Tag Archives: sublease

Lease Renewals for Medical Professionals

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An important clause not to be overlooked within a lease contract is the renewal option. Renewal options pertain to the potential extension(s) of the lease upon the date of lease completion. Renewal options will contain language regarding lease rates going forward, concessions such as free rent and tenant improvement allowances and operating expenses. All of these terms are negotiable and will play an important role in the complete structure of a lease renewal. Renewal options are meant to provide flexibility for the tenant in the future. So, being aware of how to strike the right balance, within the lease as well as the renewal, will grant medical professionals the greatest flexibility and financial outcome for their real estate interests. 

One of the most common errors healthcare providers make is negotiating lease renewals without the help of a commercial real estate professional, specifically those who specialize in healthcare lease and renewal transactions. Most healthcare groups tend to be self-reliant and entertain lease interactions from within their office. The reasoning is fairly simple, which real estate investors are aware; the majority of medical providers will rely on referrals by way of other medical providers. So, if location (even space) can be identified by referral patterns, then the use of real estate counsel is unnecessary. Or, if location will remain the same, then negotiations of a renewal may be handled in-house.

But, rather, successful medical groups, large and small, understand that in order to achieve growth, they need leverage. Landlords, especially those that are in the real estate business, negotiate with professional guidance from real estate professionals. For healthcare providers, selecting their own representation, one that has performed the same real estate surgery with multiple instruments time and time over, to advocate their position will assist in influencing the outcome favorably. Furthermore, because landlords authorize a split of the commission between the landlord’s broker AND tenant/buyer broker, providers have the opportunity to receive representation from a healthcare real estate professional at no out-of-pocket cost.

MREA is a full service, healthcare real estate firm headquartered in Houston, TX. MREA provides commercial real estate services to healthcare providers and commercial real estate investors throughout the State of Texas.

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Motivation Is Moving Medical Sublease Space

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It is no secret, physicians are looking for ways to reduce expenses. Fueled by declining revenues, insurance reimbursement issues and a multitude of uncertainty, most are either downsizing their practice space or joining larger groups or systems in order to reduce the effects of less revenue and greater liabilities. If you are in a long term lease for more space than you currently require and would like to reduce your liability, then subleasing space may be the right option.

Subleasing by physicians to physicians where referral is obtained is common. In most cases, medical providers may decide to lease more space than what is needed to sublease additional space to medical providers.

It is important to note though, all subleases must independently qualify for an exception or safe harbor to Healthcare Referral Laws. The Office of Inspector General (OIG), which identifies and eliminates fraud, abuse and waste in programs administered by the Department of Health and Human Services, has issued a fraud alert which pertains to subleasing arrangements between medical providers where referral is made. Thus, it is imperative that the parties to a sublease carefully analyze and document the process by which they negotiated the rent and obtain outside support, such as rent comparables for general and sublease space in the immediate area that support the rent being charged to the sublessee.
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Subleasing can be a challenging process if motivation is not present. Thus, it is important to stay focused on the objective and be competitive to achieve that objective.
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In general terms, a sublease will be considered competitive if:
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  • Two years or more remain on the lease (the shorter the term, the harder it will be to sublease without a large discount to the rent);
  • Space offered on a shared basis includes prime space (windows) in conjunction with less desirable space (interior);
  • Tenant is willing to be flexible with concessions (i.e., free rent, improvements to the space, rental abatement, furniture, equipment or shared resources in the event of shared sublease);
  • The space is presentable. If not, improvement allowances or, if shell, the ability to ‘turnkey’ a space should be ample and performed quickly.

Once you have determined that a medical space can be competitive, a proper determination of pricing should be undertaken. The pricing structure for subleasing the entire space will be different from the structure for subleasing a few offices within your space.

To price a space typically these general factors are considered:

  • The condition of the overall medical and office market;
  • Length of the remaining lease term;
  • The condition of the space (need for improvements);
  • The current lease rent and how it compares with the market;
  • Understand what the direct rents are in the building and what other sublease rents are for comparable sublease space;
  • Understand who will be in your pool of potential subtenants.
  • And, most importantly, have a qualified representative review the lease for language that may be conducive or restrictive to subleasing.

