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)

Economic Downturn? Renegotiate Your Dental Lease!

A One-time Gift from the Gods!

Welcome to the New Year, but I digress… as I write this the Dow is at 9,034. The Santa Claus Rally I predicted for the stock market came in right on schedule.

The next market rally will likely come when an estimated four million pilgrims stimulate Washington, D.C. on January 20 to watch the canonization of the Family Obama. Though both of these rallies are based on “Irrational Exuberance,” the psychology of hope is about all we have to move the economy forward right now.

Now for the real news – and what it means for your dental practice. The next big economic shock to hit the economy is the coming due of over $510 billion in commercial real estate debt over the next three years. About $180 billion is due this year.

These are the same cheap-money mortgages that financed the home loan debacle – only now we’re talking about strip malls, office buildings, shopping centers, and just about any type of commercial building. Now, to put a real spike through the heart of the problem, it is expected that over 500,000 retail outlets (clothing, restaurants, gift shops, etc.) will close their doors in this year’s recession.

Empty storefronts lower commercial real estate values, which need to be refinanced to stay open. The math doesn’t work. There is not enough money. Do we really need all the Starbucks, Gap and Old Navy outlets?

Look for the collapse and abandonment of low-end and middle-level commercial complexes… including those that may be housing your dental practice! Think about what happens when your neighboring shops and offices go empty and normal sidewalk and drive-by traffic slows to a crawl.

These facilities will have extreme difficulty in securing refinancing. Many will go bankrupt! At best, they will defer needed maintenance, and empty storefronts will be leased month-to-month to massage spas (think “parlors”) and other low-life businesses. Don’t laugh; I have seen real life examples of this!

Believe it or not, there is an opportunity here… for all of you renting your facilities. Pick up the phone and call Lewis Gelmon at (760) 479-9704. Lewis is the number one specialist in dental office lease negotiations.

Now is the time to renegotiate your lease… Don’t worry if it may not be due for renewal for another two or even three years. It will be another 20 years before you are in such an advantageous position relative to your landlord.

This economic moment is a one-time gift from the gods to dramatically lower your operating overhead and secure your long-term financial future. Get a professional to sit between you and your landlord… call Lewis at (760) 479-9704.

More next week…
Jim

Most Dentists Forget the Risk Costs When Leasing Office Space

Rent May Not Be the Biggest Part of Your Dental Practice Lease

dental lease advocate Lewis GelmonSpecial Lease Feature by Lewis Gelmon

Have you ever sat through one of my lectures at the Greater New York Dental Meeting, the Pacific Dental Conference, or one of the dozens of local dental association or society meetings I speak at annually? If so, you’ve heard me say, “Dentists have a much higher degree of risk in their office leases then most other tenant users in the country because of the cost of the physical plant.

Dentists share the same types of risks as other commercial tenants in offices buildings and shopping centers. However, the cost to move their business elsewhere dramatically amplifies these risks for dentists and sets them apart. Rest assured, that’s something that most landlords are well aware of!

When a dentist opens up negotiations with a property owner, most dentists commonly overlook risk and focus on rent. This is true for both new leases on first-time locations and renewals on existing practices.

Focusing only on rent is a serious oversight. The total cost of renting space should be viewed as a formula:

BR + AR + RC = TCPL
Basic Rent + Additional Rents + Risk Costs = Total Cost of the Premises Lease (over the term)

Dentists often overlook the Risk Cost (RC) component of the formula, which is a significant and often a more costly part of the equation.

Look at it another way. Take a blank piece of paper and draw a line down the middle. At the top of left side of the page write Rents and underline it. At the top of the right side of the page write Risks and underline it. Under the Rents column, add up from top to bottom the annual rents you pay the landlord each year for the term of the lease. On the right side of the page is the Risk column; you’ll likewise have to add up the costs of the risks from top to bottom you’ll end up paying out-of-pocket during the term of your lease or career. To get the total cost of leasing your office space, you will simply add the totals of the left and right columns, right? The problem, however, is that many dentists don’t know what the right column costs consist of. As a result, they don’t factor them in during their negotiations with property owners until it’s too late…

The top Risk Costs (RC) I find in most dental office leases I review include the following:

  • Having the lease terminated by the landlord unexpectedly and having to move: $350,000+
  • Having to pay the landlord a portion of the sales proceeds of your practice when you sell: $75,000-250,000
  • Unexpected or hidden rental cost increases or charges: $50,000-75,000
  • Repayment of Tenant Improvement Allowances through base rents: $50,000-75,000
  • Cost of realization of personal guarantee after practice sale: $100,000-150,000
  • Cost to Estate without a Death and Disability provision: $75,000-150,000
  • Having a poorly worded Option to Renew or missing key dates: $50,000

Not all leases will have all the above Risk Costs, but most leases will have several of them hidden within. I will often uncover well over half a million dollars in Risk Cost in most dental office leases I review. The good news here is if the Risk Costs are identified in existing leases before they cost the dentist anything, there are effective ways that dentists can eliminate them and push Risk Costs to very nearly zero. Explaining these strategies will be the topic of my next article.

Post your comments

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 to determine the Risk Costs. 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.

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