By Patrick J. Wood, B.A., J.D. and Jason P. Wood, B.A., J.D.
You just finished negotiating a very favorable rent on your dream dental office, with free rent and options to renew, a generous tenant improvement allowance, and you can't wait to get the lease so you can sign it and have your contractor start building out the office. You have also negotiated with your contractor a price for the tenant improvements, and you have obtained a loan from your lender to cover all of your construction costs. The landlord presents you with a lease which looks to be a pre-printed form, tells you that all the other tenants signed it and that the terms are standard, and asks that you immediately sign it so he can give you the keys to the building. Should you sign the lease as is or should you consult with a leasing specialist?
This articles is intended to provide an overview of some of the issues we frequently encounter at Wood & Delgado when negotiating leases on behalf of our dental clients. It is not intended to be comprehensive in nature, nor is it intended to replace the advice your lawyer may give you on a specific lease.
Once your lease is signed, you and the landlord often have opposite goals. The landlord wants the lease commenced as soon as possible so that rent payments begin, while you want the office to be built out to your specifications with everything fully functional.
If your landlord is building out the office space, it is of vital importance that you give the landlord the most detailed plans you can, specifying: carpet type; type of cabinetry; location of bathrooms, sinks, laboratory, built in desks, and reception area; and other details in an effort to guarantee that your dental office will meet your needs and expectations. However, it is important to ensure that the lease not commence until the built out space has passed inspection by the local building department. Most standard form leases provide that the build out will be deemed complete when the landlord or its contractor/architect certify that it is "substantially complete". Usually this means that "punch list" items will be completed by the contractor after you have opened for business, and this isn't the image you want to present to your patients.
If you are building out the space, select the most qualified contractor you can and negotiate an appropriate build out period (e.g., 90 days after which your lease commences). You may also want to insert a liquidated damages clause in the construction contract so that if contractor delays put you behind schedule, the contractor will pay your rent (rather than you) until the office is completed.
Nearly all leases have rent escalation clauses which are either contractual in nature or which are tied to an index, usually the Consumer Price Index ("C.P.I.") published by the U.S. Department of Labor. Contractual increases are what you and the landlord bargain for over the life of the term. More common is a cost of living adjustment tied to the C.P.I. In recent years, C.P.I. increases have averaged approximately 2% per year. However, historically the C.P.I. has had periods of great fluctuation. For instance, during the four year period between 1978 and 1982, CPI increases averaged over 10% a year!
I recommend to my clients that they have a "ceiling" on C.P.I. increases to protect them from unusual rent increases. However, the landlord will likely insist on a minimum C.P.I. increase as well.
When initially negotiating your lease, you want an option to renew your lease which is very specific as to rent. If you are using the typical standard forms, you will usually find one of two standards: (1) an increase tied to the C.P.I. increase over the last adjustment date; (ii) or an adjustment to prevailing market rent in the area. Many business people opt for C.P.I. increases. However, there is a hidden trap here for dentists in that they typically spend $50 a square foot for tenant improvements, and the landlord knows you simply cannot afford to move your office if the CPI adjustment for the option period far exceeds the prevailing market rent.
Therefore, you may want to consider an adjustment to market rent, provided that its reflects a true adjustment to market rent, and not one that restricts the rent from being reduced in a soft rental market. Also, in order to ensure that a real market rate adjustment will occur, I recommend an arbitration procedure whereby the parties each choose one appraiser, and together the two appraisers choose a third appraiser, with the two closest appraisals being averaged to determine the fair market rent. Although this procedure is rarely used, it offers protection to a dentist who has an arbitrary landlord unwilling to negotiate fairly.
Some years ago I got a call from a potential client who said that his office had been destroyed in a large earthquake that struck southern California. Although the earthquake had occurred several years before, the dentist had just received a call from the landlord telling him that the building was being rebuilt, reminding him that he still had several years to go on his lease, and demanding that he move back into the building. Since the client had already built a new dental office in another location, he found himself in a bind where he was responsible for rent on two locations.
Most of the standard form leases impose no real obligation on the landlord to rebuild, while giving the landlord the greatest flexibility in determining when or if to rebuild. By contrast the tenant is typically obligated to move back into the space within a short period of time after the building is repaired. Imagine the difficulty in retaining loyal patients when you move into interim office space only to be forced to move back to the old space one or two years later. Therefore, I advise that the tenant have the right to terminate the lease if the landlord has not commenced restoration or has not completed the work within a reasonable period.
