I’m going to add a few pointers about office leases as a continuation of Ho Sun’s excellent post about office leases.
My landlord is requiring a personal guarantee on my lease. What does this mean?
Any lease on a new practice will require a personal guarantee. My broker told me once your practice is established and shows cash flow this can frequently be removed upon lease renewal. Also, sometimes you can negotiate to get your deposit back on lease renewal.
Think about it, if you were the landlord and dropped $100k on the buildout, and the tenant moved out after one year (went broke because you didn’t read our blog about sound practice management principles, haha) and you only collected $48k in rents, would you want to be on the hook for the loss? The guarantee means you are personally on the hook for a certain amount should your practice fail. Which I thought there was a 50% chance of happening when I first opened, but everyone on our google group seems to be doing fine.
Just like everything else in life the amount of the guarantee is negotiable. If both parties are willing to negotiate in good faith the amount of the personal guarantee easily be adjudicated.
It would be just as unreasonable to make the guarantee the whole amount of the lease ($336,000) as it would be for $5000. But occasionally, landlords will still insist on this. My guarantee was negotiated down to the $17k in tenant improvements plus five months of the free rent for my five year lease. I felt this was reasonable, $17k is a lot but in the grand scheme of things if I decide to move or heaven forbid become disabled it isn’t overly putative. Looking back, I wish I had negotiated that the penalty gradually drop for every year I am renting the office and paying the landlord.
So what is a fair amount for your guarantee? In a longer seven year lease I would perhaps to try to negotiate after four years the original guarantee drops in half, or better yet for every year of the lease completed and paid to the landlord, the amount of the guarantee drops proportionally… perhaps your broker has copies of these guarantees so you’ll know what the standard is for your area.
Upon renewal of the lease you can sometimes get the guarantee removed and limit the penalty for breaking the lease early to a few months worth of rent. It depends on how much they give you in tenant improvements and free rent, as well as if the REIT needs it to potentially sell the building to investors.
What is a real estate management firm?
My building is owned by a REIT (real estate investment trust) that hires a professional management company (it’s called the Plaza company) to collect rent and take the responsibility for renting as well as maintaining the building. Kind of similar to what they have for residential real estate, for those of you who want to invest in individual properties but don’t want the hassle of playing landlord.
When I first signed my lease the building was actually owned by and individual, but they sold out to the REIT. When the building was owned by the individual, they used the same real estate management firm.
Some folks on our google group, including Ho Sun, have rented property where the landlord is hands on and manages the property himself or herself rather than using a firm. If your landlord is reasonable this works well.
The problem with this, as some folks in our google group have reported, is that some individual landlords have quirky personalities and can be very unreasonable or difficult about things considered trivial, such as charging twice the amount of rent if you stay an extra month without extending the lease, or if your practice is growing and you want to move into a bigger space in the same building, they won’t consider negotiating with you.
Location and the size of the property should be the most important criteria you look for when searching for a office lease, but don’t hesitate to sign elsewhere if you get the sense that your landlord will be difficult. All things being equal I would prefer a property management company at arms length over an individual landlord.
You might want to speak with the practice office managers in other suites in your building to see if the landlord or management company is reasonable, fixes things on time, maintains the building, responds quickly when called, etc. My agent told me that having this property management company run my property would be a big plus. He was right.
What length of time should I sign my lease for?
Leases are usually five or seven years, sometimes less at three years. If your landlord spent a lot in tenant improvements then they might want you to be there for a bit longer to recover the amounts they spent on TIs. It is important (and usually standard) to have a right to renew clause in your lease so you won’t be forced to move once your lease is up. If your practice is growing and you want a bigger space, or if you want to buy your own office, you don’t want to be locked in for too long.
If the economy is really down and you’re confident that you’re in a good area and your space is in a good location that you won’t outgrow, it might be good to “lock in” a low rate for a seven or eight year lease.
Some folks are afraid of signing for more than two or three years because they are afraid they if they picked the wrong location, or if their practice doesn’t work out they are stuck with the lease. Unless you had no tenant improvements and no free rent, usually landlords won’t allow such a short lease. Negotiate a good exit strategy without a putative amount for braking the lease as outlined above. But, there are folks we know who found a space about 1000-1200 sq ft which is probably considered too small. They signed a two year lease with option to renew for one year two times. If there are no other spaces you can find in the right location, this might be a good move.
How much in concessions should I expect for free rent and tenant improvements?
