Dentists: Protect Your Dental Lease from Inflation

Dentists: Protect Your Dental Lease from InflationHow an Inflation-Hedged Tenancy Agreement Can Save Your Dental Practice and Give You a Competitive Edge

Last week I started talking about what I see as the upcoming “perfect inflationary storm.”

While some indicators suggest that a slow economic recovery may be underway, there continues to be skepticism among many economists.

Some feel the current rebound is unsustainable and driven primarily by the massive – but temporary – fiscal stimulus promoted by the Federal Reserve.

In the past three years, for example, the Fed has injected more liquidity into the U.S. economy than in the previous 25 years, combined.1 Never before in human history has so much money entered the world’s economy so quickly, and certainly never before in American history have we tripled the money supply by 300% in less than 4 years.

Preparing for Inflation

This is setting up our economy for what could be an inflationary period of time longer and more extensive than ever experienced before.

Indeed, some business owners and financial analysts with whom I have consulted have commented that many policymakers are already well aware of this. However, many of them – as well as corporate executives and Wall Street bankers – often have vested interests, thereby making implementation of these policies difficult. Further, many have been trained as expert systems managers rather than generalists, and thus only see piecemeal solutions to these very complex problems and will be unable to replace a failed system with a new one.

What does all this mean for dentists? In my view, today’s dentist must both have the foresight to read the writing on the wall and create the tools necessary to effectively manage their dental practice during rising and high inflation. This may start with an annual inflation rate of 7% within the next 1 to 3 years, rising to double-digit inflation within 4 to 5 years.

Preparing to manage a dental practice through an inflationary period can be a daunting task when you stop to think about it. Imagine your costs going up significantly and not being able to pass those costs onto your dental patients at the same rate.

However, the good news – as the saying goes – is that you don’t have to outrun the tiger; you just have to outrun the person next to you.

Being One of the Survivors

Hedging your long-term business commitments today will give you the edge needed to outlast and outperform your competition. Many of today’s dentists opt to listen to the financial cheerleaders as if they’re financial planners because it “feels” good and because it “fits in” with their view of how the world works.

Instead, take this opportunity to be a reflective strategist and critical thinker about tomorrow. One of the greatest of these was Herb Kelleher, the former CEO of Southwest Airlines. He had a reputation for thinking outside the box, and his proactive risk management style – including his fuel-hedging program implemented in the 2000s, which allowed the airline to enter into aggressive fuel futures contracts – allowed them to better manage their costs.2

As the price of jet fuel rose dramatically during that period, Southwest emerged as the most profitable airline in the industry, driving out competitors and avoiding Chapter 11 bankruptcy – the fate that ultimately awaited all major U.S. air carriers. Southwest’s fuel-price inflation-hedging strategy provides a great lesson in how to compete in difficult economic times and emerge victorious.

Hedging against Inflation

America’s tenant-based businesses like dental offices should, in my opinion, act like Herb Kelleher by identifying the major expenses in today’s dollars, in order to hedge against future inflation.

As occupancy and tenancy costs remain top priorities in long-term lease contracts for dentists, these are critical costs to contain. As your tenancy leases roll over for renewal, avoid locking into existing options to extend the terms of the previous NNN Lease Agreement protecting the landlord against inflation by passing the costs on to you.

Be willing to “step out of the box” and renegotiate hard, both the base rent provisions, and triple net components of the lease, much like the hedging strategy employed by Southwest.

In particular, ask for longer-term rents with locked-in fixed rents, which do not rise based on the Consumer Price Index (CPI), but rather, have set increases and thereby cap off the percentage increases year over year. Landlords will generally object to this, but given today’s real estate environment, they will often concede, as they are unlikely to want to lose a good, paying tenant.

An excellent window of opportunity still exists to take advantage of struggling landlords by implementing such a hedging strategy. Only agree to triple net provisions with a cap on increases of no more than 6% year-over-year. You’ll want to do this while most landlords are still operating in a non- or low-inflation mindset and remain insensitive to this request as they do not yet foresee a high-inflation period ahead.

Although putting in place an inflation-hedging strategy will take time, planning and effort, the pecuniary benefits would be a significant competitive advantage similar to the one Southwest had if you feel there is a reasonable risk that our economy will enter into an inflationary period of time.

Considering Your Risks

What do you have to lose? Ask yourself where the bigger risk lies: paying marginally more in rent on the front end, or not having the ability to stop landlords from loading you up with additional expenses, so that in the end your triple net charges begin costing you more than your base rents?

If we hit a period of 12% annual inflation – which many believe to be a real possibility – it will only take about 3 years, under most lease agreements, for your triple net charges to start costing you more than base rents.

More importantly, consider how it will affect your competition’s bottom line. Should they fail to heed the inflationary warnings allowing their landlords the unrestricted ability to pass inflationary risk on to them you’ll have the same advantage Southwest had on its competitors.

Bibliography
1 St. Louis Federal Reserve
2 Cobbs, Richard & Wolf, Alex (Spring 2004) “Jet Fuel Hedging Strategies”

About Lewis Gelmon

Lewis Gelmon is a professional lease negotiator, educator advocate for the dental community and lives in San Diego, CA, with over 22 years of experience in the field. He can be reached for questions or comments at [email protected] or 760-479-9704.

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