In almost all cases in today’s market, medical sublease rental rates are discounted from that of the current lease rate. Subleasing space is also a time sensitive. As time passes, the space may become less desirable and the lost income

Therefore, consider being aggressive and flexible from the outset. Be sure to havea representative price and record activity on the sublease (i.e., number of tours, number of proposals, etc.) every quarter and adjust as needed. Do not let any sublease become stagnant. Whether you are looking to sublease through shared space to vacant space, remember that the goal is to reduce the lease liability, not eliminate it.

We have included an opportunity that is for sublease in Humble, Texas. Humble Medical Office Building (Abbreviated Sublease Package – Contact MREA for Complete Offering Memorandum)

Please let MREA know how we can provide assistance for this or other healthcare real estate opportunities.

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.

6 Sublease Tips For Existing Tenants

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With an abundance of rent space about to wash ashore, it may be wise to address your excess space or locations, before the next wave of renewals and relocations batter the Houston commercial real estate market.  Because this market currently favors landlords and tenants that control space within a well leased and managed or highly trafficked location, depending on the nature of the business, we suggest taking advantage of an engaged subleasing market to locate other potential users. When analyzing space to sublease, the following factors should be considered:

Space to Sublease

  • How much space is to be sublet?
  • What is the average transaction size in the market?
  • How many competitive blocks of similarly sized space exist?
  • What is the absorption of those sized units in the marketplace?

Once all of these questions have been asked and answered, the user will have a better understanding as to how long it should reasonably take to lease the space.

Configuration of Space

  • How is the space configured?
  • What is the utility of the layout?
  • Is it primarily offices or substantially open space?

The configuration of the space will also determine how easy (or difficult) it will be to lease. For example, a medical office space consisting of nothing but private consulting offices will be extremely difficult to sublease, as most office space users seek a balance between private offices and public workspace. Accordingly, subleasing that type of space will take longer than space with a better balance of private offices and workstation areas.

Furniture, Fixtures, Equipment, Etc.

In certain circumstances, the configuration of the space may be enhanced by leaving the furniture and fixtures in place. In this manner, a prospective user will not have to incur the additional costs and longer lead times associated with obtaining new and/or used furniture for this requirement. Consequently, in subleasing space, consideration should be given – and value should be sought – for subleasing space complete with furniture for both private offices and workstation areas if that represents a competitive advantage.

Lease Term Length

There is a traditional “predisposition” to find a subtenant whose needs with regard to term coincide with the term of the prime lease. However, this is not always possible. Accordingly, in marketing the space, the minimum term acceptable should be understood and dealt with. In certain circumstances, a landlord may be prepared to offer a longer term to a creditworthy subtenant, thereby creating an opportunity for the current user to eliminate all liability. Term is a critical factor and always needs to be viewed.

Rent

Simply stated, sublet space should be priced to move. The longer it takes to sublease, the more expense incurred and the less the percentage of recovery. In most markets today, it is virtually impossible to make money on a sublease transaction. Accordingly, and to repeat a theme, the goal is to move the space to minimize loss, not maximize potential (and actually illusory) gain. To that end, a rental structure should be developed which provides the marketplace an incentive for taking the space.

Improvements

In the real world, sublet space does not usually offer 100% of what the new user requires. Accordingly, money is needed for recarpeting, repainting, some construction work, etc. Many firms subleasing space prefer to grant free rent as opposed to providing cash for improvements. Irrespective of the approach taken, one thing is certain – firms subleasing excess space need to be prepared to address the concept of providing monies for improvements to the space if they expect to successfully sublet the space.

3 Tips For Startups When Leasing Space

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Yes, in 2011, we have been receiving more inquiries from startups.  With this in mind, we have documented a few ideas for business owners to take advantage of a weakened commercial real estate environment, while preserving cash and protecting themselves in a situation where future funding may be a concern.

Tip 1: Find Turnkey Space!

