Premises Lease

Is the premises leased or for sale along with the practice?

Leased Premises

A commercial lease is a very long, legal document that will ultimately be reviewed in detail by your lawyer as part of due diligence. The bank will also take the lease into account when structuring a practice loan. The length of tenancy and the various terms in the lease could have considerable impact on the value of the practice, and the ability to assign the lease and operate the practice at its current location. As a result, the premises lease deserves due consideration.

Most commercial leases for a dental practice are “triple net leases”, which means the tenant is charged a base rent per square foot, as well as a proportionate share of the landlord’s operating costs, primarily property taxes, maintenance and insurance, plus applicable taxes.

Owned Property

The option to purchase the real estate in conjunction with the practice is typically of benefit to a buyer because it puts them in control of their own tenancy. There is no longer risk of insufficient tenancy length or detrimental lease terms that could significantly impact the value of the practice down the road, or potentially require the practice to relocate. However, the cashflow from the practice would need to be able to support both the practice loan and the mortgage on the real estate unless you’re able to contribute personal funds and/or security.

Some factors to consider when conducting a preliminary review of the premises lease:

Tenancy Length

Ideally, the lease would have a minimum of 10-12 years of tenancy certainty made up of the current lease term, plus renewal options. Practice loans are typically amortized over 12 years, with banks requiring tenancy certainty over the entire amortization period. If for instance, there are only eight years of tenancy available, the bank may choose to amortize the practice loan over eight years, increasing the annual loan payments, making it harder to service the debt. This lack of tenancy length could just be an oversight by the practice owner; however, it creates risk that you may have to relocate and build a new facility in eight years if the landlord doesn’t grant further renewal options.

Assignment

Assignment is the ability to transfer the lease to a purchaser of the practice. In almost all cases, this requires consent of the landlord, which typically can’t be unreasonably withheld. However, in some cases the consent may be unreasonably withheld, or the landlord has the right to terminate the lease instead of consent to assignment. In other cases, you might have to own assets or provide financial documentation to support the ability to make the lease payments before the landlord will grant assignment.

Exclusivity

Sometimes the lease will provide exclusivity for dentistry, which is a real advantage, because it prevents the landlord from leasing space to another dentist in the same complex.

Relocation Clause

This clause gives the landlord the right to relocate the tenant to another unit in the building/complex. There are several factors to consider with this clause. How much notice is required by the landlord and is it sufficient to build a new office? Who is responsible for the relocation costs, the landlord or tenant? Must the new unit be of similar size, or could it be smaller, limiting operating capacity, or larger, increasing rental costs?

Demolition/Redevelopment/Substantial Renovation Clause

Depending on how this clause is drafted, it could mean the landlord has the right to terminate the lease if they wish to demolish the building or in some cases, “substantially” renovate, perhaps to accommodate a tenant that will pay higher rent.

This would require you to relocate and build a new facility at considerable expense also risking patient attrition. Plus, securing a loan may be quite challenging, since most banks will hold back a reserve to fund a relocation and thus will not finance as much for the practice purchase.

Also consider the amount of notice the landlord must provide and whether it’s sufficient to find a location and build a new office (e.g., 12 months versus 3). Demo clauses are becoming more prevalent, but they can still be a red flag. Some banks will do a reasonability assessment, looking at the age of the building, amount of local development etc., to determine the likelihood the demolition clause will be exercised, and take this into account when assessing available financing.