Importance of Negotiating Initial Term and Renewal Terms in Health Care Leases

In our upcoming series of blog posts, we will look at several key negotiating points for tenants in triple net healthcare leases. We will also offer suggestions for certain lease provisions that will protect tenants from overreaching and unfair expenses, overly burdensome obligations, and ambiguous terms with respect to the rights and responsibilities of the parties. These suggestions are intended to result in efficient lease negotiations and favorable lease terms from a tenant’s perspective. The first blog post in our series focuses on negotiation of initial terms and renewal terms.

Initial terms and renewal terms are important components in health care lease negotiations for both tenants and landlords. The length of an initial term, as well as of subsequent renewal terms, provides the parties with security, predictability, negotiating power and market flexibility.

When deciding between a longer or shorter length initial term, a health care tenant should compare the benefits of each. A longer initial term gives a tenant security in knowing it will not have to incur costs and business interruptions in connection with relocating and negotiating a new lease in the near future. Longer initial terms also allow tenants predictability in rental costs and leverage to negotiate other key lease points. In exchange for the assurance of having a long term tenant in place, landlords will often offer improvement allowances, rent concessions and other opportunities for tenants to improve their lease terms. For example, a health care tenant may be offered a tenant improvement allowance by their landlord, to build out their practice space, in exchange for agreeing to a longer initial lease term. However, shorter initial lease terms offer tenants flexibility in uncertain markets to potentially take advantage of better space in different geographical locations or markets. In addition, if a tenant is a new business just entering the market, they may want to agree to a shorter initial term with renewal options to allow them time to grow their business with an exit strategy if that business does not grow as projected.

With respect to renewal terms, from a health care tenant’s point of view, negotiating renewal terms in a lease offers comfort in knowing they can continue their business for a certain period of time in the same location and market, avoiding disruptions in business operations and uncertainties associated with costs of negotiating a new lease for relocation space. It is beneficial for a health care facility that has created visibility in a specific market to be able to continue its business in such market and location.

From a landlord’s point of view, renewal terms provide a dependable forecast of revenue on which the landlord can rely. Based on this forecast, a landlord can mitigate risks and costs associated with vacancies and locating replacement tenants. Most renewal terms include pre-negotiated annual escalations which provide both the landlord and tenant with predictability with respect to their future financial obligations and revenues.

Renewal terms are typically based on changing markets and market rentals. Many times, renewal term rental rates will be based on current fair market value. This allows a landlord to maximize the benefit of rising property values when adjusting rental rate terms upon renewal. For health care tenants, negotiating shorter renewal periods (e.g., two renewal terms of 3-5 years each) allows the tenant to reevaluate market conditions periodically and the option and flexibility to secure more favorable lease terms elsewhere.

Overall, initial terms and renewal terms are critical clauses in health care leases. They provide stability, predictability and mutual benefits to landlords and tenants.

In our next post, we will cover the importance of negotiating operating expense provisions, which are crucial both economically and operationally for tenants under triple net leases.

Allison Zangrilli and Zlata Fayer are Senior Counsel in Epstein Becker Green, P.C.’s Health Care and Life Sciences Group. Allison and Zlata have extensive experience drafting and negotiating commercial leases for clients in a wide variety of industries, including healthcare, hospitality, real estate and professional services. They focus on leases in medical office, retail and warehouse spaces. They are also experienced in all aspects of real estate matters, including purchases and dispositions, title matters, diligence, and financing.