Thinking Like A Landlord
When it comes to making real estate decisions for your healthcare practice, there’s a lot to consider. Should you rent or buy your office space? What is the most ideal location for your patients and referral sources? Should you choose a traditional office, retail center, or condo? Should you select a property with a NNN lease, modified gross lease, or full-service lease?
These decisions can seem overwhelming from a medical tenant’s perspective. However, there’s a way to reverse engineer this line of thinking that puts you back in the driver’s seat of your business: thinking like a landlord.
Put yourself in the shoes of a landlord and ask yourself if you would rent to you. Then, use this exercise as an impetus to pull the value levers you bring as a tenant. The better you understand a landlord’s point of view, the better you and your Agent can package your value in a Letter of Intent— and structure the best deal in a way that gets the landlord interested in stretching further for you as a tenant.
In order to think like a landlord, consider the following questions a landlord is asking themselves and talking through with their listing agent.
Question #1: Is the tenant achieving a market rate to maintain or increase the building value?
Have you ever driven by a space that’s been vacant for a couple of years and thought to yourself, “I could probably get a screaming deal here — it’s been vacant forever!”?
That’s a very natural assumption, but in reality, a lower lease rate would lower the entire value of the building if the landlord took in a lower lease rate rather than just keeping it vacant and waiting for the right deal. When it comes to investment real estate — real estate owned by landlords for lease — the value of the property lies in the lease rates landlords are bringing in, rather than the brick and mortar itself. The lower the lease rate, the more devalued the overall building becomes.
So, if you’re a landlord, you’ve likely got a “floor” to the rental rate you’ll take from a new tenant. If you took anything lower, you might help your short-term cashflow, but you’d be devaluing your entire building. A key role of a healthcare real estate agent is in part to provide you with market intel, like lease and concession comps, so you are confident you are as close to the landlord’s “floor” rate as possible. When evaluating properties where landlords are more sensitive to a specific lease rate, your objective is to then capitalize on the highest amount of concessions in lieu of a lower rate.
Question #2: Are the lease escalations consistent with inflation?
Again, commit to putting yourself in the mindset of a landlord. A landlord is going to want to keep annual escalation as high as possible to protect their investment. A tenant, on the other hand, wants the annual increase in lease rates as low as possible. Costs of ownership in a building (taxes, insurances, maintenance, etc.) typically increase slightly each year and are often, but not always entirely passed through to the tenant in the operating expenses already. Thus, landlord’s desire to protect against those increases by securing annual escalations.
The question here isn’t “can I get a lease without increases”, as a lease without annual increases in commercial real estate is extremely rare. The right question is, “how can I lower the annual escalation as much as possible in the negotiation?”
Many times, landlords tie the escalations to a Consumer Price Index of some sort. Tenants should be wary of this for a number of reasons including inability to forecast future increases and costs accurately, determining which index is utilized each year, seasons of higher inflation, etc. Healthcare agents typically negotiate to set fair annual increase of 2-3% annually to help protect their clients over the length of the lease term.
Question #3: What’s the creditability of the tenant and securitization of the deal?
As a landlord, checking a tenants’ credit worthiness is a standard due diligence step. When a Letter of Intent is asking for lower rental and escalation rates, high amounts of tenant improvement allowances, and additional free rent for build out and upon opening the new space, the landlord needs to determine if the deal (and tenant) is a “secure bet”.
An experienced healthcare realty agent will not only package the letter of intent appropriately, but will deliver key information to the landlord regarding the tenant’s background, banking approvals, strength of the healthcare industry, low default rates, etc. Many times, the landlord needs to be educated on why it would make sense to invest hundreds of thousands of dollars into a start-up practice or additional office location for a provider. This process shouldn’t catch you off-guard as a tenant. You want all the tools lined up and ready to go when approaching the landlord.
Question #4: Are there referral networks this tenant brings that add value and synergy to the building/center?
Landlords are usually in the commercial real estate business for the long game. They’re not just worried about collecting rent every month, but also to continue building value within their property for years to come. As a landlord, you would seek out practices and tenants that “make sense” in your space and will draw profitable customers and patients for years to come, along with adding value to other tenants in your building or center.
As a tenant, understanding that landlords are invested in the long run can give you an edge in your negotiations. For example, if your potential landlord already has a dentist in their complex, and you’re an oral surgeon, you automatically bring value and synergy to the center by attracting patients to both businesses, given the related nature of your work. Again, your healthcare agent can communicate the strength of synergy and stabilization you bring to the building and other tenants.
Question #5: What’s the Tenant’s longevity in the Space?
Landlords don’t like dealing with turnover. Not only does it take time to release a space, it also generally causes the landlord to lose significant money during tenant transitions. That’s why landlords are so concerned with the overall “longevity” of a tenant in a specific space. Longevity in real estate equates to how invested the tenant becomes in a property and how long a space will satisfy the needs of a tenant or business. Thus, communicating to the landlord how much the tenant will be investing into the build out, what the average tenure of the tenant’s industry is for landlords, etc., will help get the landlord to stretch further and give you greater concessions.
By thinking like a landlord, you can empower yourself and your healthcare real estate agent to better prepare, negotiate, and close on your deal. The key is to use the landlord’s perspective to spur you to build value for your practice, understand and prepare for inflation implications, secure credit in advance, position your value through “synergy,” and demonstrate your tenant longevity. This perspective shift can save you tens-to-hundreds of thousands of dollars by packaging your practice and negotiations effectively.