Dentists Gamble on Inflation with Triple Net Dental Leases

Dentists Gamble on Inflation with Triple Net Dental LeasesI’ve been telling you about how my father developed shopping centers in the 1970s and how inflation hurt landlords in the 1980s.

The new landlords learned lessons from their bankrupt predecessors, and redrafted their lease agreements to transfer inflation risks to their tenants through the NNN Lease (“triple net lease”).

When long-term tenant agreements of the 1970s began to expire in the 1990s, the landlords revised the previous gross lease agreements to their current standard NNN Lease form.

The triple net lease incorporates rising rents set to Consumer Price Index (CPI) increases and direct flow through of all operating costs to their tenants along with hefty admin fees.

This will make managing through the next inflationary period considerably more difficult for retailers and other tenants, just as it did for the early mall developers in the 1980’s.

Dental Tenants Now Take the Risk

During the economic boom years of the 2000s, the typical landlord form lease agreement evolved in terms of both their complexity and sophistication, with the bulk of new risks being borne by the tenant.

However, few – if any – dental tenants really understood or appreciated the potential inflationary risks they were being asked to absorb should the economy enter into another inflationary period. For many, it wasn’t even a business consideration, as most dentists had not operated a practice through the period of high inflation of the 1970s and early 1980s, and those that did have since retired.

Further, the dentists could only secure good locations through a highly charged competitive environment, encouraged by the landlords, and often manipulated by the brokerage community.

Brace Yourself for the Coming Storm

The result, in my view, is the creation of conditions now set for the “perfect inflationary storm.”

How many times has a dental tenant heard that this is the landlord’s standard form lease and is not subject to change or modification? In the mid-2000s, it was generally a “take it or leave it” proposition for the dentists, with easy money provided to them by bankers to build new practices, and since patient traffic was strong, in most regions, expansion and the growth of new dental offices was everywhere.

However, little consideration was given to incorporating clauses which would have prevented the offloading of inflationary risk from the landlords to the dentists. The focus was on performance and expanding the practice revenues.

Big Changes Since 2008

Dentists post-2008 were spared the greatest risk from inflation, not by having the type of lease agreements their contemporaries of the 1980s had, but rather, by the most dramatic slowdown in U.S. economic activity since the Great Depression of the 1930s.

Staggering base rents, driven by the brokerage community, combined with dramatic declines in consumer sales activity, were directly culpable for the high bankruptcy rates among America’s dental community. At present, many indicators suggest that a slow economic recovery may be underway.

However, there continues to be skepticism among many economists, who believe the current rebound is unsustainable, driven primarily by 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

As a result, the Fed’s easy money policies may pose greater threats to the long-term health of the U.S. economy than it solves.

You may want to look at it this way: If you factor in the additional liquidity injected by other major central banks, such as the Bank of Japan (BOJ), the European Central Bank (ECB), and the Reserve Bank of England, there has been more new capital introduced into the world economy since 2008, than in all of the previous years, combined.2

Too Much Money?

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. Like a powerful drug promised to cure a potentially near fatal disease, there will be unpredictable and powerful side effects.

History has illustrated, and many economists tell us, that the downside effects of printing money are often substantial. Nobel Prize-winning economist Milton Friedman, for example, has said that “inflation is always and everywhere a monetary phenomenon.”3

Simply put, inflationary pressures can result as much from the loss of a currency’s purchasing power (cost-push inflation), as it can when the demand for goods and services is constrained by limited supplies (demand-pull inflation).3

By increasing the supply of dollars since 2008, without a corresponding rise in Gross Domestic Product (GDP), you will not be able to stave off inflation, inevitably leading to the loss of the dollar’s purchasing power. Indeed, since 2008, GDP has risen by about 3%, while the money supply has risen by over 300%.4

According to best-selling author and economist David Wiedemer, the real cause of inflation is “increasing money supply beyond what is needed to keep up with economic growth.”3

In the past, raising interest rates was generally seen as the best way to control inflation. However, this can no longer be as effective a deterrent as previously used because the GDP in the United States is 70% consumer-driven. The Fed can temporarily delay inflation with a slow and steady rise in interest rates and claim that some inflation is actually good for the economy but cannot prevent it or control it as easily as in the past.

