5 Mistakes Doctors Make When Leasing Medical Office Space

by from Medelita | Tuesday, Apr 02, 2013
tags: Guest Blogs

Reprinted with permission from JP Roach, Associate and Assistant General Counsel at Hughes Marino.

Click here to read the original article.

Finding the right real estate for your medical practice can be laborious, time consuming, and expensive. At Hughes Marino, we help companies make the right real estate decisions for their businesses by delivering great spaces and lower rents. In my role as leader of the Medical Practice Team, I help physicians and other healthcare professionals make the best real estate and space planning decisions for their practices. Medical space is very different from traditional office space with its own set of challenges that require the utmost care when leasing such space. What follows are five mistakes doctors often make when signing a new medical office lease. Our Medical Practice team not only helps you avoid these mistakes, but also guides you through every step of the medical office leasing process to help you find the perfect solution for your practice.

1. Signing a Personal Guarantee

Landlords love personal guarantees. However, as a tenant, you should not. 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 your personal assets (e.g., house, cars, retirement funds, etc.) are at risk should you default on your lease. The landlord will tell you the high cost of the tenant improvements that are often needed for medical office space creates additional risk, and that you need to sign the personal guarantee to provide additional security for your full performance of the lease. We disagree. The landlord who owns a medical office building should expect a high level of tenant improvements will be required. Further, the rental rate for medical office space is typically higher because of the tenant improvement contribution by the landlord. This is nothing more than a simple application of risk and reward. Yes, there is risk to the landlord in a real estate lease transaction, but that is why the rental rates for medical office space are higher than those for traditional office space. At the end of the day, it all comes down to the negotiations. If the landlord wants to reduce risk by requiring a personal guarantee, should there not be a corresponding reduction of the rental rate? Are the improvements highly specialized? Is the medical practice a new business, or is there a solid history of financial performance to ease the landlord’s concerns? Are there other suitable properties where a personal guarantee would not be required? If some form of personal guarantee is warranted, there are steps you can take to protect yourself and limit your exposure. For example, if you are in a partnership with multiple doctors, try to limit your guarantee obligation to your percentage ownership in the practice. Also, you should be able to structure a guarantee that declines each year as the landlord’s exposure is reduced. Additional weapons in your negotiating arsenal can 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.

2. Underestimating the Cost of Tenant Improvements

Tenant improvements for a medical office suite can be very expensive. Building out space to fit the unique needs of your practice can range anywhere from $50 to $250 per square foot, depending on myriad factors such as the current condition of the existing suite (warm or cold shell), the level of specialized requirements for the practice (e.g., plumbing in exam rooms, lead walls for x-ray units, surgery components, etc.), and personal choice of improvement finishes. It is important to understand the implications of the current condition of the suite and how that affects the purchasing power of each tenant improvement dollar the landlord is providing. 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 you are getting into before you sign a lease. Our team helps you assess the current condition of a space by developing a detailed and competitive budget for the construction project while you are still evaluating your options.

3. Underestimating the Timeline and Complexity of the Build Out

Just as the cost for tenant improvements varies by practice specialization and current condition of the suite, so does the project’s complexity, and ultimately, the timeline for delivery of the finished space. For example, a practice requiring a surgery suite and digital x-ray units will take substantially longer to design, permit and build than a family practitioner’s office that may just require individual exam rooms. We typically advise our medical clients to plan for a minimum six-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 a year or even longer. So it is crucial to deploy the right team of experts from the outset. Time is one your best leverage tools in real estate negotiations. If you run out of it, things can get expensive fast. Our team provides professional construction and project management so that you understand the complexity of the project and can plan accordingly.

4. Trusting the Landlords and Their Agents to Represent You

In a lawsuit, it is illegal, unethical – and even illogical — for an attorney to represent both the plaintiff and the defendant. There is an obvious conflict of interest. In real estate transactions this practice is called “dual agency,” and it carries with it the same inherent conflict of interest, except that it is legal and done all the time by so-called “full service” real estate agents. We are unique because we represent only tenants; never landlords. Landlords hire the “full service” real estate agents to find doctors to fill their empty medical office buildings. These agents’ interests are in lock step with their landlord employers and their singular aim is to maximize the rent paid by the medical tenants. On the other hand, tenants want to pay less rent. And yet many unsuspecting physicians trust these very same landlord/full service agents to advise them in their real estate negotiations. These physicians are often later disappointed that their agent did not do more for them in the negotiations. But if they understood the agent’s true allegiance, they would understand their motivation. The inherent conflict of interest that exists in dual agency relationships plagues the commercial real estate industry and should be avoided by physicians – and other tenants – at all costs.

5. Trying to Go It Alone

The old adage may be, “Physician, heal thyself,” but when it comes to real estate, you are best served by an expert who will capitalize on market conditions to obtain the best possible real estate outcome for you and your practice. Every space is different, and each landlord’s situation is unique. How long has the landlord owned the building? How long has the space been empty? Does the building owner have a large loan coming due? Rents are not set by landlords; they are set by tenants. What a landlord is willing to accept is often subject to wide swings based on what the tenant will agree to pay. But don’t try to go it alone. As a physician, your time is best spent focusing on your practice and working with your patients. The same way you hire a practice manager to manage your practice, an attorney to handle your legal affairs, an accountant to handle your taxes, and a financial adviser to manage your wealth, find a qualified, conflict-free medical office expert, someone worthy of your trust, and then empower that real estate professional to guide you in your real estate planning and negotiations to save you time, risk, and money. The first step is to start with Hughes Marino. Please feel free to contact JP Roach, head of Hughes Marino’s Medical Practice division, directly at jp@hughesmarino.com for a complimentary analysis of your practice’s real estate needs. JP Roach is an associate and Assistant General Counsel of Hughes Marino, a San Diego commercial real estate company specializing in San Diego tenant representation and building purchases. Contact JP direct at (619) 238-2111 or jp@hughesmarino.com to learn more.