Medical Buildouts Paying the Price

By Charles L. Feitel

If you are a physician moving to a new space, or opening a new location, do not take your build out lightly. In the old days, doctors typically leased space in medical buildings. It used to be standard for a landlord to lease space “as is.” This meant that the doctor would lease a space, which used to be leased to a different physician, and the new doctor would make his/her own modifications to the space.
Well, times have changed and it is now a lot more complicated. Many doctors have taken space in non-medical buildings, and institutional investors or real estate investment trusts (REITs) now own many medical buildings. So why does this matter to a doctor evaluating his/her choices for new medical office space?
Landlords look at the “net” bottom line of a real estate transaction. Let me try to define this in simple terms. Landlord A is asking $25.00 full service to lease medical space. This same landlord is usually willing to contribute a certain amount of money for tenant improvements (TI). The net deal is what is important to the asset manager working on behalf of the property owner. Illustrating by example, if the landlord contributes $10.00 towards the build out, that amount is spread over the term of the lease. So over a five year deal, the improvement allowance costs the landlord $1.00 per year. Therefore, the net rent received by the owner is $24.00 full service. If the contribution was $10.00 per square foot this would be $2.00 per year, and therefore, the net to the landlord would be $23.00 full service.
Moreover, depending on the financial strength of the medical practice, landlords are often willing to extend credit towards the build out. By example, if the cost is $50,000.00 the landlord can spread this amount over the term of the lease and amortize with a competitive interest rate. Then the amount is added to the rent and paid back monthly by the physician.
Which scenario is the better suited to the doctor depends on the whole picture. Does it make sense to spend $10,000.00 out of pocket to save $1.00 per square foot in rent? Or is it more sensible to let the landlord pay for the entire build-out and invest the capital somewhere else? These questions should be researched and answered before signing on the bottom line.
Who should do the build out? Often time doctors have contractors with whom they have worked before and provide competitive pricing and quality work. But, are they familiar with the building in question? Will they make an error, which will cost time and money with respect to permitting? Conversely, if the landlords contractor performs the work is the construction management fees a fair one? Talk to your accountant and real estate broker before closing the deal. These and other questions should be answered before going forward on your next build out.