Truth in any space relocation is that the simple act of “moving” is expensive! Not only does the search for office space rob operating officers of hours that they should be spending growing the business, but it also creates several additional expenses. These expenses, for example, include having to pay movers, order new telephone systems, purchase new furniture, add telco/data cabling, request new service contracts, change paper advertising, etc.

These expenses can range from ten thousand to one hundred thousand dollars, depending on the space requirement. The best way to reduce expenses is to find a commercial space that is already furnished and comes with a telephone system. In an environment of shrinking balance sheets, opportunities are available via other businesses that are downsizing and trying to sublease space. The majority of sublease spaces have furniture and phone systems in place, in which these companies would rather include, as it would create an additional expense for them to be removed. The most attractive feature regarding subleases is that the rent is typically discounted when compared to space offered by landlords, as the tenants have greater motivation to lease.

Tip 2: Negotiate Low Rent Today and Let it Increase in the Future!

Most businesses today have had the feeling that if they “burn” through current funding too quickly, they may not be able to come-back for more. So they find themselves hunkering down wherever you can. Most business owners are not aware, but they can actually negotiate an extremely low rental rate today, one that landlords would of laughed at just a few years back. This is true. The reason: The landlord’s sweet spot and what they are most concerned are “Effective Lease Rates”. An Effective Lease Rate is the “average” lease rate over the life of the lease term.

Tip 3: Negotiate Termination Options!

Many office lease obligations could create a situation where the owners are held personally liable. If provided with this conundrum, sometimes it is best to negotiate a lease-termination option with the landlord, one in which the landlord and tenant determine how losses will be reimbursed, sometimes at significantly discounted payment(s).

If you should have any inquiries regarding this article or commercial real estate interests, please do not hesitate to contact Robert S. “Bob” Lowery.

A Well-Crafted Letter of Intent

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Plain and simple: We, as partners in a real estate transaction, need to resolve as many issues as possible for your business, before the lease is drafted.

While we have encountered several competing brokerage firms using letters of intent / tenant proposals based on basic business terms such as rent, area, and escalations, we understand that dozens of other issues typically surface with the presentation of the landlord’s draft lease. From our point of view, this is the worst time for disagreements or misunderstandings to emerge. Your urgency to close the deal and get the relocation program underway can now pressure you to concede to unfavorable lease provisions.

A well-crafted letter of intent / tenant proposal can prevent this situation from occurring.

This type of proposal covers, in detail, the terms and conditions of the deal. It is delivered to the landlord, or landord’s leasing broker, to demonstrate intent to lease or purchase as well as for qualification and negotiation purposes, prior to the drafting of a lease.

What does this accomplish?  Your legal fees are reduced, and your leverage is conserved.

Comprehensiveness is crucial and when we draft a proposal with the highest attention to detail, nothing is taken for granted.  While listing broker’s tend to cast as little light on detail or imperfection, it is assumed that any issues omitted or inadequately addressed will ultimately be resolved in the landlord’s favor.

Among other questions that our tenant representation team has catered for industry specific needs, we find these proposal inquiries commonly omitted from letter of intent / tenant proposals, which should be clearly addressed in ours . . .

  • What restrictions will be put on the use of the premises?
  • Which of the landlord’s expenses will be included in calculating operating escalation, and which will be excluded?
  • How will you be charged for electricity usage? If sub-metered, what is the landlord’s profit margin?
  • What rights will you have to sublease the space? If there is a profit, which party will get the benefit?
  • What rights will you have to renew the lease? How will the renewal rent be determined?
  • What rights will you have if the landlord defaults on a mortgage or a ground lease?
  • What rights will you have to make alterations to the space?
  • What will your obligations be at the expiration of the lease?
  • Which party will pay for working drawings?
  • Which party will bear the cost of bringing the space into compliance regarding any Disabilities regulations?
  • During what hours will the space be heated and air-conditioned?
  • What penalties will accrue if the landlord does not deliver the space on time?

These are only some of the potentially deal-breaking or otherwise costly issues that the proposal should address. If they are resolved, final lease negotiations will be relatively swift and painless. If not, you preserve your options while looking elsewhere.

This post was republished from Robert S. “Bob” Lowery’s original post, “Resolving Issues Prior To A Landlord’s Lease”