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You may not realize that commercial real estate leasing considerations and IT have much to do with one another, but converting to electronic healthcare records (EHR) can bring the connection to light. The process puts more demand on your IT infrastructure, and your ability to successfully complete the conversion to an EHR can be impacted by how your lease is written. So as you consider the current incentives and future requirements of converting to an EHR, you should also make sure that you are fully aware of how your lease may impact this process. Below are a few of the key provisions to be professionally evaluated as part of the process of converting to EHRs.

Alterations: If you make changes to your filing room, what steps will you have to take – both with your landlord and the applicable permitting authority to ensure code compliance? Do you need the landlord’s consent; what conditions will the landlord place on their approval? What if the changes are only cosmetic; does that change anything? Will you have to restore the changes? How and when will you know what you have to restore?

Infrastructure: If the EHR servers will be on-site, there are numerous considerations for the room that will house the equipment. Even if you currently have a room that is dedicated to IT equipment, the change to EHR may put more importance and stress on that space. Considerations include calculating the required cooling, floor load, security, electrical (capacity/dedicated outlets) and landlord access rights.

Operating Expense Passthroughs: Landlords often give themselves the right to submeter both the premises and certain equipment. Understanding the process through which landlords may measure and submeter is important when you are getting ready to change the use of a filing room, install millwork for tablets, or increase the capacity to your server room. Key considerations include studying the impact of submetering on additional rent and ensuring that the landlord doesn’t double count utilities.

Space Measurement: The architectural work that will likely be required to obtain a permit to convert filing space to another use (i.e. another revenue-generating exam room) is an expense, but it also presents an opportunity to ensure that the rentable square footage measurement was determined correctly. What method of measurement was the landlord using? Was it verified? Many tenants focus on the Rate per Square Foot, but not the Square Foot component of the calculation – both have an equal impact on your actual rent.

Landlord’s Lien: Does your landlord have a lien on the personal property within your space? Many leases include this provision, and the important implication is that such a lien can inhibit your ability to finance key equipment, including servers.

In general, healthcare practices should be aware of the terms in their lease and how these terms (or requirements or conditions) may impact their business. EHR conversion brings many of these provisions to light, as your lease may impact both your ability to effectively convert your practice to an EHR and the associated costs of the conversion. A professional analysis of your lease will bring these considerations to your attention and help you make smart decisions as you move forward.

Depending on the circumstances, much can be achieved through competitive renegotiation. For those who do not have a professional tenant representative in-house, engaging a tenant representative with a medical specialty to perform the analysis is a key first step. The engagement signals to the landlord that you’re serious about having every option and deal structure professionally evaluated. The process starts with having your lease professionally abstracted and your operating expenses analyzed. The output will establish a baseline of rights and costs and help you evaluate the costs and impact of moving forward with the conversion.

Quick. How much money did you pay in operating expense passthroughs last year?

After most practices sign a lease, it goes in a drawer somewhere for the next several years. In some cases, the lease or renewal was well-negotiated; a tenant representative was engaged to properly determine needs, thoroughly evaluate options, leverage the market and work in concert with your attorney to negotiate every aspect of the lease. Here’s the problem: your lease is only as strong as your ability and willingness to enforce it.

One of the most common ways companies get overcharged by virtue of not enforcing their lease is operating expense passthroughs. A year or so after you sign the lease, you start getting bills from the landlord for projected increases to building operating expenses, such as maintenance, snow removal, landscaping, insurance, utilities and various building repairs. How much time do you spend with those statements?  Around the beginning of each subsequent year, you’ll get a reconciliation statement showing the difference between what the landlord budgeted and what the landlord actually spent. Spend a lot of time on that statement? Do you tap into your extensive database of nearby buildings to compare expenses to make sure they are within the arms-length competitive market? Do you compare your operating expense exclusions in your well-negotiated lease with those for which the landlord is charging you? Of course not–you have a business to run.

 That’s where we come in. Our team has been conducting these reviews for over 18 years and routinely discovers errors. So how do we get the erroneous charges removed/refunded?  Sometimes, the landlords will acknowledge the error and cooperate. Other times, our buying power in the market helps. Here’s the best part–we don’t charge for the service, because over 90% of practices that use the service engage us to handle their leases when the time is right and we take pride in enforcing the leases that we work hard to negotiate.

