Need Practice Space? Real Estate Tips to Live By
At this point in life, you probably have some experience in real estate. You’ve likely bought or sold a home or two, or at least rented an apartment. So when it comes to finding and securing practice space, you might be thinking ‘I’ve got this.’ After all, you’ve been through the process before. Or have you?
Commercial real estate is in a whole different world than residential, with different rules of the road. There are a lot of nuances that even the most experienced homebuyer just doesn’t know about. That can mean costly mistakes for your practice—mistakes that can start out small but compound over the years.
So if you’re thinking of relocating or opening a new location, or even if you’re happy with where you’re at but not sure if you’re getting the best deal, keep reading. Our commercial real estate rundown will help you head into your next real estate transaction with eyes wide open.
Who’s Got Your Back?
No matter how sharp a deal maker you think you are, you probably shouldn’t go to a landlord or seller on your own. Why? “We have a specific business,” emphazises attorney Charles Feitel, president of Health Pro Realty Group. There are a lot of nuances in commercial real estate that most people just aren’t familiar with.
Plus, the data you need to make good decisions isn’t out there and available to everyone. “The data for commercial real estate is very clandestine by design,” says Feitel, who spoke about medical office space at 2017’s Vision Expo West conference along with Gary Gerber, OD. Residential data is “all over the place,” he says, but “there’s nothing like Zillow for commercial.”
So, the very first thing you need to do is obtain proper representation. This means working with a licensed commercial real estate broker, preferably with experience in medical space. The best part? As the lessee or buyer, you won’t pay for their service. A real estate broker earns their fee by splitting the commission that the seller or landlord pays to their broker.
Your broker will help identify space that fits your needs and budget, and will negotiate with the landlord or seller. That’s usually more difficult that it seems. In order to get the best deal, “you need to know what you can get in your market,” says Feitel, and “the numbers the landlord [or seller] tells you is not what the market is,” he warns. Often, office buildings are owned by institutional investors and they are laser focused on making a return on investment—not on what’s a fair deal for you. With a broker, “at least you’re gonna get market if nothing else.”
When it comes to obtaining space for your eye care practice, the traditional advice that ‘it’s always better to buy than rent’ doesn’t apply. Sure, owning your practice location can look like a pretty good deal. You can write of the mortgage interest and depreciation, and you’ll never have to worry about some landlord raising your rent. Besides, real estate always appreciates so you’ll make money when it’s time to sell, right?
Not so fast. This is another area where the realities of owning a commercial space could be surprising. When you purchase a home, you’re usually focused on not only finding a great place to live, but also earning a return on investment (ROI) when it comes time to sell. But medical space is different, and there are definite downsides to ownership. “You need to look at the entire picture of costs versus benefits,” advises Feitel. For example:
You’ll need to do more work.
In addition to running your practice and seeing patients, you’ll have to deal with the aggravation of owing a building. You’ll be responsible for repairs from small (a leaky toilet) to large (a roof replacement). You’ll have to manage multiple vendors like landscapers, a janitorial service, and pest control. Do you and your staff have that kind of time?
Making your next move could be tough.
Medical practice spaces present unique challenges when it comes time to move on, according to Feitel. Say you buy space when you’re younger and just starting out. You always assumed you’d expand when you outgrew the space, but now you find that zoning restrictions won’t allow it. You’ll have to move if you want to grow your practice, and chances are you’ll end up trying to sell. After all, you’re not about to lease it to a competitor—especially since you don’t want to relocate too far from your established patient base. But because your space is highly specialized, your buyer market is much narrower. You’ll need to either find someone willing to take on the renovation expense, or another medical practice willing to purchase it as-is
Appreciation isn’t guaranteed.
In theory, the value of real estate goes up over the long term. But that timing might not coincide with when you’re trying to sell. For example, there are still markets where properties haven’t recovered the value they lost in the last economic downturn. “As everyone knows, we’re not back from 2006 yet,” Feitel says. If your property loses value and you can’t hang on to it long enough to see it bounce back, you may never recoup your investment. In situations like this, ownership “can kind of be an anchor on your exit strategy,” Feitel notes.
The decision to buy versus lease depends on a lot more than your financial situation. It also depends on your local market. What do construction costs look like in your area? Is there even rentable space in your desired location? Some of these things are out of your control.
Know the Real Estate Lingo
Commercial real estate has its own language. Here’s a quick roundup of some basic terms you need to know:
Base Rent: The minimum monthly amount you pay your landlord. Never calculate a location’s affordability based on only the base rent. It’s comparable to the principal amount of a mortgage. It may seem low, but after you account for interest, taxes, and insurance, the true cost ends up much higher.
CAM: Common area maintenance is a fee above and beyond your base rent. It could be flat or variable, and is based on the percentage of the total building square footage that you rent. It may include costs like landscaping, security, elevator maintenance, and more. You can try to negotiate a cap on CAM fees, but at the very least, make sure that CAM expenses are well-defined in your lease.
Concessions: These are allowances you’ve negotiated to receive from the landlord. They may include discounted or free rent, tenant improvement allowances, reduced escalations, or another benefit. The higher the vacancy rate in your area is, the more amenable a landlord will be to concessions.
Escalation: An automatic annual rent increase. Over time, the cost of owning property increases. Escalations help landlords offset the cost of owning an aging building. But if the local market isn’t keeping pace with your escalations, by the time you’re a few years into your lease, “you’re paying way too much over market rate,” says Feitel. Try to negotiate a cap on escalations, or a fixed increase.
