Buy, Rent, or Lease

There are many ways to invest in your business, including purchasing, rather than leasing, the physical plant in which your business is located. On the one hand, owning a building increases the financial risks associated with your practice. Buying a building means putting more eggs in that one basket. On the other hand, owning your building helps diversify your investment portfolio and gives you more control over the likely value of the investment. That is not to say that buying gives you complete control. Consider whether land values are appreciating, stable, or depreciating.

Risk factors aside, owning your building brings increased responsibility and less flexibility should you decide to move; however, a well-chosen property may provide some financial advantages while you are building your investment portfolio.

Freestanding buildings are not the only option when it comes to buying office space; buying an office condominium is often another option. This option may be attractive due to relatively lower costs and the proximity to other healthcare professionals. It is essential, not just important, to read and understand the documents that govern a condominium (see Checklist 2). These include, but are not limited to, the bylaws, declarations, and rules. As is always the case with important and complex documents, it is worth having an Attorney read them so you know what you are getting into.

CHECKLIST 2

Documents To Check Before Purchasing a Condominium

1. Articles of incorporation

2. Bylaws

3. Rules and regulations

4. Budgets (past, current, and proposed)

5. Minutes of recent meetings

Finishing out an existing space or building from scratch may be the only way to have your office configured the way you want it. Having your space laid out the way you’ve envisioned can contribute to increased productivity. Keep in mind, however, that over time, the ideal configuration is likely to change. This can be due to endogenous factors, such as the growth of the practice, or exogenous factors, such as changes in technology that require different types of space. It is important, therefore, to think through the likely changes your business will experience as far out in time as you are able.

Building from square one can be much more expensive than other options, especially when you consider the value of your own time. Some of the planning and oversight can be delegated to architects, consultants, and even spouses, but you should be heavily involved at every step of the process. You are the only one who knows firsthand how your space will be used and how even minor changes can enhance or detract from its efficiency.

When building or buying a space, you likely will benefit financially from mortgaging the expense. Mortgages may have hidden costs, however. Lenders use closing costs, appraisal fees, and other expenses to boost profits on loans that are advertised at attractive interest rates. When borrowing money to purchase an office, consider these sometimes-hidden costs.

Leasing or Renting Office Space

In common parlance, the terms “leasing” and “renting” are often used interchangeably. In fact, despite many similarities, leasing differs from renting in that leasing connotes a longer-term commitment from both parties. Accordingly, some of the points of negotiation associated with leasing may not be necessary in a short-term renting circumstance.

TIP: Talk to colleagues about what they wish was different in their office layout. Learn from their mistakes.

For many Healthcare Entrepreneurs, leasing space is a more attractive option than buying or building. There are, in fact, several advantages to leasing. For example, leasing tends to require less working capital than buying or building. In addition, leasing allows a bit more flexibility if and when you want to relocate your office.

On the other hand, if you don’t own your space, someone else has significant influence over your practice. Consider, for example, the landlord who announces their intent not to renew your lease when it expires because they have a larger tenant who wants more space. In effect, the landlord would be compelling your practice to relocate.

Always have written agreements when accepting responsibility for office space or other real property.

Reviewing a Real Estate Lease

When it comes to leasing space, the rental amount may be complicated by the different variables that landlords manipulate in order to get their price. It is not uncommon for landlords to advertise a reasonably attractive rental rate and then, after a prospective tenant shows interest, announce that there is also a fee for Common Area Maintenance (CAM). CAM fees typically cover things such as the landlord’s property taxes, the costs of selected utilities, landscaping, and other common area expenses associated with running a building. The CAM may be expressed as a fixed dollar amount, but more often is expressed as dollars per square foot of space rented.

The impact of CAM fees can be substantial. For example, if a tenant agrees to lease a 1000-square-foot space at $20 per square foot, they reasonably expect the rent expense to be $20,000 per year ($20 x 1,000) or $1,666.67 per month. If there is also a CAM fee of $5 per square foot, the actual cost of leasing the space is increased by 25% or $5,000 per year. The actual monthly cost is $2,083.33 ($25,000 per year).

In most locales, rental fees are subject to sales taxes, which must also be considered when budgeting. In addition to the $20,000 per year for rental costs in the example above, the sales tax would be $1,600 per year in a jurisdiction that levies an 8% sales tax. In this example, a space that seemed to cost $20,000 per year has ballooned to $26,600 per year. That is considerably higher than the original expectation and may make the space in question infeasible.

TIP: Before committing to a space, check the quality and strength of the internet and cell phone signals in that space.

The cost of utilities must also be taken into account. Utilities include water, sewer, garbage collection, electricity, telephone services, and internet access. The costs usually will be the same or similar from building to building in the same county, city, or nearby town, but this is not always the case. For example, different buildings are wired for services from different Internet Service Providers (ISPs). When you are selecting a location for your business, you may also be narrowing your choices for ISPs. This can have implications for the cost and quality of your internet access. Naturally, lower-quality internet access can negatively affect your office’s productivity. With so many practice management software programs stored in the internet cloud, unreliable internet service can be disruptive to your business.