So how do you know that you’re not being overcharged? Send us your reconciliation statement when you receive it along with your lease, if we don’t already have it. Those documents will get us started on our confidential, no-cost and no-obligation review.

Rate. Landlords focus tenants on the rate, and as a result, the rate is the most common term tenants and their business advisers focus on when discussing their leases with each other.  Tenants need to go beyond landlord marketing strategies to understand the other 24,999 words in a lease that can cost them money.

We’ve discussed some of the important clauses that tenants need to have negotiated long before they ever get to an initial lease draft, so this article will discuss why landlords get away with brainwashing some tenants into focusing on the rate. Landlords view real estate as a commodity; in other words, they own their buildings and want to lease them in ways that maximize their proformas. To do so, landlords try to convince tenants that they should treat real estate as a commodity as well. Landlords know that many tenants may opt for the path of least resistance, rather than professionally evaluating their real estate to maximize savings and mitigate risk; therefore, landlords quote rental rates without any explanation for how the facility is measured, what additional future costs may be applicable and what upfront buildout costs may be hidden.

The solution to landlords’ ostensibly simple but realistically time-consuming strategy is to treat real estate as a process integral to your business. Here are a few basic steps to demonstrate to your landlord through your actions that you’re taking the process seriously: 

• Have your lease, facility & operating expenses professionally analyzed
• Program future needs against your existing plan to understand efficiency
• Study the landlord’s portfolio & debt to gauge potential renegotiation success

By treating your real estate as an integral business process, you will not only save money, improve your facility and mitigate your risk via the other 24,999 words in the lease, you will also save time. Landlords, by design, make the leasing process seem simple initially, then stall during negotiations knowing that time is on their side. By taking the process seriously, you will ultimately save time by forcing the landlord to take you seriously as well.

“There’s so much vacant space out there. Why doesn’t the landlord just drop the rate and lease it?

That’s a question I get a lot from clients, particularly in this economy. As a tenant representative, part of my job is to answer it. Below are a few reasons, which demonstrate why each market, landlord and building requires a different approach. 

• Financing – Keep in mind that most commercial loans often have a short term. Also, keep in mind that it’s not just new buildings and recent sales that were overleveraged and financed inexpensively during the last decade; many long-time landlords refinanced their buildings during this period as well. Some landlords (even in this region) that bought, built or refinanced last decade have at least one of two problems:
  1. Their loan is about to expire and they can’t renew it without injecting more equity, escrow or deposits…or they may not be able to renew it at all.
  2. They’re in technical default. In this case, they’re paying their debt service, but have exceeded their Loan-to-Value threshold (the value has dropped) or Debt Coverage Ratio (not bringing in enough rent to cover the debt payments).

In either case, renewing a tenant or signing a new tenant below market turns a theoretical loss in property value into an actual loss, as they’d be locking in lower cash flows and a lower than originally expected sale price.

• Equity Partners – Most landlords (whether a REIT, insurance company or private equity firm) are some form of partnership. In any case, decisions involving whether or not to enter into a transaction are rarely made by a single individual. In addition to the vast majority of owners needing their lenders’ approval, they also need approval from their equity partners. Are the partners willing to lock themselves into a loss, or would they rather take their chances on market recovery? If a transaction will trigger a lender requiring them to infuse more equity, that could also be a reason to wait.
• Near Term Sale – Just as an owner doesn’t want to show a loss to his lender, he doesn’t want to lock himself in to a lower sale price by signing a lease that will yield him (and a future owner) to a lower net operating income. Many people don’t realize that most of the investment return is not made from rent—it’s made from capitalizing the net operating income upon disposition.
• Bad Precedent – Cutting one inexpensive deal with a tenant could lead to several more inexpensive deals with both existing and prospective tenants in the future, especially when tenant representatives like us get a hold of the information.

So, the next time you wonder why there’s vacancy in your building or another in which you may be interested, let us know. The answers may surprise you.

Your landlord just left you a message—your lease is up soon.  

It’s the last thing on your mind. You don’t know what your business is going to look like over the next couple of years and the last thing you want to deal with is an office/facility move.  

The good news is that the landlord says he’s going to give you a “great deal,” so you ask him to send over the terms. He sends a proposal with a lower rental rate than what you’re currently paying, and you feel good about it.

That’s where your trouble begins.

What most tenants don’t realize is that a mere 20% swing in the rental rate is not the biggest determinate of the actual costs you will incur under your lease; in fact, in many cases, it’s not even in the top ten.  

