Practice Profitability
There are many important decisions that new dentists are faced with after having completed the hurdle of graduating from dental school, becoming licensed to practice, and earning an income.
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 market-savvy 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 is 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.
Here are just a few business stipulations that can wreak havoc on a practice’s financial health:
1) RELOCATION CLAUSE:
- With short notice, the Landlord can mandate that the tenant move his/her 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 HE/SHE WISHES TO EXERCISE THAT RIGHT.
2) THE LACK OF INCLUDING AN SNDA (Security, Non-Disclosure, & Attornment) AGREEMENT AS PART OF THE LEASE:
- Without going into a huge legal definition, here’s why this agreement is so important for the dental tenant. Basically, it protects the dental tenant from losing his/her lease and forced to vacate the premises, if the building goes into foreclosure anytime during the dental tenant’s lease term.
- 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 business-protective 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: new owner could decide to repurpose the building and force the dental tenant to vacate. A huge bank loan still exists, the dental tenant is unable to obtain more financing for another office, and is 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 he/she 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.
- THIS FORM SHOULD BE SIGNED BY ANY CURRENT/FUTURE OWNER OR ANY CURRENT/FUTURE LENDER IF THE BUILDING IS SOLD DURING THE TENANT’S ENTIRE LEASE TERM. IT IS TO BECOME A PART OF THE FINAL LEASE DOCUMENT.
- DON’T SIGN A LEASE WITHOUT THIS PROTECTIVE AGREEMENT! CONSIDER IT A DEAL-BREAKER!
3) RECAPTURE CLAUSE:
- 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! NEVER 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.
PARKING REQUIREMENTS
DON’T wait until the lease is signed and you’re in the build-out stage. The wrong parking ratio can put you in a world of trouble. It is not the responsibility of the Landlord to determine the suitability of usage for your space – and that includes the correct parking ratio.
There are many attributes and considerations in spiking down the right location for a dental practice. Some, or many attributes are easily overlooked – for various reasons - usually due to the lack of knowledge necessary to dig deep down into the location selection process. And DEEP DOWN is putting it mildly. Parking doesn’t get nearly as much attention as it should.
The key to understanding the parking subject is that there are different types of parking. Dental tenants must understand those types, how they differ as to their usage requirements, and the importance of adherence to mandated parking ratios in space selection. Parking space allotment can fluctuate over time, based on the type of user. Parking is a very important consideration for patients. A successful dental practice owner will want to make a trip to the dentist as positive as possible, without the parking hassle.
There are three types of commercial parking usage:
- General Office – non-medical user
- Retail
- Medical/Dental
Medical/Dental Parking and Retail would be appropriate to dental users.
The parking ratios are stated from a viewpoint of a MINIMUM requirement of spaces per tenant, based on the square foot occupancy of each tenant in order to be compliant with city codes. Looking at it another way, each tenant is limited to a MAXIMUM number of vehicles allowed for the amount of square footage he/she is leasing in the building.
The parking ratios for Retail space and Medical/Dental office space are normally the same. Meaning: Medical Office Parking and Retail Parking require more parking spaces per square foot of leased area, whereas General Office requires fewer parking spaces per square foot of leased area.
It’s a given that Parking Ratios are based on the type of use. Dental offices must have an adequate number of parking spaces per square foot. Landlords, by in large, adhere to the parking requirements to get the highest and best use of their building.
The real-world: Depending on the parking spaces available, in a general office building, if a LL leases to a medical user – because of parking requirements – there may not be enough spaces to lease to a general office user. No Landlord wants to soak up the cost of empty space. We’ve seen Landlords of non-medical office buildings refuse to lease to a medical user. They prefer to adhere to zoning ordinances and keep occupancies at the optimum.
For any built-out dental space, there still remains the requirement of adequate parking. For any building alteration, interior or exterior, whether remodel or new construction, permits at certain stages of the build-out process need approval in order to obtain a CO.
If a dentist buys a practice (along with the real estate) and has a problem with parking, shame on the purchasing dentist for not performing the due diligence required to resolve the parking situation. Dental Space Location 101. Verify parking requirement VERY early. Same advice in buying a practice that has a lease connected with it. Resolve the parking situation (and many other items) by renegotiating the lease. It is not a given that dentists “inherit” bad situations in the real estate portion of their practice. Change the situation, if possible. If not, WALK and select an alternate space. Enough new challenges happen during practice ownership - don’t inherit a selling dentist’s headaches! This rings true in each and every aspect of the real estate portion of practice ownership
A real-world horror story: A dental tenant selected a space in a general office building that was previously zoned for medical and was previously leased to a medical professional, who was relocating elsewhere. A lease was negotiated and executed – all systems go. Plans and permit issued to begin remodel process. Permits approved at proper intervals. Near the end of the build-out, the architect advised the tenant and the Landlord that the number of parking spaces for current zoning requirements was insufficient. It was assumed that, since the prior tenant was a medical tenant, the required number of parking spaces met the zoning ordinance, and there was no need to pursue the parking question. The result: the Landlord had to ask the Zoning and Compliance Department to issue a variance and “grandfather in” the outdated parking requirement in order complete the permitting process and obtain a Certificate of Occupancy. Inadequate parking – No Certificate of Occupancy – No Patients – No Income. In the meantime, operating expenses continue.
Parking spaces use 300 SF, considering turnarounds and back-up lanes. Some developers may build more parking spaces than required by the minimum, but it is not typical. It’s more costly to provide more parking spaces than mandated, which is why many developers don’t do it.
A dentist can project all he/she wants about future practice growth. It’s merely a projection. There are no crystal balls. Too many changes happen over time. The bottom line is: a certain number of parking places must be available for a dental practice, commensurate with the amount of the practitioner’s leased square footage within the building. In fact, depending on the terms of a dental lease, the dental tenant can be in default if he/she dominates excessive parking spaces.
Tenants, and Landlords alike, must play by the “parking” rules, per local Building Codes and ordinances.
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