EVALUATING LEASING VS. OWNING
In today’s commercial real estate market one of the most important financial decisions that a medical practice (whether a solo or group) can make is whether to enter into a lease or build an owned facility. The focus of this article is to provide practices with the tools to evaluate whether entering into or continuing a lease is preferable to owning their own facilities.
SEVEN IMPORTANT LEASE TERMS THAT HAVE MATERIAL LEGAL AND FINANCIAL CONSEQUENCES TO THE OPERATION OF A PRACTICE (HOW MUCH IS YOUR LEASE REALLY COSTING YOU?)
There are more than seven issues that a practice could consider, however, in general the ones listed below are the most important ones:
1. Lease Term And Extension Rights: The initial term of the lease should cover the depreciation period and investment return time line of any leasehold improvements. The renewal periods should provide a sufficient length of time to protect the practice from any major adjustments in the basic lease payments and costs. The practice’s rights to extend the lease must, among other things, provide it with time to review alternatives and the ability to understand how the lease payments will be calculated for the next lease term.
2. Operating Costs: The lease terms should be clear on what the practice is paying for other than the lease payment and how those expenses will be calculated.
3. Assignment And Subletting: The practice’s right to sublet or assign can be important when considering a move to another location. In connection with an assignment, the financial responsibility under the lease should be transferred after some period of time.
4. Non-competition Restrictions: The last thing a practice needs is another practice providing the same services at the same building or commercial development.
5. Guaranty: A personal guaranty should be avoided and, if not, then the terms should be reasonable so that the landlord does not avoid its responsibility to mitigate its damages.
6. Relocation Rights: The right to relocate within the building or commercial development in connection with a disaster or eminent domain should ensure that the replacement facilities are at least equal to the abandoned facilities and require that appropriate adjustments are made to the lease payments and operating costs.
7. Indemnity: The indemnification terms should be mutual between the landlord and practice and set forth the required insurance each party secures. The grounds for indemnification should be reasonable, i.e. the practice should not be responsible for anything out of its control.
FIVE LEGAL ISSUES TO FACTOR INTO YOUR EVALUATION OF A LEASE VS. OWNERSHIP OF YOUR OWN FACILITY (HOW TO DETERMINE IF OWNING A PRACTICE LOCATION IS RIGHT FOR YOU?)
1. Property Acquisition Agreement: The agreement should clearly and correctly state what the practice is buying and the quality of the title. Both are fundamental issues that can affect the success of securing bank financing of the property acquisition.
2. Loan Documentation: The practice should determine whether the loan may be an acquisition loan and/or a construction loan. The timing of when the practice starts repaying the loan should be considered in conjunction with when the practice starts occupying its facilities. The terms of personal guaranties of the equity owners should contemplate whether the practice will expand or decrease the number of equity owners.
3. Construction/Development Agreement: The agreement should explicitly set forth time lines for project deliveries by the contractor and penalties for failures to deliver. The practice should know the financial stability of its contractor and its past history in completing similar projects.
4. Zoning and Permitting: Even before proceeding with the acquisition of the property, the practice should understand whether the proposed location is zoned for its business and what types of permits are required for its operations. The practice should also know how difficult it will be to get a zoning or permitting waiver or a change (i.e., cost and time).
5. Premises Liability: The practice now has more responsibility as the owner, but it also has more control over the facility to ensure that the risks are being handled appropriately.
The foregoing article provides only a brief overview of the material issues and every issue may not necessarily apply to each practice and its circumstances. Hopefully, this will serve a starting point of the analysis of the issues facing a practice as it determines whether to lease or build its own facility.