This is setting up our economy for what could be an inflationary period of time longer and more extensive than ever experienced before. Next week, I’ll tell you more… and how dentists can safeguard their practices during inflationary times.

Bibliography1 St. Louis Federal Reserve2 International Monetary Fund3 Widermer, David (2010) “Aftershock”4 GDP Statistics About.com Guide

Dentists Don’t Sell Their Practices, They Sell Their Leases…

dental lease advocate Lewis GelmonThe Hidden Costs of Bad Dental Practice Leases
Special Lease Feature by Lewis Gelmon

Dentists are shocked when I tell them that you don’t really sell your practice; you sell your lease. This simple but disturbing reality has become evident to me from the thousands of leases I have reviewed for dentists since 1994.

Dentists spend decades building good will and providing excellent dental care. They spend hundreds of thousands of dollars on marketing, state-of-the-art equipment, and creating a comforting environment for patients and staff. Unfortunately, all the money, time and effort spent does not necessarily translate into a high sale price.

How can a dentist avoid that unfortunate fate? With a proper office lease agreement that has been carefully crafted for a dentist planning to sell his or her practice.

Over the years, I have been invited to speak at dental conferences (like the Greater New York Dental Meeting, the Pacific Dental Conference and countless local dental societies and association meetings) on this subject. However, my mission is still far from complete.

It seems that more and more dentists are finding themselves caught in a classic landlord trap. I receive one or more phone calls each week from dentists across the country who are in the process of selling their practice but have run into problems with their landlords. These calls all tend to sound the same.

The dentist sounds stressed on the phone. He explains that he has tentatively sold his practice. When he approached the landlord to assign the lease to the new owner, the landlord asked for a letter formally requesting the transfer of the lease to the new dentist. A few days after sending the letter, the landlord called. After reviewing the lease agreement, the landlord has determined that he now has the right to terminate the lease and remove the original dentist from the premises.

The landlord goes on to explain the dentist’s choices. He can give the space back and vacate the premises as promised in accordance with the lease. Alternatively, he can pay the landlord a fee for agreeing to waive the right to exercise their option to terminate, allowing the dentist to remain on the premises and sell the practice. Depending on location and the value of the sale, this fee is usually somewhere between $75,000 and $250,000.

Take a moment to process that: It can cost a dentist up to a quarter of a million dollars to transfer their lease. I’ll bet you didn’t know that, huh?

Property owners often understand the business of dentistry better than dentists themselves. In fact, many landlords pride themselves on such business practices as a way to share in the sale proceeds of their most valuable professional tenants. Buried deep in the lease agreement is an “Assignment Provision” that governs the details of how to transfer the lease (change of control) when selling the practice. These provisions are often extensive and hard to understand. Most allow the landlord overwhelming control over who you can sell, as well as the opportunity to prevent the sale or terminate the lease. In my opinion, the purpose of these onerous sections is simply to provide property owners with the opportunity to share in the sale proceeds of your practice when you sell.

But do you really want your landlord to make a hefty profit from the sale of your dental practice?

The solution is simple. I like the over-used but very true axiom, “An ounce of prevention is worth a pound of cure.” If you ever plan to sell your practice, you need to make sure you can first sell your lease. This requires knowing where the risks are before putting your practice up for sale. Given that there are other potential problems, the best thing you can do is to have your lease properly reviewed to ensure it’s structured correctly for sale and follows good leasing guidelines for dental offices.

Looking for more information on the topic? You can reach Lewis Gelmon at (760) 479-9704 or lewis@lewisgelmon.com. For only $495, he will personally review your lease. Plus, get a $200 discount until October 31 just for mentioning The Wealthy Dentist. All reviews are guaranteed. If you don’t feel you have received the value, he’ll give you a full refund, no questions asked.

Lewis Gelmon is a former landlord, lease negotiator, and shopping center manager. Now a dental tenant advocate, he regularly lectures for dental groups across North America and the UK. He is the most published author on the subject of dental lease negotiations. His Good Leasing Guidelines for Dentists have been critically acclaimed by numerous dental groups. His mission is to raise awareness among dentists on the risks hidden in their office leases.

