Medical office tenants are one of the most underrepresented category of commercial real estate tenant in the United States, often representing themselves, working with the landlord directly or the landlord’s broker as a “dual agent.” Working with leases once every 5-10 years, busily managing their medical practice, and having the feeling of few choices and little leverage, medical tenants commonly sign very long-term leases at the highest rents in the market, relative to their standard office building peers. But it doesn’t have to be that way, even though you might feel anchored to your current location. With the right representation and proactive approach, medical office tenants can still get good deals, provided they’re informed about the most common pitfalls in the commercial real estate process.
1. Assuming Renewal Rates Are Non-Negotiable, Always Increase or There Is Some Universal “Market”
Many doctors and their practice administrators believe their renewal rate is dictated by some universally agreed upon “market,” and that the rent always goes up at renewal. However, there is no market for space, as it assumes that all landlords have the same capital structure, occupancy level and motivations, and that all medical office tenants have the same use and tenant improvement requirements (for example, ophthalmology spaces and plastic surgery spaces look very different). Lease renewals are one of the best opportunities to negotiate, but you must plan well in advance of your expiration date. The best renewals are done when the tenant has a “relocation mindset,” and while moving might be expensive and disruptive, signing an above-market 5-10 year lease can be far more costly.
Reciprocally, losing you as a tenant is very costly for the landlord in downtime, tenant improvement remodel and leasing costs, and landlords do not have the power that you might think they have. Medical office availability in the San Diego County region is 9.0%. However, the UTC and La Jolla submarkets have availability rates of 18.6% and 15.8% respectively, whereby these historically premium submarkets are experiencing unusual softness due to new medical space that have been slow to lease. As a surprise to most medical tenants, both in San Diego County and nationally, the average medical space remains on the market for 11 months before a new tenant is secured.
Seeking equity and fairness in the tenant’s cost and disruption during a move, as well as the costs to the landlord related to that move, savvy medical office tenants with the right representation can push to get reduced rent, free rent and remodel allowances, even on a renewal.
2. Telegraphing Your Intentions
Landlords are always trying to gauge whether a tenant plans to stay or leave. Do not tell the property manager, maintenance workers, or worse, the landlord’s broker, what your leanings and intentions might be—they are all double agents working for the landlord. For doctors, the most powerful form of leverage in lease negotiations is the possibility of relocating and hiring independent tenant representation to lead you through your relocation options and the process. While moving a medical practice may create temporary disruption, a long-term vacancy is far more risky and costly for a landlord. If you openly telegraph that you intend to stay, you immediately relinquish that leverage, and become subject to the landlord’s “market” terms as dictated by them.
3. Thinking of the Building Owner as Your Friend or “Partner”
Way too often, we hear a business owner say something like, “We have a great relationship with our landlord,” as if the landlord is going to cut that tenant a favorable deal. Landlords are in the business of paying their mortgage and expenses, giving a return to their partners or investors and making a profit—in that order. While there are surely exceptions, many building owners strategically befriend their tenants, hoping that the tenant behaves captive during renewal and doesn’t engage qualified representation that the landlord must pay. It’s the ultimate pro-am competition, where landlords run circles around tenants and have heard every line in the book they helped to write. What business reason is there for landlords to have “relationships” with tenants, whereby a landlord is then vulnerable to leaving economics on the table, eroding the landlord’s profit? None, not one.
4. Waiting Until the Renewal Notice Arrives to Start Your Negotiations…or Worse, Exercising an Option to Renew
We have heard hundreds of times where tenants say, “I signed a lease with two five-year renewal options,” as if they have some kind of future preferential right or leverage. In fact, unless it’s at a favorable fixed price, a renewal option only serves as a blocking mechanism to prevent the landlord from leasing your space to another third party.
The failure to engage the landlord well in advance of the typical 8-12 month renewal notice window is the clearest indicator doctors give landlords that the tenant intends to renew, and also that the tenant is not allowing sufficient time to build out or remodel a space for their needs elsewhere. Waiting to exercise a renewal option triggers a process where a tenant pays a magical “market rent” as determined by the landlord, most commonly without any free rent, tenant improvements or new protections on operating expense increases. The option process the tenant initiates is often “binding” on the tenant, so there is no walking back from a bad landlord opinion of value, and it often strips away all leverage that a tenant would otherwise be able to create by going to market to play out their move options.
Instead, imagine going to market and pressing all landlords in your area to create an auction for your business. You will get a completely different end result than exercising your formal renewal option that relies on lease comps (most often other people’s bad deals in a better market). The earlier you begin discussions, the more credible the possibility that moving becomes and the stronger your negotiating position.
5. Thinking the Landlord’s Listing Broker Will Treat You Favorably, or Even Fairly
Building owners often have their listing broker do their bidding—that charming, friendly face you see showing space who always seems to know what’s going on. But you must understand that person is the outsourced sales and marketing arm for the building owner, essentially serving as the landlord’s proxy. What you tell them is not confidential, and the landlord knows exactly what your limitations are, whether or not you’re looking at other options and in many cases, what those options are.
Sometimes, these “listing teams” split up and have one agent represent the landlord and one represent the tenant, but these listing teams are long-time business partners and share the commissions generated. They cannot negotiate against each other and, in no reality, should be expected to. It’s a structure to skirt around the conflict of interest of the same broker representing two parties with opposite financial and strategic objectives.
Commercial real estate leasing is a more complex and risk-filled process than doctors and their practice administrators could ever imagine, and only by working with a tenant-only representative and firm can a medical office tenant be assured not to make these mistakes, and the myriad more that lie below the surface.
