§ 8A.01 Medical Office Lease Issues

• Jurisdiction: United States
• Publication year: 2022

§ 8A.01 Medical Office Lease Issues

Medical office leases differ from retail, industrial and administrative office leases due to patient care and healthcare regulatory issues. Medical tenants may be governed by healthcare regulations that impact business terms such as rent and the term length. They may also have differing utility, parking, life-safety, and signage needs, as well as require landlords to provide uninterrupted utilities¹ or bring common areas into compliance with current Americans with Disabilities Act (the "ADA")² and other accessibility code requirements. Whether representing the landlord or the tenant, to successfully negotiate a medical office lease, a practitioner must understand the unique operational and legal needs of a medical tenant.

[1]—Lease Term

The term of a lease for a medical office lease may be impacted by healthcare regulatory requirements, the cost of constructing medical space, and the additional permit, licensure, and certification requirements for certain medical space. A lawyer should consider these additional costs and construction timelines in structuring delivery obligations, permit contingencies, lease commencement, free rent periods, early access, and other lease term-related concepts. Individual physicians may seek termination rights to plan for retirement.

If the lease is governed by federal anti-kickback and physician self-referral regulations, as further discussed in Section II below, then the lease term must be at least one-year long.³ If the parties terminate within the first lease year, they are prohibited from entering into a new lease with each other for the same space until the first anniversary of the original lease.⁴ The lease term may also not commence until all parties have signed the document, effectively prohibiting retroactive dating of leases.⁵

Constructing tenant improvements for medical space can be more expensive than constructing non-medical space, prompting tenants to seek longer terms and larger tenant improvement allowances.⁶ The average cost to build out general office space in 2015 was approximately $40 per square foot, whereas the average cost of medical tenant improvements averaged between $50 and $100 per square foot.⁷ The high cost of specialty medical equipment and plumbing requirements, as well as the need to comply with licensure and certification requirements, can drive up construction costs. As a result, average medical office leases tend to have lease terms ranging between 7 to 10 years, whereas general office tenant leases often have lease terms ranging between 3 to 5 years.⁸

Additionally, medical tenants may seek longer rent abatement periods or stronger early access rights to account for the longer buildout timelines for medical space. In setting delivery, term commencement, rent commencement, and other critical lease dates, counsel should consider the time it takes to construct the facility, obtain licenses and certifications to operate (see Section 1(d)(iii) below).⁹

[2]—Operating Expenses and Above-Standard Services

Since the year 2000, to provide more convenient options to patients, the healthcare real estate industry has moved from a hospital campus-centric development model to a model that locates new facilities in suburban shopping centers or other nonmedical buildings.¹⁰ Healthcare organizations that are facing declining reimbursement rates find retail space with its lower rent rates an attractive option for lowering operating costs while optimizing convenient care. Medical use, however, can be incongruent with retail or office uses, with medical tenants demanding more services or systems, such as additional electrical or water capacity, generators, after-hours security, and life-safety systems.

Medical office tenants often use more utilities than office or retail tenants and may demand building services outside of normal business hours or building services that exceed standard services. Specialized medical or diagnostic equipment, such as X-ray, CAT scans and MRIs, for example, can use more electricity than standard office equipment and some specialized services, such as dialysis, can use more water.¹¹ In addition, many healthcare providers, such as 24/7 urgent care centers or physicians with extended office hours, use a greater percentage of utilities than businesses that do not operate after-hours. Some medical office tenants require backup generators to ensure an uninterrupted supply of power. In addition to asking for after-hours security, medical office tenants may also ask for more frequent or extensive janitorial services, oxygen supply lines, or additional signage for wayfinding. Therefore, the lease should address the tenant's disproportionate use of these utilities and services so that operating expenses can be equitably allocated.¹²

There are a number of ways landlords can allocate the cost of these additional services or systems. The most accurate approach is to separately meter or sub-meter utilities. However, this option is often not feasible from an engineering or cost perspective. Alternatively, landlords may employ "cost pooling," a cost allocation method whereby the tenant's pro rata share of operating expenses is subject to adjustment by the landlord to accurately reflect the tenant's share of a particular cost that is not applicable to all the tenants in the building.¹³ For example, to determine a tenant's pro rata share of electricity, landlords may engage an electrical engineer to estimate such use. In some instances, the tenant and landlord may agree to determine a tenant's pro rata share of utilities by relying on a tenant's records, such as the number of gallons of water the tenant used per square foot at a comparable location. Additionally, landlords may approach this issue by capturing the average operating expenses for a certain period of time prior to the tenant's occupancy to set a baseline for the operating expense. The tenant would then be responsible for any costs in excess of the baseline figure. With this methodology, the tenant should ensure that all variables remain constant, other than the utility usage, during the time used to establish the baseline and the period of time during which the tenant's use is measured.

[3]—Operational Issues

[a]—Signage

Signage is a significant concern for medical office tenants from both a branding and wayfinding standpoint. A medical office tenant will want the right to install its brand logo signage in a location that will advertise its business and enable patients to locate the office with ease. The lease should include an exhibit that depicts the style and location of any signage that the landlord has pre-approved. In addition, a tenant will want the right to include its name on any directory boards in the building, and on any monument or pylon signs, for wayfinding purposes.

[b]—Parking

[i]—Minimum Parking Ratios

A medical office tenant's parking requirements may differ from that of an office or a retail tenant. Issues sometimes arise if parking ratios satisfy code for retail use but not for medical use. For example, in Buellton, California, medical office tenants must provide at least one parking space per 200 square feet of space to be occupied by the medical practice, but retail tenants are only required to maintain one parking space per 300 square feet.¹⁴ Due diligence should be performed to confirm the required parking ratio specific to the tenant's use and to confirm that the property at issue can support that ratio.

[ii]—Accessible and Convenient Parking

Depending on the type of healthcare services offered, medical tenants may need more parking spaces, accessible parking, reserved or dedicated parking, and/or parking in close proximity to the premises, all of which will need accessible paths of travel.¹⁵ For example, rehabilitation facilities specializing in the treatment of mobility-related conditions require twenty percent of patient spaces to be accessible.¹⁶ Notwithstanding regulatory requirements, patient volumes drive a need for additional reserved parking spaces located near the building's entrance.¹⁷ The code required number of handicap parking spaces may be insufficient to meet a tenant's operational needs. Thus, the lawyer must consider whether the medical tenant will need more parking spaces than required by code.

Temporary closures of parking areas due to repair or maintenance pose another issue. A lease should address this potential scenario by prohibiting closures that reduce the tenant's parking below its required ratio without the tenant's consent or by requiring a landlord to provide alternative, equivalent parking during any closure of the parking areas. Additionally, a tenant could require the landlord to provide valet services at the building to accommodate any patients that may have difficulty traveling to the premises from the alternative parking area.

The following provisions address a few of the parking issues discussed above:

Tenant shall have the right to use [insert code required number of spaces for specific medical use at issue] parking spaces per 1,000 square feet of the Premises or such greater amount as required by local code (including handicapped parking spaces located near the entrance to the Premises) in locations in close proximity to the Premises in the parking areas depicted on Exhibit ___ (the "Parking Area").

In the event it is necessary for Landlord to temporarily closes any portion of the Parking Area in order to perform maintenance and/or repair of the Parking Area, Landlord may temporarily close such portion of the Parking Area if Landlord provides Tenant, at no additional cost to Tenant, alternative parking during the entire duration of such closure in an amount equal to or greater than the number of spaces taken due to the closure in a location near the Building but in no event farther than [insert acceptable distance] feet from the Building or in a location farther than [insert

...