Picture yourself about to begin the process of renegotiating your dental office lease with your landlord.
It seems straightforward enough, right? You are going to propose a decrease in rent because your dental colleague next door is paying $2 less per square foot than you – now, this just doesn’t seem fair! You believe you should be paying the same or less than them because you’ve been a tenant at the property for a much longer period of time, and have never defaulted on your rent, right?
Well, what if I told you that your neighbor’s office lease may in fact have lower rental rates, but also limits their ability to sell the dental practice. In addition, the lease contains language permitting the landlord up to 50% of their eventual practice sale proceeds. Now, what if I told you that your lease contains the same major pitfalls. So…is it still just about the rent?!
Enhancing your knowledge about the following key lease provisions can help you build a proper dental office lease renewal negotiation strategy, and protect you from unnecessary risk. Let’s discuss a little further.
Assignment of the Lease: The Assignment provision is certainly one of the most critical provisions in your lease agreement. When the time comes for you to sell your dental practice, you, the future buyer, and your landlord will likely follow the terms contained within the Assignment provision. Consider the following scenarios:
- Landlord’s Consent: Most office lease agreements state that the tenant needs to obtain the landlord’s consent to an assignment of the lease. If your lease states that “consent may be arbitrarily withheld by, or at the sole discretion of the landlord”, you may be in for a very unpleasant surprise when your landlord denies their consent for any reason that he/she chooses. Furthermore, some landlords may agree to be “reasonable” when consenting to an assignment of the lease, with the caveat that the net worth of the dentist purchasing the practice is not below a minimum amount. How many new graduates or young dentists do you know with a minimum net worth of $500,000?! Sounds like an unfair request.
- Landlord’s Right to Practice Sale Proceeds: You have built a successful practice over the last 30 years, and your production has increased significantly. What if your landlord had the legal right to take “consideration”, or proceeds that you receive from the sale of your practice? Most dentists are shocked to learn that come sale time, they owe their landlord 50-80% of the practice sale proceeds for consideration. Take the time to review the Assignment clause in your lease agreement thoroughly, as this provision is included within a significant number of dental office leases.
- Post-Sale Financial Responsibilities: Provided that you have avoided the above mentioned Assignment clause pitfalls, you may think you’re in the clear, right? Well, not quite. What many dental tenants don’t realize is that when you assign your lease to the purchaser, often times you still remain financially liable under the lease. Your personal liability will remain unless you are able to successfully negotiate this provision out, or at the very least, amend the terms so that you are released after a more reasonable period of time. You don’t want to receive a call from your old landlord well into retirement with a request for rental payments because the new tenant has defaulted!
Options to Renew: After a lengthy negotiation with your landlord, you’re pleased that they have provided you with two additional five-year renewal options so that you or a future buyer can remain in the space for years to come. You are confident that this is of great benefit to you as your practice has just become much more “sellable”. In principle, perhaps yes, however in reality, maybe not. Have you checked the language in your “Options to Renew”?!
- Options for a Future Buyer: Many renewal option provisions state that they become null and void if the tenant’s lease is assigned or subleased. The renewal option that you thought you had may in fact not exist when you sell the practice and assign the lease to a future buyer. A lease without substantial term directly impacts the value of your practice in the eyes of a buyer; and they will likely need a long enough term to satisfy their lender.
- Determining Rental Rates: Many “Options to Renew” state that rental rates will be negotiated by the tenant and the landlord at the end of term; however, many options do not specify the process involved in determining this amount if the parties disagree, causing you to remain in limbo over a rental dispute. This situation can be avoided by adding language stating that your rent will be determined based on a review of comparable properties in your market and that, if necessary, a third party will determine the rent if you and your landlord cannot agree on the amount after a set number of days.
- Demolition/Redevelopment Clause: Imagine getting a notice from your landlord that the building you practice in will be undergoing a major redevelopment. Your landlord sees dollar signs where you simply see a great practice location. Landlords have been known to maximize the value of their real estate investments by inserting terms and clauses into leases that pose significant long-term financial risk to the tenant. One strategy they use is building flexibility into the lease agreement. This flexibility often appears in the form of a “Demolition/Redevelopment” clause, also known as lease termination rights for your landlord. Essentially, these provisions enable the landlord to terminate your lease early, should a redevelopment opportunity arise. As off the wall as it sounds, the land in which your small medical building is located may be worth more if redeveloped as a 30-story condominium building! The good news is that there are some strategies available to try to minimize the effects of the dreaded Demolition/Redevelopment clause at lease negotiation time.
In summary, while all of the above are some of the more critical clauses found in dental office lease agreements, they by no means encompass all of the potential pitfalls that you may encounter in your lease. It is critical that you review your lease agreement in detail, whether you are renewing your lease or are starting a practice and have been presented with a new one. It’s recommended to consider hiring a professional dental office lease negotiation firm to represent you. Your dental office is a precious investment that is an essential component of your business and overall success – review the lease agreement, and remember that it’s certainly not all about the rent!
Author: Scott Goldberg, MBA, Director of Leasing, Cirrus Consulting Group
Scott Goldberg is the Director of Leasing at Cirrus Consulting Group, a firm devoted to providing office lease negotiation and review services for dentists. Scott has provided real estate consulting services to thousands of dentists throughout North America, and is well regarded as an authority on dental office leasing matters.