Dental Leases for Two of Five Dentists

Dentists and commercial real estateThree out of five dentists own their dental practice facilities, while the remaining 40% rent, this survey found. Fortunately, only 4% of dentists are worried about their business mortgages.

Commercial real estate is going to be the next shoe to fall,” declared a Florida dentist. “It may be possible to use this period to do some renegotiating, particularly if you are on the downhill side of the mortgage.”

Of the dentists in our survey…

  • 24% own their building free and clear
  • 32% own and pay a reasonable mortgage
  • 4% are worried about their mortgages
  • 20% have long-term dental leases
  • 20% have leases up within the next 2 years

Here’s what else dentists had to say:

  • “I think that in a down economy the landlord should also expect lower rent.” (California periodontist)
  • “Buying my building was one of the best investments I ever made, but it was a tough first 7 years.”
  • “Our area has become run-down. We wish we could afford to move.” (North Carolina dentist)
  • “It costs so much less to lease.” (New York dentist)
  • “I will be paid off in 4 years. I built a duplex, rent the other side to another dentist. Cash flow is negative, but it currently nets $1,000 to principal per month and pays all the interest. In 14 years it will paid off and rent free. It won’t be tax and insurance free, but it will make a $60-65k a year difference in income the first year it is paid off. Rent if you plan to grow, but own for the intermediate to long term (15+ years).” (Texas dentist)
  • “I own the building outright, free and clear. I lease the building to my dental corporation. It works out well.” (Virginia dentist)
  • “Will be owned free and clear in one year. Better to own and move when/if you want to, rather than depend someone else.” (Oregon orthodontist)
  • “I would like to own it. With this economy, the prices of commercial real estate are falling rapidly, indicating that this could be a possibility.” (Florida dentist)

Read more: Dental Leases and Dental Mortgages

Dentist Leases: Inflation Risks and a Changing Economy

Dentist Leases: Inflation Risks and a Changing EconomyBusiness leases were very different back when my father was a mall developer.

As I described last week, he opened a shopping center in Canada where he prioritized the landlord-tenant relationship. As a landlord, he worked hard to help his tenants achieve success.

Unfortunately, he was unable to cope with the rising costs of operating the shopping centers due to inflation in the 1980’s. Today, malls, strip centers and medical/dental buildings are primarily managed by institutional owners.

Tenants are no longer viewed as collaborating business interests; now tenants are commodities to be bought, sold, discarded or traded in favor of the mall owner’s and mall stockholders’ bottom-line.

Dental Leases Used To Be Simple

The most direct result of the inflationary period of the early 1980s was the advent of – and now widespread use of – the “net” form of lease, commonly referred to as the “net lease” or Triple Net Lease Agreement (NNN). In fact, many tenants cannot even recall a time when the NNN Lease wasn’t in effect.

However, prior to the 1980s, most dental leases were, in fact, of a “gross” nature. Under the Gross Lease Agreement the dentist paid one rent, which covered all of the costs a landlord might incur, including such things as parking lot maintenance, insurance, repairs, etc., leaving plenty of room for landlord debt service and profit. Most gross lease rents were set to rise by about 3.0% annually, because inflation for the previous 30 years averaged about 3.2% per annum during the post-War era,1 making such an agreement simple to manage for both landlord and his dental tenant.

But when the costs of operating malls and other commercial properties unexpectedly and quickly began to rise as a result of higher inflation, the mall and property owners were forced to absorb the additional expenses, thereby cutting into their profit margins.

This forced mall owners such as my father to pay both higher mortgage rates and rising operating costs. When inflation was finally contained at the expense of the mall owners rather than the retailers and shoppers, it forced many early developers into bankruptcy and malls into foreclosure.

The Triple Net Lease Becomes Standard

When the foreclosed shopping centers were ultimately resold to other interests, the new shopping center owners applied the lessons they had learned from their bankrupt predecessors, and redrafted their lease agreements to transfer inflation risks to their tenants through the NNN Lease.

As the long-term tenant agreements of the 1970s began to expire in the 1990s, the landlords would not renew the previous gross lease agreements unless they were revised to their current standard NNN Lease form, which incorporates both rising rents set to Consumer Price Index (CPI) increases and direct flow through of all operating costs to their tenants along with hefty admin fees.

