Most dentists are eager to become a practice owner after working as an associate. It’s safe to say that very little time is devoted to the “business of dentistry” in dental school, and especially in the real estate realm. The big picture is that the real estate costs connected with practice ownership are second only to those of payroll, which makes real estate a major slice of the “ownership pie.”
Most dentists start their practices from ground zero and enter into a lease, because it’s much more attainable for the practitioner rather than tying up working capital in real estate ownership. Leasing can secure the space for a long time, yet allow for future flexibility should area demographics change. Obtaining financing for a practice purchase is more difficult than obtaining financing for a lease. Purchasing a practice requires a much higher loan amount, and many banks are unwilling to risk financing a dentist that has limited experience in practice operations.
Opening a practice is always a risk – financially and emotionally. All practice owners have two main goals: personal fulfillment and practice profitability.
In terms of practice profitability, a dynamic location and marketsavvy lease economics are significant factors in the financial health of a dental practice. Other factors in practice ownership, outside of the real estate portion of a practice, certainly affect profitability, as well.
What else directly affects practice profitability? There is a hidden link between the dental lease and practice profitability, and it is business protection within the lease. Dental tenants take on twice the amount of financial risk than landlords, thus the need for a heightened level of business protection, which can be achieved through a well-negotiated lease that secures long-term rights and privileges.
The key to understanding this concept lies in recognizing what a lease really is and the important part it plays in profitability:
A lease is a binding agreement between a tenant and a landlord. It’s a risk-shifting structure full of complexities. Leases offered by landlords are always skewed to favor the landlord by shifting risk to the detriment of the tenant. A lease can be a tenant’s best friend or mortal enemy, and it’s largely dependent on how it is negotiated prior to final agreement. Should a conflict arise, all parties look to the lease for resolution.
It is comprised of two operative functions: legal and business. The legal function should be handled by a licensed attorney experienced in dental leases to make sure all stipulations are legally valid in nature, both in verbiage and in enforcement ability. A dentist should always obtain legal review prior to signing a lease.
The business function addresses the business stipulations in a lease that are outside the legal framework. Many hidden business stipulations contained in the dental lease can threaten the financial stability of a practice. They are perfectly legal but BAD BUSINESS for the dental tenant.
A Few Business Stipulations That Can Wreak Havoc on a Practice’s Financial Health
1) With short notice, the landlord can mandate that the tenant move their practice to another suite within the building without compensation for lost revenue, loss of visibility and access, loss of time to move (furniture, equipment, records), equipment re-installation, continuation of employee payroll while the practice is not open for business, printing of new business literature, printing and mailing of “new address” notice, and revising the online marketing system.
The same size of the space is only the tip of the iceberg. It’s known as the Relocation Clause and IT’S LEGAL in a lease, but is detrimental to any dental tenant. THE RELOCATION CLAUSE MUST BE NEGOTIATED TO PROTECT THE TENANT’S CAPITAL INVESTMENT. MANY TIMES, IT CAN BE ELIMINATED ALTOGETHER. IF NOT ELIMINATED, IT SHOULD BE NEGOTIATED TO MAKE IT VERY COSTLY TO THE LANDLORD IF THEY WISH TO EXERCISE THAT RIGHT.
2) Building foreclosure can have a devastating affect on the dental tenant. In most states, in the event of a building foreclosure, all leases are voided. Without a businessprotective stipulation, the dental tenant is forced into renegotiating the lease with a new owner regarding the lease rate and any other stipulations that were in place prior to the foreclosure. Worst-case scenario: the new owner could decide to repurpose the building and force the dental tenant to vacate. A huge bank loan still exists, and the dental tenant is not only unable to obtain more financing for another office, they are also unable to produce the same revenue. Credit can be ruined. Nearly as bad, the lease rate is increased and the dentist will be trapped because they can’t afford to move and get another loan to rebuild elsewhere. THIS IS LEGAL, but can be devastating to the dental tenant without the inclusion of an important agreement in the lease. DON’T SIGN A LEASE WITHOUT THIS PROTECTIVE AGREEMENT! CONSIDER IT A DEAL-BREAKER!
3) In the event that the dental tenant wishes to sell his/her practice, the landlord has the right to void the existing lease and negotiate a new lease with the practice buyer. Because the clause existed in the original lease, the practice seller can be forced to lower the selling price in order to compensate for the additional rent required by the new owner to lease the space at the new increased rate for the remainder of the lease term. Because of the exposure to loss in the event of a practice sale, A TENANT SHOULD NEVER AGREE TO THIS LANDLORD’S REQUIREMENT! DON’T SIGN A LEASE THAT CONTAINS THE CLAUSE THAT GIVES THE LANDLORD THE RIGHT TO RECAPTURE A LEASE!
Business protection is a defining feature in any well-negotiated lease, especially for dentists – it’s a real game-changer, because it’s a major factor in practice profitability. Many of these business risks can be shifted away from the dental tenant with proper negotiation. Yet, the concept of business protection is most often overlooked during the course of a dental lease transaction.
Why? Many commercial brokers and some attorneys are unaware of the hidden business stipulations that are particular to dental practitioners. Dentists need for a heightened level of protection due to the large capital investment in start-up costs, as well as shouldering the ongoing responsibilities required in day-to-day operations.
There are lots of myths out there about commercial real estate. It’s not a one-sizefits- all profession.
Here are thre top three myths that cost dentists thousands of dollars:
1) All commercial leases are the same
2) All commercial real estate brokers are the same
3) The landlord will offer a discount to the tenant if the tenant as no broker – in other words, the dental tenant is wading into unchartered waters, having no one to watch his/her back.
Don’t Drink the Kool-Ade!
Dental leases are complex and contain many ambiguities that place the dental tenant at a much higher risk than a general commercial tenant due to the large investment in building improvements. Make sure to hire a broker who knows dental leases and the importance of business protection that is outside of the legal realm. All parties to a real estate transaction have the right to licensed real estate representation. It levels the playing field between the parties. Written appointment of an exclusive tenant broker will protect against conflicts of interests and should define fiduciary responsibilities to protect the dental tenant.
There are hundreds of horror stories told by dentists that blindly believed the above three myths mentioned above.
The results? Low-performing locations, over-market economics lacking in build-out and other landlord allowances, and committing to a lease that didn’t contain the necessary business-protective stipulations. Dentists have lost their leases through no fault of their own, with no way to recover their capital investment. They have had latent defects occur in the building structure that cost them employees and patients. They have even had their financing ability inhibited. The list can go on and on. These horror stories can rob wallets and cause sleepless nights. These horror stories could have been avoided with tenant-protective stipulations within the lease agreement.
A tenant broker who specializes in dental leases will know the keys to selecting the right location, will negotiate marketsavvy economics favorable to the tenant, will understand that the dentist is in a heightened risk situation and will make sure to incorporate business-protective agreements into the lease that are 100 percent outside of the legal realm. It’s all about business risk avoidance for maximum protection in the here-and-now, as well as far into the future. There are no predictors in life. Expect the best, plan for the worst.
Dentists should be able to focus on case acceptance and patient treatment – free of worry about the real estate portion of their practice.