Avoiding Costly Renewal Mistakes
Understanding medical-specific renewals is a vital part of any medical portfolio strategy, as the option to renew typically occurs every five to ten years for each location your practice operates. Medical real estate is one of the largest expenses and potential liabilities for any practice, making it an important focus. However, renewals are the most commonly misunderstood and least utilized for improving your bottom line, mitigating future risks and increasing flexibility in the ever-changing medical world.
Unfortunately, most medical groups treat renewals like government budgets with expected yearly increases regardless of the current state of the market. This type of mindset plays right into the hand of the landlord as it leads tenants to renew the lease on their own and accept higher rents than necessary with minimum concessions.
In order to succeed with renewals, leverage is needed to negotiate from a position of strength. This is tough to do as the stigma in the real estate community is that doctors never move, they can and will pay more, and that doctors/administrators handle their real estate on their own because they have a long-standing, previous relationship. No matter how you look at it, most renewals leave the landlord in control with major profit centers already built in from the previous lease. Without understanding the landlord’s mindset, you will always be at a disadvantage.
To give yourself the advantage, you have to think like they do. If you were to leave, what would happen? They would have to find another tenant, which could take an average six to twelve months, clean the suite, potentially rearrange the suite, offer a tenant improvement allowance for a new tenant ranging from $2-$4/SF per year, give free rent and more. The bottom line is that the landlord doesn’t want you to move, but if you don't create leverage, statistics say you won’t. Consider these five important points for negotiating a successful renewal:
1. Know critical date and renewal options
It is essential to know what dates trigger a change in the lease. Most critical dates come into play nine to twelve months before your lease expiration, but there are other dates that may potentially affect the lease including rent increases, termination clauses, options, etc. What or who keeping track of this? Do you have a tracking system or an expert focused on critical dates? Missing these dates could cost the practice opportunities in the market to save money or, even worse, be penalized for failing to meet lease requirements.
2. Know your business needs now and what they can be in
In today’s challenging medical environment, it is sometimes difficult to predict what might happen in the future. Knowing where you are size–wise and where you expect to move will go a long way for an optimal real estate strategy. Do you plan on selling your practice to a group or merging with a hospital? This will have an impact on when you should renew, how long you should renew for and how to structure your lease to keep you flexible. Will you need to add certain medical specialties or medical equipment into your practice? Do you want exclusivity? These considerations will also influence the type of use and restrictions placed on the lease that are important more than ever as the landscape shifts for profitable medical facilities. It is not only about size and rent, so coming up with the correct strategy will make all the difference.
3. Know the market
Knowing the current medical market in your area for each type of potential medical space (high-end medical building, retail, office building), tenant improvements, concessions, etc. is very important to reach a favorable deal. The biggest mistake is looking at where your lease ended with increases that may not necessarily be a reflection of where that market is today. Once the lease is complete, the mindset has to be as if you were moving in again as anyone else would be. Be wary of language that does not give you the option to renew at Fair Market Value as some renewal options will try and force you to renew at a level equal to where the lease ended.
4. Create leverage
Creating leverage is everything in negotiating. Unfortunately for medical groups, it is tough to create leverage because of the underlying assumption that most medical groups do not move. (Why would they? They invested a lot of money in the buildout, have lots of equipment in the space and their patients know where they are). With such notions working against you, there are a few ways to create leverage: a. Have someone else negotiate on your behalf; b. Go out into the market to create competition, and; c. Create the appearance that it is a possibility that you could leave. If you do all three, you can show the possibility that there is a potential for your relocation allowing for a true business negotiation based on concrete facts rather than just a feeling.
5. Negotiate maximum concessions/reductions
Negotiation is the final piece to a successful renewal. Once you understand the needs of your practice, have a handle on the current market and have created leverage, you are now able to negotiate from a position of strength. With market data to support your position, you can come to the table with an offer that mildly challenges the landlord but is not so insulting that it halts negotiations.
The objective of a successful renewal is to come to an agreement that reduces or includes free rent, increases your work letter to improve your office for future business, and/or offers other options that create the flexibility needed for your practice to thrive throughout the upcoming lease term. Following these five tips will position your medical group with a much needed advantage in an always competitive market.