The 10 Biggest Legal Mistakes Physicians Make in Negotiating Leases with Landlords

Excerpted from The Biggest Legal Mistakes Physicians Make: And How to Avoid Them
Edited by Steven Babitsky, Esq. and James J. Mangraviti, Esq. (©2005 SEAK, Inc.)

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Executive Summary

Negotiating a favorable lease is of critical importance to any medical practice. Physicians need to recognize the common problems that arise in medical leases and should retain experienced counsel to help them negotiate the most favorable terms. Failure to negotiate a lease or failure to fully comprehend the terms of the lease can lead to serious problems.

 

Mistake 1        Failing to Understand the Patient Demographic

Renting commercial space is different from renting a residential apartment and should never be approached in a casual manner. Once physicians have decided on the nature of their practice and the type of patient they want to attract, they must decide whether to be located in an urban, suburban, or rural environment. In an urban environment, physicians want to make certain there is ample, convenient parking, or if they are located in a large city such as Chicago, that they are located close to public transportation.

Physicians who want a cash practice need to be located in a wealthy neighborhood and in a building with upscale amenities, while physicians who treat mostly patients with workers’ compensation claims would want to locate their office in a neighborhood where their patients are most likely to live.

 

Action Step     Before physicians begin reading newspaper ads or making the rounds with brokers in search of their practice location, they must first decide the type of clientele they want to treat.

 

Mistake 2      Being Unaware of the Different Types of Leases

Leases come in a variety of flavors, but all leases tend to favor the landlords, since they are usually written by landlords. Just because the terms are written on a preprinted form does not mean that they cannot be changed. Physicians should feel free to have their attorney negotiate the terms for them.

 

Gross Lease. A gross lease is sometimes referred to as a “pass-through lease” or a “full-service lease.” The lessee pays only the base amount for the duration of the lease. Occasionally, the lessee may be required to pay certain additional costs. Consider, for example, the following scenario:

Dr. Rimilov has entered into a five-year lease. He has rented 1,500 square feet in an 18,000 square foot building. He pays $14 per square foot, so his base rent is $21,000 per year, or $1,750 per month. This rate includes utilities, maintenance, taxes, and janitorial services.

 

In some gross leases, Dr. Rimilov will pay only $1,750 per month for five years. At the end of five years, the term of his lease will end or the lease will be renegotiated. In other instances, all or certain cost-of-living increases and building expenses will be added to the rent after the first year of the lease and he will be responsible for payment.

 

Graduated Gross Lease. A graduated gross lease is a good idea for physicians who are starting out in practice, since it keeps costs lower initially. Consider, for example, the following scenario:

 

Dr. Rimilov has entered into a five-year lease. He has rented 1,500 square feet in an 18,000 square foot building. He pays $14 per square foot, so his base rent for the five years is $105,000 (which includes utilities, maintenance, taxes, and janitorial services), as in the previous example. Over the five-year lease, he will pay $1,000 per month the first year, $1,500 per month the second year, $2,000 per month the third year, and $2,125 per month the fourth and fifth years. At the end of five years, he will have paid the same amount as in the previous example, but because he was able to make lower payments initially, it will be easier for him to manage the finances of his practice when he is first starting out.

 

Adjusted Gross Lease. The adjusted gross lease is the same as the gross lease but gives the lessee more control. For instance, newer buildings generally permit the lessee to control the amount of air conditioning or heat in the lessee’s office. This works to the lessee’s advantage if the lessee’s hours are fairly standard and works against the lessee who has evening or weekend hours. Again, consider the following scenario:

 

Dr. Rimilov maintains a 1,500 square foot practice. His hours are Monday through Friday, from 9 am to 5 pm. He seldom has emergencies. Dr. Rimilov’s neighbor, MicroWare, is a 1,500 square foot software company, with office hours Monday through Saturday, from 7 am to 11 pm.

 

In a gross lease, the heat and air conditioning costs would be split equally between Dr. Rimilov and MicroWare because each has the same amount of gross footage. The amount of time that each used the air conditioning unit would not be considered. In such a scenario, MicroWare would obviously benefit: Dr. Rimilov would be paying for air conditioning he was not receiving. In an adjusted gross lease arrangement, MicroWare and Dr. Rimilov each would have a meter and neither would benefit to the detriment of the other.

The Net Lease. Under a net lease, the lessee pays for all utilities, maintenance, taxes, and janitorial services. As a result, the base lease payment should be lower than it would be under a gross lease. The lessee has more control over expenses (except for taxes and increases for common areas) because the lessee decides which vendors to use and to what extent.