According to my real estate agent the landlord wants to say they got a certain price per sq ft to make the building attractive to any potential buyers. So it’s in their advantage to a certain extent to have a higher rent and give you more for TI. But this has to be balanced with their needs for cash flow. How much you get depends on the market- supply and demand for rentals, and how motivated the landlord is to get someone in the building.
Most solo eye docs are trying to conserve cash, so having the landlord pay for TIs rather than taking out a loan is considered advantageous. If the lease is longer then they have more time to amortize the amount paid for your TIs thus you will get more upfront, either way you are paying a fixed amount it’s just how much of it is a TI allowance vs rent.
Same goes for free rent. I got five months upfront where I didn’t have to pay any rent. The five months began after I moved in when all TIs done. (I have heard of the lease commencing on the first day the TIs begin, well before your suite is ready for move in).
Obviously this was beneficial when I was only seeing three patients a day. But, I told my agent that I would rather have paid rent for the five months and a lower rent over the term of the lease (for tax purposes would have helped to have more deductions this year); he told me they wouldn’t have agreed to it because they want to show they leased for a certain price per sq ft. Again, most solo eye docs are trying to conserve cash so they would happily take the rent free months up front.
Note that my six months of free rent was contingent on paying rent for sixty months. Some folks are able to negotiate a five year (60 month) lease and pay rent for 55 months (five months free) which is more favorable. My landlord gave me a three week “move in” period before the clock started to tick on my five free months, so I didn’t push things too hard.
As many of you know I got lucky and found a psychologists office the rooms were the exact right size. They gave me $17k and I only spent $16k for three counters and drawers and cosmetic touch ups.
Considering that some folks in our group have over $100,000 of TIs and have to pay for much of it themselves, finding the right office may have been a high mid five to low six figure gift!
Is it better to rent in a medical office complex or in a commercial or mixed tenant area?
My office is located in a medical complex adjacent to a hospital. This usually requires a higher rent than a mixed use complex with retail. The reason for this is because you’re paying a premium to be located right next to the hospital, this makes it easier for many doctors to go and to hospital rounds or other business before or after office hours. Ophthalmologists are bit different because we don’t do much if any inpatient work. On the other hand, if there are primary care docs in or near your building it might be easier to capture their business. Also, hospitals don’t pick their location without getting a bunch of consultants to analyze the area to make sure it can support health care professionals- hospital executives are not idiots and won’t pick a location where they can’t turn a profit. Also hospitals are usually located in nicer, more visible and easily accessible parts of town. One office complex I looked at was a few blocks away but cost much less, but for me I wanted to be in a more visible location closer towards the hospital.
One nice thing about medical office complexes is that the primary docs will be very likely to refer to your office just for the sake of convenience. So it helps if you have several of them in your complex. But sometimes they already have arrangements with other groups in town, so YMMV.
There are plenty of people who are in retail complexes and do very well. So at the end it doesn’t matter, as long as you pick a good location that’s easy to find and access it will work out. Personally, I like going to the hospital cafeteria for lunch, but then again one of my friends has his office in the same complex as a Grimaldi’s pizzza…. 🍕🍕🍕
Should I be concerned if there’s another ophthalmologist the same block or even office complex as me?
Absolutely not. Someone once gave me great advice: “find out who the busiest person in town is an open up right next to them.” This is completely true- you don’t want to open up where other ophthalmologists are sitting around not doing anything, or in an unattractive location to medical practices.
There’s an ophthalmologist right across the parking lot from me, and out of my office window I can see the building where the biggest mega group in town opened up, a year after I opened my solo practice. Guess what, I’ve grown the way I’m supposed to and will expect to be busier than what I want to be in a few years.
There is a good reason why so many medical offices are within a few blocks of each other- it’s a easy to access, heavily trafficed location. If I opened in an area further out because I was afraid of competition, it would simply hurt me because it would be harder to find my office, or it wasn’t in as good of a location. Don’t forget that all patients will come to a nicer location, but if your practice is in a bad part of town, patients that live in the nicer parts of town may choose not to come.
Having said this, sometimes in your lease you can get your landlord to agree to not have someone in your same specialty in your building, but Ho Sun had another ophthalmologist in his first office building and it didn’t change anything. It’s not like patients saw the other office and decided to cancel their appointment with him and see the other doc.
If you’re in a smaller town it may not be politically considered to be too “nice” to open up adjacent to another doc if you aren’t in a medical complex, the politics in every town will vary. But the bottom line is that plenty of practices can coexist within a few blocks. I look at the fact that the mega group opened up near me a confirmation that I picked a good location.