Location, location, location. It’s an old adage that especially applies to dental practices. Many dentists work tirelessly to secure a good location for their practice. Either because they want a short commute, great visibility, less competition, or all of the above. Unfortunately, most dentists stumble on a crucial step — they don’t spend enough time negotiating or understanding their commercial lease before signing.
If you’re a dentist starting or purchasing a dental practice, understanding the commercial lease must be an integral part of your transaction. After all, the lease is the anchor that secures a home for your office. On one hand, the lease can be a liability if it includes burdensome provisions that hamper the practice. On the other hand, it can be a valuable asset when it’s properly reviewed and negotiated by a dental practice attorney and allows you to grow the practice without disruption.
- It is vital that dentists understand these basic lease terms before signing their commercial lease:
Premises
The lease describes in detail the premises or space that is the subject of the lease, including a description of the size, configuration, and location of the premises. The actual floor size is also important in determining any additional rent you may be required to pay under the lease, including common area maintenance expenses.
When reviewing a commercial lease, make sure to confirm the floor size and that the landlord will not interfere when remodeling or repairing parts of the building.
Relocation Clauses
A relocation clause is a nasty lease provision that permits the landlord to move the dentist to another space in the building without their permission. While unlikely to be used, such clauses can be devastating for your practice, especially if:
- the landlord doesn’t have to pay for your buildout
- reimburse you for moving expenses
- give you a similar-sized space in the building
Smart dental attorneys will push hard to either remove these clauses or mitigate any risk of out-of-pocket expense should the landlord insist the clause stay in the lease.
Lease Term
A commercial lease may list several dates, which may be confusing. The “Effective Date” of the lease is the date the lease begins, even if you haven’t taken possession of the premises or started paying rent.
The “Commencement Date” is usually the date you take possession of the premises.
The “Rent Commencement Date” is the date you first start paying rent. Your Commencement Date and Rent Commencement Date may be on the same date. However, if you’ve negotiated any free rent at the beginning of your lease, then your Rent Commencement Date will start after your Commencement Date.
The “Lease Termination Date” is the date your lease expires and you must move out of the space. An important note: If the landlord is building out part of the space for you, it’s critical that both parties clearly specify the lease Rent Commencement Date. You need to make sure that the Rent Commencement Date starts after the buildout space has been delivered.
Options to Extend Lease Term
Option terms are your unilateral rights to extend the lease term. It’s important to understand that these options:
- are usually personal to you, the tenant (they can’t be transferred to someone else unless the landlord agrees to do so)
- can be revoked if you default during the lease term
- do not have to be honored if you fail to exercise the option in the exact manner outlined in the lease
The rent during the start of the option term is usually based on the fair market value of rent in the area. The lease describes how that formula is determined. You should work with your attorney to make sure these options are transferable. This will help smoothen the process of selling your practice when that time comes.
Base Rent and Additional Rent
Your base rent is the minimum rent you’ll pay, calculated by multiplying the square footage of your premises and the agreed price per square foot. Your base rent will usually increase every year by:
- a set rental increase (usually between 3-4%), or
- by the Consumer Price Index (an index published by the United States Department of Labor that tracks the average change over time in prices paid by urban consumers for a market basket of goods and services)
Additional rent covers any additional monetary payments you must pay under the lease. If the lease is an “NNN” lease or “Modified Gross” lease, then the additional rent will cover your proportionate share of common area maintenance expenses, real estate taxes, and insurance premises.
Common Area Expenses
As a tenant, common area maintenance (CAM) charges are one of the net charges billed to you in a commercial triple net (NNN) lease. A wide range of expenses is incurred to operate, manage, and maintain the building where the premises are located. These will be passed onto the tenants of the building based on the tenant’s proportionate share of the total square footage of the building.
CAM charges are usually estimated for the year and paid by the tenant each month. After the year ends, the landlord will calculate the actual CAM charges for the previous year and reconcile the charges. If you are underpaid, the landlord will bill you the difference. If you overpaid, the landlord will credit the following year’s CAM charges.
Savvy dentists negotiate audit rights into the lease, allowing them to review the landlord’s records to confirm that the landlord’s CAM calculations are correct. Even if never used, the audit right, at the very least, keeps the landlord honest.
Guarantee
When entering into a lease as a professional corporation, the landlord will most likely require you to personally guarantee the lease. A guarantee allows the landlord to seek payments under the lease against you personally instead of only against the professional corporation. This is something to be aware of, as defaulting on your lease will lead to personal liability.
Compliance with Laws
The compliance section of the lease will lay out who is responsible for ensuring the rented space complies with building codes and other applicable laws, including the Americans with Disabilities Act. Oftentimes as the tenant, you’ll be responsible for keeping the interior of the premises in compliance with all laws, as well as any exterior modifications needed based on your specific use of the space. However, the landlord should be responsible for keeping the exterior and common areas in compliance with applicable laws.
Insurance
It’s imperative to begin searching for business insurance that will satisfy the terms of your lease as soon as possible. Your lease will often specify the type and amount of insurance you must get. Generally, this must be completed by the time the lease term begins.
Indemnity
An indemnity clause obligates a person to compensate another person for a particular financial loss suffered. Often, a lease will have multiple indemnity clauses.
Here’s a common example. Your lease may require you to compensate the landlord for any damages due to hazardous materials that you spill on the property, while also requiring the landlord to compensate you for any damage that is caused by their negligence. Because leases are meant to protect the landlord’s assets (the building), indemnity clauses are usually favorable for the landlord. It’s important to understand the risks involved in these clauses and mitigate them by maintaining solid insurance policies.
Assignments and Sublets
The assignment clause is one of the most critical lease provisions for a dentist.
An assignment and sublet clause allows the dentist to find someone to assume all rights and obligations under the original lease or sublet part of the leased space. At some point, you may consider selling your practice. To do so, you’ll need to assign the lease to the buyer. As such, the assignment clause must be carefully reviewed to determine if there are any onerous provisions included within the clause like a recapture provision or transfer premium.
Recapture Provision
A recapture provision in the assignment clause allows the landlord to terminate the lease and make you leave the premises if you ask permission for a sublet or an assignment. If used, such a circumstance can be catastrophic for a dentist looking to pull the equity out of their practice in a sale. Even if the provision is never used, it still makes the practice less attractive to a buyer looking over a seller’s lease. The recapture provision is something to watch out for, and something you should remove if contained in your lease.
Transfer Premium
A transfer premium, the nasty twin brother of the recapture clause, allows a landlord to charge the dentist money for transferring the lease. Sometimes this fee might be as simple as a set amount ($2,500) to as high as a percentage of the purchase price the dentist gets from the sale. In the latter, the transfer premium is a double whammy as it takes money off the top of the sale price while making the practice less attractive to a buyer and thus reducing the sale price. An experienced dental attorney will know how to spot these provisions and work with the landlord to take them out of the lease or mitigate the potential damage.
Conclusion
A dentist’s lease is a critical legal contract that should be thoroughly reviewed before it is signed. If not, you may be sitting on ticking time bombs and devaluing your practice.
Feel free to reach out to Pacific Health Law with questions about a letter of intent or your dental practice sale or purchase. With over 10 years of experience in working with dentists, I effectively help achieve their business goals with clarity, confidence, and peace of mind. Schedule an appointment today.