Ideally, I would recommend that the damage section of the lease contain at least the following requirements: that the landlord carry full replacement cost insurance; that the landlord commence repairs within 90 days and complete them within 180 days, failing which the tenant may cancel the lease; and that the tenant carry full replacement cost insurance covering replacement of tenant improvements and equipment.
A client of mine I am currently working with is selling his dental practice in the Hollywood area of Los Angeles. His lease was negotiated many years ago and the lease rate is substantially below market, provides that the current tenant remains liable for the entire term plus any options, and allows the landlord to receive any rent payable by the buyer to the seller in excess of the amount being paid by the seller to the landlord. The lease also provides that the landlord can deny the assignment if it would upset the tenant mix in the building.
The landlord disapproved the assignment even though the buyer had the same financial net worth as the seller when he signed the lease. The landlord also claimed the new dentist's operation of the dental practice would upset the tenant mix in the building, even though there were no other dentists in the building, but said that he would permit the assignment if there was a 100% increase in the rent. The landlord also sought to retain a portion of the purchase price, saying that $50,000 of the purchase price represented the difference between market rent and what the seller was currently paying.
I recommend you build some "teeth" into the assignment language to allow you greater flexibility when selling your practice. I strongly suggest you try to incorporate the following into each assignment clause: that the landlord cannot unreasonably withhold its consent to the assignment; that the landlord must consent if the buyer has substantially the same net worth and credit history as the seller at the time of signing the lease; that the landlord cannot deny an assignment based on tenant mix or tenant exclusives if the assignee is a dentist; that the selling dentist be released from liability at the expiration of the existing term; that the landlord have no right to adjust the rent to market upon assignment; and that the landlord has no right to claim a part of the sale proceeds upon the sale of the business.
All standard form leases contain condemnation clauses usually labeled "eminent domain" and pertaining to the government condemning the building where the dental office is located. Unfortunately, most of these clauses severely restrict the award the dentist would otherwise be entitled to by operation of law.
Recently, a client whose lease I negotiated was able to receive in excess of $100,000 from a condemning authority which was widening the street where the client's office was located, and needed to use the property as part of the widened street. We had drafted into his lease provisions allowing him to claim loss of goodwill, the unamortized value of tenant improvements, and moving costs. These clauses are particularly important when the office is located in older urban areas and re-development areas.
What happens to the lease if the dentist dies or becomes disabled? No standard form lease I am familiar with permits the dentist or his estate to be relieved of liability under these instances. Therefore, I always attempt to negotiate a release if the dentist dies or becomes disabled, in exchange for payment of several months rent following such occurrence.
Many leases contain relocation rights whereby the landlord may move the tenant to another location within a building. Special care must be given in drafting these terms so that the tenant is not moved to an inferior location, so that all costs of the move are paid by the landlord, and to ensure that the landlord build out nearly identical dental office space prior to the date of relocation.
Every lease has a subordination clause requiring that the tenant's lease be in a junior position to the lender on the property. They usually state that the tenant will be bound by the lease terms if a new owner acquires the property, typically through a foreclosure sale. However (and this is the trap for the tenant who has paid for substantial tenant improvements), these clauses do not require the new owner to honor the lease, and thus the tenant faces the potential loss of the lease and all tenant improvements following a foreclosure. Careful lease drafting prevents this result.
As a final issue to consider in drafting leases, nearly all leases protect the landlord from liability for his actions or inactions. At a minimum, the landlord should be liable for his own actions, such as when he fails to properly maintain the building causing water damage in your operatories. I have observed instances where a landlord's insurance company has denied coverage to the tenant when a claim was submitted to the insurance company based on such water damage.
A prospective tenant should always remember that the lease the landlord presents him was drafted by the landlord or his attorney. The reader should use a qualified attorney to review the lease and make necessary changes, as otherwise will you will end up with a one-sided lease containing few protections that benefit you. Entering into a landlord/tenant relationship is a little bit like getting married, and the relationship is likely to last a long time, for better or worse. A careful review of your lease documents before signing will ensure a better relationship between you and the landlord should troubles arise.
|