 

Action Step     Unless they are sophisticated in leasing medical practice facilities, physicians should consult with a health care real estate lawyer to negotiate a lease. Activities that are perfectly legal and make excellent business sense in a nonmedical setting can subject a physician to severe penalties and possible jail time in a health care setting.

 

Mistake 3     Personally Guaranteeing the Lease

Most landlords require that the lessee sign a guaranty of the lease. This document is extremely important. It means that the lessee is personally liable for payment of the rent on the premises. If the physician’s practice is unsuccessful and must be shut down, the physician will still be liable for payment of the balance of the lease term unless he or she finds another tenant for the space. Even in such an event, the lessee will most likely not be relieved from payment until the original lease expires. Even if the physician signs a guaranty with a partner, the physician will be primarily liable for the entire amount that is due. For instance, if a physician has assets and the partner does not, the landlord may go after the physician alone for the entire amount due. The physician may in turn sue the partner but if the partner does not have assets, the physician is out of luck (and out of money).

 

Action Step     If the landlord insists on a personal guaranty, the physician should seek to limit the duration. For instance, the physician should try to have the personal guaranty limited to one year or 18 months if he or she is negotiating a five-year lease. If the landlord will not negotiate the term, perhaps the landlord will negotiate a limitation on the amount of the guaranty.

 

Mistake 4     Entering into a Percentage Lease

In a percentage lease, the lessee pays the landlord a percentage of the lessee’s gross income. Although perfectly acceptable in a retail setting, it is not permitted in health care. For a physician, giving a landlord a percentage of his or her gross income may be construed as fee splitting.

 

Action Step     Physicians should not even think about making this mistake.

 

Mistake 5     Failing to Understand “Pass-through” Expenses

Many leases have a cost-of-living increase included. This increase is generally based on the Consumer Price Index (CPI) for the area where the space being leased is located. Physicians should be sure to have the type of CPI clearly described in their lease and that the increase is capped by a certain percentage of the lease. Physicians should also request that the amount of rent be decreased if the CPI falls. In addition, w

hen physicians receive their yearly statement showing their increases, they should make certain to review these increases with their accountant immediately. Also, if the building is not fully leased, physicians should be sure they are not paying for the shortfall. The lease should state that expenses will be adjusted as if the building were fully occupied.

 

Action Step     Physicians should examine their leases carefully to find out whether they will be responsible for payment of pass-though expenses. If they are responsible for payment, they should make certain that they know the exact pro-rata share of the building that they are leasing. They should not take the landlord’s word for it. Physicians should measure the office space themselves (which can be easily done by counting ceiling tiles). Also, physicians should find out whether their leased area includes just their office space or also part of the common areas, such as the hallways or the lobby of the building (the “load factor”). Physicians may wind up paying for the pretty atrium on the eighth floor when their office is on the third floor.

 

Mistake 6     Failing to Get the Lease in Writing

There are many types of leases, and each has its pros and cons. The one thing to remember is that the lease controls a physician’s ongoing relationship with the landlord.

 

Action Step     All leases should be in writing, even if it is a close friend who is leasing the office space. Life has its ups and downs. That close friend could get divorced and lose the property in the divorce settlement, allowing the spouse, as owner of the building, to evict its tenants.

 

Mistake 7     Failing to Include All Important Terms in the Lease

The lease should contain all terms that are important to the physician. For instance, if a physician has a lease with an option to renew in five years, he or she should make certain that there is a formula in place in the lease terms to determine the price to be paid in five years. If the neighborhood in which the practice is located becomes fashionable, the increase could be 200% to 300%. On the other hand, if the price is tied to the rate of inflation or other objective criteria, the physician will probably be able to handle an increase more easily.

 

Action Step     Physicians should never leave issues to be determined at some later date. The issues never get resolved until an answer is needed, and by that time a physician is subject to the landlord’s whims.

 

Mistake 8     Failing to Read the Lease

The lease may be one of the most important documents that physicians ever sign, so they should be sure to read and understand it. Even when the lease is long and in very small typeface, physicians should read it anyway.

Action Step     When a physician cannot understand the lease, he or she should be sure to get a written explanation from the landlord. The explanation should be attached to the lease. In addition, the physician should make sure the language that was not understood is crossed out and that the landlord puts his or her initials near the changes.

