had occurred a year and one-half prior, the physician had received a call from the landlord telling him that the building was being renovated and the lease term was still in effect. Since the client had already built a new office in a separate location, the group found himself in a sticky situation where there was the possibility of paying on two leases.

Most of the standard physician office leases impose no real obligation for the landlord to rebuild, and provide the landlord the greatest flexibility in determining when or if to rebuild. By contrast, the tenant is typically obligated to move back into the space within a short period of time after the building is repaired. But, imagine the difficulty in retaining patients when the move into interim or new medical space is necessary, especially when unexpected. Therefore, it is becoming a common request for the right to terminate the lease if the landlord has not commenced restoration or has not completed the work within a reasonable period.

Assigning or Sublease a Space When Selling a Practice

Suppose a lease was negotiated several years prior and the lease rate is substantially below market and the current tenant remains responsible for the entire lease term plus any options. The lease also provides that the landlord can deny the assignment if it would upset the tenant mix in the building.

The landlord disapproves the assignment even though the buyer of a practice has the similar financial net worth as the seller when they signed the lease. The landlord also claims physician group’s operation would upset the tenant mix in the building, even though there were no other like physicians in the building and attempts to negotiate.

How Can You Avoid Situations Like These And Other…?

  • Eminent Domain?
  • Road Construction?
  • Tenant Becomes Disabled or Dies?
  • Foreclosure Sale?
  • Relocation Rights?
  • Water Damage?

Summary

A prospective tenant should always remember that the lease the landlord presents is subject to negotiation. The tenant should use a qualified real estate counsel to review the lease. Entering into a landlord/tenant relationship is similar to getting married, and the relationship is likely to last a long time, for better or worse. A careful review of your lease documents before signing will ensure a better relationship between your group and the landlord should issues arise.