Here are just a few things the landlord may not be telling you.

• He can do better. Most landlords (and lenders) assume they can keep a tenant, especially a medical practice, at more expensive terms than they can acquire a new one (particularly in this market). However, you should be getting the better deal. Your buildout (if any) is less, you have a proven track record of paying your rent (really important these days) and you’ve abided by the terms of the lease.
  
• Is the space even measured correctly? BOMA, WDCAR or any standard at all? After all, your base monthly rent is Rental Rate X Square Feet.
• Are you getting a new base year on your operating expenses and real estate taxes? These are the hidden costs of a renewal.
• Is the landlord in (or close to) default with his lender? The value of your building may have gone down; is the landlord above his Loan to Value threshold? What’s the landlord’s debt coverage ratio, and will the building’s rent roll support it? Unlike owning a house, it’s not enough for a landlord to simply make their payments to the lender on time; they must show that the investment is performing or they risk losing it, and you can, in turn, risk losing your right to lease and occupy the space without a firm SNDA provision.
• What renewal/expansion/contraction options will you have during and after your renewal term?
• Parking can be free, both now and during your renewal. Some markets fluctuate between free and paid parking depending on the market. Parking costs can add another $2 per square foot per year (double that downtown), unless you pass that burden onto the employees.
• What’s the remedy if the landlord defaults on his management, buildout and transaction cost obligations?
• What audit rights do you have to protect against being overcharged on operating expenses?
• Are your rights to make alterations and remove trade fixtures and equipment protected, or does he or the lender have a lien on them?
• Is the landlord contesting his real estate taxes? He should be, but he may not care, particularly is the building is fully leased.
• If you are getting a buildout or space renovation, how secure is the landlord’s ability to fund it, and what’s the remedy if he doesn’t?

Any of these deficiencies in the lease you’re about to renew can cost you substantially more than the little base rental rate “discount.”

When you get the call (or, better yet, before you get the call), call us and send us your lease (if we don’t have it already) to review.  Even if you have no intention of renewing, the landlord can’t view you as a captive tenant, if you are to not only secure the best economic terms possible, but also maximize your protection under the lease. With us involved, the landlord will take seriously the possibility that you will vacate their building and recognize you as a free agent.  

So interest rates are low, prices are stagnant and you’re thinking about buying a commercial building or space for your practice (or perhaps as a side investment for yourself). There are a lot of people telling you what a great time it is to buy, so what’s the problem? You will need to carefully analyze the opportunity to ensure that you’re not only buying at the right price, but also acquiring an asset that will not adversely impact you in the future. In other words, your success doesn’t hinge on your timing; it depends on how well you can evaluate the property.

Here are a few considerations before we start looking for a property:

Is It Really For Sale?

Is the owner really selling or using you to effectively appraise the property for the lender?  Professional appraisals provide lenders with a precise estimate of value, but not always an accurate one. If you are not actively negotiating transactions in this market, how could you possibly know what a building is worth (based on the replacement cost, income or comparison approaches)? The only true test for some lenders is what bona fide third party offers the owner can obtain through marketing the property for sale. Those offers may end up merely enabling the owner to refinance their expiring or defaulted debt, not creating a transaction.

Is It Really Not For Sale?

A far better method for acquiring an asset (once we’ve determined that owning an asset is ideal) is to determine the ideal property based on your business needs. This goes deeper than budget and location; it explores related infrastructure, sustainability and changes to your business. From there, let’s identify potential fits that are not “on the market” and then research the owner’s situation and building’s true value. This process will yield stronger options at better values.

Replacement Costs

Developers aren’t building much speculative product, in part, because buyers can purchase an existing asset at a lower price than the cost to build one.  In the mid-2000s, this was not the case; both users and investors bought, in most cases, at prices substantially higher than the cost to build, which drove up land prices as the focus shifted to new development further out in the suburbs. You need to evaluate the true replacements costs of the property and justify to yourself and your lender that the particular asset is worth the price.

Pro forma

What could you lease or sell the property for if your business was no longer a good fit for it (or if you’re not the only occupant)? How long would it take and how much would it cost? Among other costs, count on tenant improvements, abatement, operating costs and brokerage & legal fees. Given those costs, at what price should you pay for the building?

