Renting to a Drug Rehab Facility

[Brent Seehusen]

I have a unique opportunity to consider. A friend of mine is co-owner in a drug rehab clinic that operates in Southern California. Currently, they have three locations, all of which are houses within SFR neighborhoods. They are looking to expand by either acquiring or leasing more houses.

A house has come up for sale next door to one of their existing houses, and due to the convenience that would provide from an operational standpoint, they want to open up shop there.  The problem is their capital is tied up, so I've been asked if I would like to purchase the house and then lease it back to them.

Here are some pros/cons that I can think of:

Pros:

• -We haven't agreed to a rent amount, but it will be above market rate.  How much above market will be the determining factor whether I want to move forward or not.
• -There will be zero vacancy from my perspective as a landlord.  They will be housing the recovering addicts two to a room with a max occupancy of six patients.  My rent will be paid by the rehab center and not the actual residents so I'll have no vacancy or turnover costs.
• -They will pay for most maintenance, excluding large capital intensive items.  We may go 50/50 on those larger items.
• -The rehab has it's own liability policy that I believe will add me as a named insured (I need to verify this.)
• -Possible long term lease of 3-5 years.
• -Possible sale to the rehab clinic in the future.  Again, could be above market value depending on how badly they want it at that time.

Cons:

• -The clinic could shut down if the city/state passes new laws. Right now, this type of arrangement is perfectly legal (clinic within SFR neighborhood), but that could always change.
• -The insurance market could change by denying/reducing coverage to addicts, putting this clinic out of business.

The way I see it is even if the clinic shuts down and they break their lease, I could always rent it at market rate to a normal family, or I could just sell the property. So what am I overlooking here? Do I need my own liability insurance? LLC? Are there some lease terms that are common for commercial real estate that I should try to get included?

On it's face, this deal looks good but I don't know what I'm overlooking, and I still need to agree with them on the rent amount.  A lot hinges on that.  If I can't get a substantial premium above the market rate, it's not going to work out.

[Brian Ploszay]

This is a good, yet complicated deal.  The goal is to make them stay for a long time.   If they stay for 10 years, it could be a very good investment.

1.   Make sure the lease includes all maintenance and they need to be in charge of all interior repairs.  This is not a normal rental house.

2.   Put in the lease that they pay water / sewer.    Also, any increases in Real Estate taxes.

3.   Make the lease at least 3 years.  Try for 5.

4.   Carefully financially model this, so you make a profit.

5.   Analyze the house if you get it back one day.  Can you get out of it with a profit?

6.   Keep a larger security deposit and demand that the property be delivered back in perfect shape.

7.   Totally understand the laws of the area.   Opening up another drug rehab center is something that local neighbors probably don't want.  Is the property zoned / approved for such a house?