One of the largest annual expenses of any medical practice is the cost associated with the space in which it operates. In today’s recovering economy, the medical office building sector has rebounded, too, making leasing costs for medical practices an even more important consideration, particularly in Maryland where real estate costs and cost of living are higher than in neighboring states. Medical office building sales have increased and vacancy rates have begun leveling out from their high in 2009 – making it crucial for physicians and medical office administrators to understand all of the options available to them when negotiating a new lease.
Medical practices should view their leases as they would a personal investment. The total lease obligation for a medical practice can range from hundreds of thousands of dollars to millions of dollars depending on the size of the space, the rent per square foot and the length of the term.
A medical practice will have only one opportunity to get it right – at the time the letter of intent and lease are negotiated. It is, therefore, critical to retain experienced attorneys and accountants who have substantial leasing and related experience. Perhaps more importantly, the medical practice will need a leasing broker that specializes in leasing medical office space and that knows the market in order to negotiate the best deal possible. Having the right team could save the practice a substantial amount of money over the lease term.
The four most important factors of a new lease (or lease renewal) to consider are:
- Lease Term
- Tenant Improvement Allowance
- Security Deposit/Limitations on Risk
1. Lease Term
A new medical practice that is establishing itself can reduce its financial exposure by considering a shorter-term lease (5 years or less) with one or more renewal options thereafter.
A more established medical practice might consider a longer -term lease (10 years or more) with one or more renewal options thereafter.
Remember, however, the longer the lease term, the more concessions (for example, rent abatement, tenant improvement allowance and free rent) the landlord is generally willing to consider.
Base rent is generally dictated by the market value of the space, which is determined by factors such as location, type of building and location of the space within the building. New buildings with more amenities cost more.
The length of the lease term and rent concessions granted to the tenant can also affect the base rent.
In today’s market, landlords often will consider some component of free rent or abated rent for a period of time.
3. Tenant Improvement Allowance
An important component of any new lease is the monetary contribution by the landlord to the build out of a practice’s space (sometimes known as a tenant improvement allowance). The greater the contribution by the landlord, the less money a medical practice will be required to pay out of pocket for construction expenses.
A carefully drafted letter of intent and lease should provide that the tenant be permitted to use the tenant improvement allowance for hard costs of performing improvements and soft costs (e.g., architectural and engineering fees) of construction.
The lease should also be clear that the landlord will pay the contractor directly (or jointly with the practice) so that the practice is not required to pay construction costs prior to being reimbursed by the landlord.
4. Security Deposit/Limitations on Risk
The amount of the security deposit will most likely be dictated by the practice’s financial strength. If the practice is new or does not have strong financial statements, the landlord likely will require some combination of cash and personal guarantee(s).
If a personal guaranty is required, try to limit the amount of personal liability under the guaranty (in the form of a fixed dollar amount) instead of merely guaranteeing all obligations under the lease.
The landlord might agree to reduce the cash security deposit over time as long as the medical practice is not in default, sometimes referred to as a “burn off” or a “phased reduction.”
An alternative to providing cash for the security deposit is a letter of credit issued by a bank, with the landlord as the beneficiary. While this frees up the practice’s cash, letters of credit often entail fees.
Other leasing considerations include assignment and subleasing rights, default and remedy provisions and holdover. Decisions regarding a medical practice’s lease (or lease renewal) could have far-reaching implications. Careful consideration must be given to every aspect of the lease transaction prior to execution.
Reed P. Sexter is Vice President and Senior Counsel at Shapiro, Lifschitz & Schram, P.C. where he advises numerous local medical and dental practices on entity formation, leases, property acquisitions, partnership agreements and employment agreements. He can be reached at firstname.lastname@example.org