Letter of Intent: An LOI puts your commitment to rent the space in writing and summarizes the terms of the lease. It could be binding or non-binding, so be sure you know the terms before you sign. Also, make sure all of the terms from the LOI actually made it into the lease.
Net Lease: A type of lease where you are responsible for expenses beyond base rent. There are several types of net leases, but a triple net (aka NNN) is most common. In addition to base rent, a NNN lease requires you to pay property taxes and building insurance, plus maintenance, repairs, and other operating expenses like utilities.
Tenant Improvements: Any renovations or construction you do to customize your space. An allowance (TIA) can be negotiated with the landlord, and any costs above that is your responsibility. Therefore, you should know how much your improvements will cost before negotiations. You’ll want to make sure you have the option of using your own choice of professionals. The ability to choose a designer, architect, and contractor experienced in medical space is essential.
Restrictive covenants: Most often found in “office condos,” these are rules that govern activities and improvements that can take place at each unit in a building. Medical and dental are not allowed in every place as a matter of right, notes Fetiel. He recommends that practices try to avoid buildings with restrictive covenants, if possible.
What’s Your Type?
When searching for practice space, you’ll need to decide between traditional office space and retail space. Many optometrists will go for retail space, according to Gerber, especially if they have an optical dispensary. They reason that more visibility (drive-by or foot traffic) means more opportunities for business. Retail centers also often have an “anchor tenant”—like a grocery store or Target—that helps draw consumer traffic to the center.
If you’re an ophthalmologist, or an OD with a more medically-focused practice, think about whether or not you really need that retail exposure. Chances are you don’t. And if you still think you do, back up that feeling by conducting an analysis to figure out where most of your patients are coming from. Data can help you make that decision. Retail rent can be double or triple what an office space would be, warns Feitel, and retail landlords will often not give you as much of a contribution to your build out. You’ll have to shoulder more of the cost on your own.
Striking a Deal
No matter if you are looking for a brand new practice location, or the lease is up at your current location, negotiation is a top concern. Due to the specialized nature of eye care offices, your lease is likely to be longer than a regular office tenant. That makes the negotiation especially important—and it’s not as simple as you think.
“It doesn’t work where you ask for four months of free rent, the landlord says one, and you agree on two. That’s not how you do it,” warns Feitel. There are situations above and beyond meeting in the middle. For example, if you think you drove a hard bargain and got a month of free rent, “if you’re in a market where it takes eight weeks to get construction permits, you got nothing,” he continues.
Even the term “free rent” can be misleading. Maybe you negotiated “free rent” only to later find that only the base rent is free. You still have to pay CAM on that free rent, or maybe you have to pay all the nets. You need to know what the rent inculdes, but more importantly, what the rent does not include, emphasizes Feitel.
Another top tip? If you like the space you’re in and you want to stay, start the renewal process early, advises Feitel. The landlord will typically send you a renewal notice when you have a few months left on your lease. If you wait till then, time is not on your side. Why? “The minute you call the landlord and say ‘I want to stay’ there’s no negotiation [and] the only leverage you have is leaving.” That’s not realistic because even if you did want to relocate, you wouldn’t have time.
Feitel recommend securing representation and starting renegotiations 9-15 months in advance. That way, there’s time to get a better deal. “When you know you want to stay that’s when you need the help the most.”
Need a Loan? Start Here.
In a residential transaction, you usually begin loan shopping very early in the process, before you even start looking at properties. When searching for commercial space, it’s different. You need to find out how much you need first, because if you get free rent or a landlord contribution, you won’t need to borrow as much, advises Feitel. It doesn’t make sense to get a bigger loan you need and just give the lender back the extra. You’ll have already paid interest on that extra money that you never needed in the first place.
When shopping for a loan, Feitel recommends visiting your own bank last because typically that’s where you have the most leverage. Get everyone else’s terms first, then go to your own bank, present them with that information, and see what they can do for you.
When leasing practice space, getting the best deal isn’t the only thing you need to worry about. Leasing arrangements are one of the many activities subject to regulation under fraud and abuse laws like the Anti-Kickback Statute and the Stark Law. If you intend to lease space from space owned by a hospital, health-system, physicians or their immediate family members, or physician organizations, you’ll need to make sure the lease arrangement fits into one of those regulations’ safe harbors. Here’s how:
- Make sure the lease is commercially reasonable.
- The rental rate must be set in advance.
- Make sure the rental rate is fair market value (FMV). This includes any tenant improvement allowance and landlord concessions.
- Lease terms should never take into account the volume or value of referrals between the landlord and tenant.
- The amount of space must be reasonable and necessary for its proposed use.
- The lease must be in writing and signed by both parties.
- The lease term must be at least one year.
- Holdover periods cannot be longer than six months and the holdover rate must be at fair market value.
While these two laws and their corresponding safe harbors are similar, each has its own nuances. Before you sign any lease, be sure you consult with an attorney well-versed in healthcare law. But there’s no need to spend your dollars on an attorney from the get-go, Feitel says. Let your broker negotiate the basic terms of the LOI and the lease. When you get the lease document, have your attorney look it over to ensure that everything from the LOI made it into the lease and to make sure there’s nothing onerous, he recommends.
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