How should I structure an offer on this dentist office?

Question

All:

I'm considering making an offer on a commercial building that is leased to a dental office and would love some advice on how to structure.

Here's some info :

• It has been leased by the dentist for the last 12+ years
• The lease is month to month
• The dentist is paying $900/month
• The market rate on this building is ~$1800/month
• Property is listed for 175k but can be bought for 150k
• If it were vacant it would be worth ~150k
• The owner has had it listed for over 1 year
• The owner does not owe anything on the building
• After taxes/insurance I estimate the owner only nets $500/month at most (owner is responsible for repairs)
• Owner seems content with the current rent amount or selling and cashing out

It's my belief that the dentist does not try and sign a long term lease because the rent is so cheap. He simply doesn't want to bring up the issue. I've been told that moving dental equipment is pretty expensive and moving offices would be quite expensive. Although this is not a huge home run by any means, I would be interested in getting this property if I could get the dentist to sign a long term lease at market rate while it is under contract and before I close on it.

However, I am concerned that if I approach the dentist with this new lease that he may just go to the owner and work out a higher rate and cut me out of it. I'm also only interested in purchasing if I can get the new lease while under contract. The value to me in this deal is mostly in the lease/tenant.

I'm not sure I can achieve this but would love to hear suggestions.

Taylor Hazard · Answer

Add a contingency in the contract tied to the execution of a new lease with the Tenant. If the Dentist balks at the higher rate offer him a teaser rate for the first year that bumps to market in year two so he can adequately plan for the increase.

Not only is it expensive and cumbersome to relocate a dentists office but his patients are likely all local to the neighborhood and relocating may see him lose business. What is the vacancy rate for medical office space? Is there competing space down the street he could move or would he have to travel far to find a new space? Could he find space in 60 days if you terminate the mtm lease?

You could add a clause to the contract allowing you to market the space while its under contract, maybe you find a new tenant but most likely it motivates the dentist to sign a new lease.

Paul Halphen · Answer

Something seems off here.  Why is the dentist not buying the property? Why does the owner want to sell after all this time?

If you are able to dig into those questions and get good answers...

• For whatever reason it seems a tenant finds it more palatable to passthrough $200 of owner's expenses than have a $200 rent increase.  I'd work to get that property to NNN or at least some form of net and you have a much better looking deal.
• $5 net for old medical in a Two Notch like business corridor in Columbia is still under market.  
• I'd work in strong increases y/o/y and try to lock up the dentist until he retires (10 year + lease).
• Know you have tremendous leverage over the dentist with a mtm lease.  He is an idiot putting his business at risk like that. Makes me think he must be older, almost retired.

Joel Owens · Answer

Have you read the actual lease or are you just going off of what the seller is saying?

Often sellers leave out key items because they forget or they want the buyer to buy into the deal and spend money before dropping on them.

I just find it really hard to believe that a Dentist doing great business at such a low rate would not want to lock that in long term way before now. The only reason I could see them doing that is if they were planning to move to a better located property for paying higher rents or they were looking into getting their own building constructed and put a loan on it.

You need to check the lease and see if the Dentist has a ROFR (right of first refusal) on it. If they do you can forget it as the Dentist would likely love to buy the property for that cheap of a price and keep his cost low then pass on his ROFR so you can almost double the rent on him.

Dentists can make pretty good coin 200k to 300k a year so generally if landlords try to squeeze them they have options. If the area has almost zero vacancy then options to move can become more limited. If you try to raise rents then a developer with a brand new building in a better location can come calling and say for close to the same rent can have a new building and more foot traffic and eyeballs on the business to drive revenue per sq ft.

Taylor Hazard · Answer

*Listing it online in places you have access too. Vast majority of commercial space is listed on Costar.

Taylor Hazard · Answer

First step is to educate yourself on the medical office market in your area. Certainly you need to know if your estimation on market rates are accurate but also if the dentist can up and leave to a space across the street.

Best bet would be to interview some medical office brokers, let them know you have identified a property and may need to hire someone to list it. They will give you all relevant data points and then, should you need to fill a vacancy, you will have brokers ready to go.

Will Gaston · Answer

@Taylor Hazard the rate for this type of building seems to be in the $10-$12/ft range. He's paying ~$5 which is close to industrial space rates. I see very few spaces (if any) in the area that would even work that are listed on Loopnet.

I think if I got him the $8-$9/ft range the first year or two and and he didn't have to move then he would be happy. But I'll definitely do some more due diligence on the vacancy rates. I'm guessing that a lot of that space is leased without brokers ever listing it online.

Will Gaston · Answer

@Taylor Hazard all great ideas. Especially the teaser rate.

I don’t know what the medical vacancy rates are in my market but was hoping to structure something that would still keep him there and for a long time. I think some escalations may help with that instead of immediately going to market rate.

How should I structure an offer on this dentist office?

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