Viability of tenants and market

If there are other tenants, what is the default risk? Looking at prior year’s financials isn’t good enough anymore. How viable is their business model going forward?

Ownership Structure

What pressure is on the owner to sell? What debt is on the property and how much control does the owner have? What type of owner is it? Is it a REIT that needs to free up cash or pension fund that is oversubscribed to real estate in their portfolio?

Building Due Diligence

There are also the more obvious due diligence items like is the building structurally sound, are the mechanical, electrical and plumbing systems in good repair, is the building ADA compliant, is the property devoid of hazardous materials, are the utilities serving the building adequate, what easements and other encroachments may impact the property and how well will the building accommodate your specific buildout?

Don’t buy the hype when it comes to real estate. Some buyers (both users and investors) made good investment decisions a few years ago, and some buyers are making ruinous purchases today. Buyers of a few years ago that planned long-term, built out or maintained the building properly to add value and aligned their real estate to their sound business model are largely going to do very well. Purchasers jumping at lower prices without looking beyond their initial requirements may have a rougher go of it in the coming years. There’s not a “good time” or “bad time” to buy, just an ongoing need for thorough evaluation.

Having previously spent a decade working for “full service” commercial real estate firms, I know the difficulty of trying to represent tenants at a firm that also represents landlords. Invariably, you create a conflict of interest with your client or your firm. Below is a visual comparison of a full service commercial real estate firm’s revenue potential from a landlord versus a tenant:

Proportions based on an average building size of 200,000 square feet compared with a full floor (20,000-square-foot) tenant. Listing fees estimated at 2-3% transaction value (10-year term), one year of asset management at $0.10 per square foot, one year of property management at 3% of building revenue and construction management at 5% of costs; tenant representation fees estimated at 4% of transaction value (10-year term) and project management at 5% of costs.

As the chart demonstrates, landlords are simply a larger source of revenue than tenants for firms that represent both. The revenue potential comes from not only the larger amount of space that a landlord owns (compared to the amount that a tenant leases) that the fees are calculated upon, but also the broader array of services that landlords buy. Now imagine how this chart would look if your landlord (or a landlord of a building you’re considering) has a large local or national portfolio of buildings; the fee potential from the landlord side compounds several-fold, while the revenue potential from the tenant side remains the same.

Most tenants are in tune to the conflict of interest if their broker is also representing the landlord of their building (also known as dual agency), but many tenants do not see the hidden conflicts of interest. For example, if the firm is pursuing listings or other work from a landlord while someone is representing a tenant within that landlord’s portfolio, will that individual be encouraged not to push to hard on particularly contentious negotiating points with that landlord?

 Here are a few steps you can take to uncover any potential conflicts:

• Ask your representative for a complete list of any of his firm’s listings as well as financial services, property/asset management and construction management work with your existing landlord and with any landlord in your target market.
• Ask your representative if he will agree, in writing, that his firm will not to pursue any listings, financial services, property/asset management or construction management work with any landlord under consideration.

There are several good listing, asset/property management and development firms in our market and across the country with which we have a strong working relationship. However, it’s important to understand from where each firm derives its revenue and to avoid conflicts of interest that can cost your company money and result in you taking on undue risk.

Of course you do. Your landlord buys lunch for you and your office now and then. He tells you what a smart negotiator you are, how much he tries to take care of his existing tenants first and how he’s giving you discounts and other free services. All of this makes you feel good, but it’s probably costing you money and increasing your risk.

Here are just a couple of barriers that you’re up against in a “negotiation” with your landlord:

• The landlord himself/itself that knows far more than you about commercial real estate, facilities, lenders, building codes, construction and lease provisions.
• All of the landlord’s service providers: listing agent (in-house or third party), property manager, contractors, architect, engineer, real estate attorney and lender know more about commercial tenant leasing than you do, and you’re negotiating against them whether you see them or not.