Another element of the lease that deserves attention is who is financially responsible for the maintenance and repair of building systems. Ideally, the responsibility remains with the landlord, but many leases shift some, if not all, of that burden to the tenant. Heating and air-conditioning equipment repair and maintenance can be among the most expensive costs.

Consider the difference between a lease that requires the tenant to have and use an annual air-conditioning maintenance contract versus a lease that requires the tenant to have the same contract and be responsible for repairing the air-conditioning system if and when it breaks. In the latter case, if the equipment is irreparable, the tenant must buy the landlord a new heating and air-conditioning system.

Like all contracts, leases have what Attorneys refer to as “term and termination” language. This language addresses how long the lease will last and the conditions upon which it will terminate. In general, the longer the lease, the lower the monthly cost of leasing the property. Many landlords propose high lease rates and leave it to the prospective tenant to ask for and negotiate a lower rate. If you are willing to sign a longer-term lease, you should ask for lower rates than those charged for tenants who are on shorter-term leases. Savvy Healthcare Entrepreneurs actively and unabashedly negotiate the terms of every lease.

Most leases also have what is referred to as an “escalator clause.” This clause prescribes an annual increase in rent throughout the term of the lease. Sometimes the increase is expressed simply as a flat percentage of the previous year’s rent; other escalators are tied to economic indices, such as the cost-of-living index. Escalator clauses protect the landlord from the rising costs of running the building; however, the tenant faces increasingly higher rents.

It is always worthwhile to negotiate with the landlord to ensure the escalator clause is removed from the lease or, at a minimum, set at a reasonable rate. Although businesses in most industries can raise their rates to offset increases in the cost of living, healthcare fees are often fixed over time, so even a small increase in rent may constitute an actual loss at the bottom line of your business.

Offices for rent come in all sorts of configurations. Some spaces are configured as shells with no interior walls; others have been previously occupied and are configured with walls, plumbing, and electrical wiring in place. As you consider how best to configure your space, remember that if you are leasing, you likely will be responsible for restoring the space to its original condition when the lease ends. So, don’t knock down walls or make other significant structural changes without the landlord’s written consent and written assurance that the changes you make will be accepted as “original condition.”

New tenants typically are offered build-out allowances if they will be occupying an office shell. Build-out allowances are the monies, or other considerations, a landlord provides to get a space configured to a tenant’s liking. When the space under consideration is an empty shell, a build-out allowance should certainly be a part of the negotiations. Such allowances can often also be negotiated when an already-finished space needs an upgrade or alteration. Although not technically part of a build-out allowance, items like new carpet and fresh paint should be discussed even if the space is suitable for occupancy as is.

Remember, when you are renting, any and all improvements belong to the landlord. Consider soundproofing, for example. The landlord may have budgeted for standard wall construction and standard insulation in walls. You may want more insulation and sound-reducing wall construction between adjacent examination rooms to protect the confidentiality of patient-doctor conversations. The landlord may try to pass that extra expense to you, pointing out that subsequent tenants will be perfectly content with standard construction. Regardless, such points should be negotiated.

Few spaces are suitable for immediate occupancy without some modifications. The modifications can range from simple and easy to complex. One often overlooked pre-occupancy activity has to do with cleaning the office space. This includes cleaning the air-conditioning vents so that any accumulated mold and other toxins do not present a problem. Likewise, cleaning carpets and repainting walls should be addressed prior to moving in. Ideally, you can negotiate to shift those costs to the landlord.

Many landlords ask for “first and last month’s rent” to be paid in advance of moving into an office. From the landlord’s perspective, the last month’s rent can be used if the tenant fails to pay the rent at the end of the lease term. The landlord can use another portion of the sum, the security deposit, to repair damages after a tenant moves out. Unless otherwise prescribed by law, leases should be negotiated to specify that monies paid in advance be held in interest-bearing accounts and that the resulting interest belongs to you, the tenant.

Laws governing how security deposits can be used vary from jurisdiction to jurisdiction. Regardless, it is worth negotiating with the landlord to ensure that the lease clearly states how the security deposit can be used and under what conditions it must be returned in full. To avoid possible disagreements about the condition of the space before and after occupancy, make a video of the entire space before moving in and ensure any change to the property, including relatively minor things such as hanging diplomas, are approved in writing by the landlord.

Deposits and other advance payments should appear on your company’s balance sheets so your company is credited for that asset. This, along with a note on your calendar, also reminds you to ask for the money deposited when you leave the leased space.

Excerpted from Lucrative Practices: The Comprehensive Handbook for Healthcare Executives by Michael B. Spellman, PhD.