 

Mistake 9     Failing to Tailor the Lease to the Needs of a Health Care Facility

Leases are often drafted by landlords; other times, a retail, standardized form is used. Although these forms are useful in certain situations, they will not be applicable to a health care practice.

 

Action Step     Physicians should make sure that the following points are covered in their lease:

  • Is sufficient storage available for their supplies both within the office and in storage bins (if available) in the building?
  • What provisions will be made for signage?
  • Are there restrictions on having certain types of equipment in the office, either as a result of the weight of the equipment or the use of such equipment? Will such restrictions affect the physician practice, either now or in the foreseeable future?
  • Is the space Medicare approved?
  • Is there emergency access to the office space? Are the elevators (if any) operational 24 hours a day?
    • Are there facilities for the handicapped? Physicians should refer to local codes to ascertain the types of facilities required for the handicapped and not take the broker’s or landlord’s verbal representation for compliance unless the landlord is willing to provide a signed statement that the office facility is in compliance with the codes regarding access for the handicapped and if the facility is not in compliance, the landlord will make the office facility compliant within 30 days or pay the cost of having the physician do so. Making an office compliant with regulations regarding access for the handicapped can be expensive, so if a physician is not prepared to bear the brunt of paying for such improvements, he or she should get the landlord to agree to make the necessary improvements.
  • Are the exam rooms sound-proofed to maintain patient confidentiality?
  • Will other doctors practicing in the physician’s specialty be permitted to lease space in the building?
  • What are the conditions, if any, that would permit the physician to sublet or assign the premises? Physicians should get those conditions in writing even if they think they will never want to sublease or assign the office. A physician may outgrow the office and require additional space elsewhere or may find that until his or her practice office grows it would be in his or her financial self-interest to lease part of the space to another practitioner when the physician is not there. Physicians should never agree to “working it out” when and if the time comes. It usually does not work out in their
  • Is the lease between only the landlord and the physician’s practice or is the physician personally liable under the terms of the lease?
  • Is there access to parking 24 hours a day? If the building has parking, are discount parking validations available for patients?
    • Is there sufficient space in which to expand the practice?
    • If the physician is adding office space, is the physician required to use the lessor’s space planner or permitted to use one he or she chooses?

If the physician is permitted to use his or her own planner, the physician should make certain the planner is experienced in the medical field and get references and visit offices that the planner has created. If the physician must

  • use the landlord’s planner, the physician should make sure to obtain a written representation from both the landlord and the planner that the planner is experienced in planning medical offices and will be responsible for anything built that is not in accordance with customary medical space. Often, specialized medical equipment, such as x-ray machines, requires specialized wiring and lead lined walls, ceilings, and doors. Physicians should make sure that the planner has this information as soon as possible so that the space can be built to suit the requirements.
  • What utilities are provided during which hours? For example, in Florida, a physician would want the air conditioner on before the office opens and kept on until the last person in the office leaves.

 

Mistake 10   Failing to Provide an “Out” If Needed

Physicians who

need a loan to start their practice but are unsure whether they will qualify for one should make certain that the lease provides them with an escape clause.

 

Action Step     The following clause would give a physician an “out” if he or she fails to qualify for the loan: “This lease is subject to Tenant obtaining a written commitment within ____ days of the date hereof for a loan in the principal amount of ______ at an initial rate of interest not to exceed ____ percent for a term of ___ years. Tenant will make application therefore within five days from the date hereof and use reasonable diligence to obtain the loan commitment and to satisfy the terms and conditions of the commitment and to close the loan. If the Tenant fails to obtain the commitment or fails to waive Tenant’s rights hereunder or after diligent efforts fails to meet the terms and conditions of the commitment, then either party may by written notice to the other cancel this lease and tenant shall be refunded his deposit.”

 

Conclusion

A physician will likely spend most of his or her life in the office. Moving can be stressful, expensive, and deleterious to patient care as files have a way of getting lost and computers tend to develop strange maladies when moved. Physicians should not let a broker negotiate the lease for them. The broker’s commission is generally tied to the amount of money to be paid as rent so the broker has an inherent conflict. Also, the broker will most likely not have an understanding of health care law. Even when working with a lawyer, physicians should make sure that they understand their rights and obligations from a business perspective. It is the attorney’s job to protect their clients legally, not make business decisions for them.

Finally, physicians should develop a lease that permits them and their landlord to co-exist happily for a long time.

 

Written by:

Deborah A. Green, Esq.

Peer reviewed by:

Marc G. Epstein, Esq.

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