A good landlord that will placate you from the second you walk in the door, because they want you to believe that you can successfully negotiate for yourself. They know that you’re successful and are involved in other business negotiations. They also know that real estate has a certain appeal to it, and most people think of all real estate as a commodity, because they have, in their personal lives, rented an apartment and bought a house before. Here are just some of the costly mistakes you will make by treating the commercial tenant representation process as a commodity:

• Waiting until you receive their lease to negotiate (or have your attorney negotiate) legal terms
• Not fully understanding the competitive pressures and drivers of each landlord
• Negotiating when you should be going silent
• Failing to understand the entities comprising each landlord and working for each landlord
• Divulging information about your company at the wrong time
• Failing to understand how landlords make up for the cost of rent discounts and free rent
• Not getting your own space plans done properly
• Not getting your own detailed pricing with all divisions of construction

The list above is very basic. We could have written pages of mistakes I’ve seen over the last decade. The reality is that there’s no text book or Google search or past business experience that will enable you to properly manage the tenant representation process. You need the right experience and the right process to avoid getting burned with undue additional rent, buildout costs, inefficiencies and excess liabilities after you sign the lease. You need someone that the landlord will take seriously and that is not emotionally involved.

Outages are sometimes unavoidable. However, tenants frequently endure interruptions to services critical to their operation for reasons within their landlords’ control. Below are some questions you’ll need to answer to understand how well your practice is protected from service interruption?

• What electrical capacity standards are in place, and what constitutes excessive usage?  Are your rights to a generator or UPS clearly defined?
• Who is responsible for water & waste lines in your facility, and at what points must the landlord provide tempered water?
• If you’re not exclusively on the first floor, is the landlord required to keep one working elevator in operation at all times?
• What are the landlord’s cleaning specifications?
• How strong are your access rights and to where do they extend? Under what conditions may the landlord inhibit your access or employ their access rights in your facility?
• What standards exist for HVAC service and what maintenance requirements are in place? How much notice and payment is required to obtain service “after hours?” Even tenants with their own service accounts and maintenance contracts still rely on the landlord’s cooperation and ability to properly maintain utility lines.
• If the landlord fails to provide the services in accordance with defined standards, what are your remedies?

Too often, tenants settle for vague landlord service requirements because neither they nor the people representing them have the time or the facility expertise to understand what specific protections need to be negotiated based on the tenant’s needs and the building’s capacity. The resulting costs and disruptions can erode any other favorable aspects of a lease (i.e. low rental rate). Further, the absence of protections, particularly for more technical facility users, may diminish the value of the lease in the eyes of a perspective purchaser of a tenant’s business.  With the right programming, evaluation and negotiation, you can strengthen your lease and avoid costly interruptions to your business.

Tenants must prepare for the changes associated with a new landlord. We have previously discussed the importance of having estoppels professionally reviewed and revised prior to an acquisition of a building or portfolio. However, there are several changes associated with a building’s transfer of ownership that should be evaluated, including: 

Ownership structure:

REITs, private equity holdings, insurance companies and pension funds comprise the primary types of owners. As groups, they operate very differently; as individual entities within each group, the contrasts can be pronounced. Therefore, an experienced, professional evaluation of not only the priorities and pressures on each ownership type is important, but also a study of the individual landlord’s plans and vulnerabilities is crucial. Tenants often get caught up in conventional notions that all landlords want to keep their buildings occupied and respond to market conditions; this belief can have costly implications not only amidst renewal and new negotiations, but also during day-to-day operations.

Management:

There are fundamental differences between in-house and third party property management services. Further, depending on the priorities of the managing member(s) of ownership, the focus of the people that both maintain the services on which tenants rely and charge for those services (typically in the form of operating expense passthroughs) can vary tremendously. For example, many tenants are content that, while their leases leave them unprotected in some areas or don’t properly account for passthroughs, the services work fine and the passthrough charges being billed are minimal; all of this can change with a new management company, particularly with respect to using passthrough charges to enhance cash flow.

Leasing:

Tenants are frequently confused by the landlord’s leasing representative, whether the person(s) is in-house or third party. The most common mistake relates to understanding who the leasing person represents; a close second is overinflating that person’s role in the process. Listing agents are typically friendly and accommodating, at least initially, giving some tenants the false impression that the person is merely facilitating a transaction rather than subtly omitting key parts of the process that can protect tenants. Further, there are drastic differences in the decision-making authorities and influence of listing agents. Their role, particularly when an ownership change occurs, must be properly understood through the larger context of the ownership stack to avoid falsely relying on ineffective promises.

As previously discussed, leases are dynamic, not static, documents that need to be regularly reviewed. These annual reviews should include professional evaluation of operating expenses, understanding remaining liability in the context of the business plan and benchmarking. When building ownership changes, the importance of these reviews are magnified. While a tenant may not want to change anything about the lease or facility, with new ownership, change is imposed upon the tenant.