The result will make managing through the next inflationary period considerably more difficult for retailers and other tenants, just as it did for the early mall developers in the 1980’s.

Dentists Now Take the Risk

During the economic boom years of the 2000s, the typical landlord form lease agreement evolved in terms of both their complexity and sophistication, with the bulk of new risks being borne by the tenant.

However, few – if any – dental tenants really understood or appreciated the potential inflationary risks they were being asked to absorb should the economy enter into another inflationary period. For many, it wasn’t even a business consideration, as most dentists had not operated a practice through the period of high inflation of the 1970s and early 1980s, and those that did have since retired.

Further, the dentists could only secure good locations through a highly-charged competitive environment, encouraged by the landlords, and often manipulated by the brokerage community.

The result, in my view, is the creation of conditions now set for the “perfect inflationary storm.” I’ll describe what I mean – and what you can do to protect yourself – next week.

Bibliography1 Rattner, Steven (January 5, 1981) “Federal Reserve Sees Little Growth in ’81 with Continued High Rates,” New York Times

Dental Tenants and Changes in the Landlord Relationship

Dental Tenants and Changes in the Landlord RelationshipGrowing up in the 1970s, as the son of a Shopping Center Developer, I became acquainted early in life with leasing terms such as Percentage Rent, Natural Break Point, NER and so forth.

My father spoke highly of his tenants and took a genuine interest in helping them succeed in their business. When a tenant had trouble paying rent, he would spend time with them trying to understand the reasons, and when possible, made concessions such as rent reductions.

In close collaboration with his tenants, my father appreciated that his success was dependent upon theirs. This is a contrast to the manner in which landlords operate today.

Looking Back

It takes me back to 1978, when I was a 10 year-old boy, watching my father prepare for the grand opening on the first expansion wing of what was, at the time, one of Western Canada’s first regional shopping centers.

He would walk the corridors of the mall with a bullhorn, directing construction workers, ensuring that the opening would be on time. Located in Red Deer, in the Province of Alberta, a town of 50,000 and a trade area of a quarter-million consumers, the mall was comprised primarily of local retailers who generally made a prosperous living.

Helping Retailers

The day before the mall was to open to great local fanfare, my father noticed that the new optometry store had almost no inventory, as their expected shipments had not yet arrived.

He immediately went into action, contacting optometrists at other locations he owned, and asked them to forward as much of their excess stock as possible. In return, my father gave them various concessions, such as future rent reductions.

By the end of the evening, over 40 boxes of frames, glasses and other eyeglass products had arrived at the new mall, and the optometrist was able to open his store, fully stocked. My father understood that a retailer never gets a second chance to make a good first impression.

1980s Inflation

Unfortunately, several years after the mall opening, in June 1982, Canadian interest rates similar to those in the United States had risen to 21.5%1,2. These higher interest rates were the result of the Bank of Canada’s and Federal Reserve’s attempts to contain spiraling inflation, which over the same period, had risen by more than 13 percentage points in both countries1,2.

Sadly, my father was unable to cope with the rising costs of operating the shopping centers, hurting his malls, his business and his pride. As visionary as he and many other developers at the time were, they were unable to foresee the business-altering impacts of inflation and the consequent rise in interest rates.

Tenants as Commodities

Today, malls, strip centers and medical/dental buildings are primarily managed by institutional owners, where tenants are viewed not so much as collaborating business interests, as they are commodities, where they are bought, sold, discarded or traded in favor of the mall owner’s and mall stockholder’s bottom-line.

When the costs of operating malls and other commercial properties unexpectedly and quickly began to rise as a result of higher inflation in the early 1980s, the mall and property owners were forced to absorb the additional expenses, thereby cutting into their profit margins. Many properties were foreclosed and resold to other interests. The new owners applied the lessons they had learned from their bankrupt predecessors, and redrafted their lease agreements to transfer inflation risks to their tenants through the “net lease” or Triple Net Lease Agreement (NNN).

This will make managing through the next inflationary period considerably more difficult for retailers and other tenants. Next week, I’ll explain why some dental leases can be so tricky.


Bibliography
1 US Business Cycle Expansions & Contractions (undated)
2 Bureau of Labor Statistics, Consumer Price Index, All Urban Consumers – (CPI-U)

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