CREJ - Healthcare Properties - September 2016
With the continued growth of medical office space in the Denver metro area, there also has been a steady increase of tenant representation brokers in the medical office market. Of the approximate 10 million square feet of on- and off-campus health care real estate in the Denver metro area, most all transactions today surrounding physicians or health systems have representation – and for good reason. There are several nuances surrounding medical office leasing compared to traditional office leasing that make having representation critical for tenants. On the brokerage side, representing medical office tenants demands a high-level understanding of the health care industry and how it can impact site selection. Issues like the Affordable Care Act, patient privacy, changes in information technology, hospital system strategies and the political climate of health care all have the potential to influence decision-making. Tenant representation brokers who stay informed on these complexities will be more successful in setting expectations with their client and better able to have educated discussions throughout the decision-making process. Here’s a closer look at some specific considerations that tenant representation brokers may encounter in the pursuit of space for a medical office client. Use. Space that is available in a building that your client desires does not necessarily translate to being available for your client’s use. Many landlords in nonmedical office buildings do not want health care providers in their building for a number of reasons, which include: increased traffic through the building, impact on parking, tenant finish costs, intensive property management issues and stress on the mechanical systems. Additionally, landlords may be concerned with providing Americans with Disabilities Act requirements as well as the perception of ill patients utilizing their office building. In circumstances where landlords allow the use, there may be restrictions on competing practices in which exclusivities unique to a particular practice type are in place. This is very common on hospital campuses where the system will not allow competing uses to compete with their employed practices, such as pharmacy, physical therapy and others. Inquire about a landlord’s willingness to lease to a medical office tenant and explore any competitive restrictions as soon as possible upon site identification in order to manage a client’s expectations. Timing. There are several moving parts that can impact timing, such as selecting a space, negotiating a proposal and getting all decision makers aligned. In some instances, the build-out process alone can last four to five months or longer, depending on how specialized the requirements are and how long it takes to obtain a permit. Additionally, physician groups may be made up of several doctors, all with an equal say on decision-making, which can lead to lengthy intervals of time before everyone can make a decision. Using a practice manager as an outlet for giving and receiving information is key. Tenant finish. In most cases, one of the most difficult terms to negotiate in the proposal is tenant finish cost. Depending on the existing condition of the space, the total job cost can easily be $50 to $60 per sf and, in some cases, in excess of $100 to $110 per sf for traditional medical office space from shell. In the event there is a difference in the landlord allowance and the total tenant finish cost, prepare your client for the possibility that they may have to write a check or obtain a construction loan from a bank. Term. Driven mostly by the high-dollar tenant finish cost, the term of a lease is generally seven to 10 years, and sometimes longer, for both the landlord and tenant to account for allowances. In shorter- term leases, the allowance provided by the landlord will cause too large of a gap for the tenant to cover the cost of construction. Amortization of additional funds can be an option to close the gap, but landlords are in the real estate business and not the banking business so this option has its limits. Creditworthiness. The high-dollar allowances that landlords give make for an even greater importance for tenant creditworthiness. Landlords giving an allowance are not just providing a mechanism for completing construction, but ultimately they are investing in the physician’s business. The payback period on tenant finish and commissions can be as many as three years, which is why landlords need tax returns, balance sheets, profit and loss statements, and an understanding of the physician’s business plan. Brokers also need to discuss the possibility of personal guarantees with their clients, particularly if the practice is a startup. Having tenant financials and a good understanding of your client’s business plan at the ready will only help move the deal along smoothly. Physicians should seek all the counsel they can while searching for space. Tenant representation brokers are equipped to qualify candidate properties, leverage brokerage relationships and negotiate to achieve market terms for their client. However, educating your client prior to their search and, most importantly, setting expectations on the nuances mentioned above will increase the chances for success and provide for a more seamless transaction.