Building a Dental office to rent out

6 Replies

HI,

I am considering constructing a 2200 sf dental office. Due to the specialization of the plumbing and electrical, etc, I will have an above average outlay in cash compare to office/retail space. Estimates from architect/contractor are coming in around 285/sf. The practice will furnish their own chairs, wall fixtures...basically providing the vanilla shell. Dentist is willing to sign a 10 yr lease and is credit worthy. NNN lease.

 I already own the land its going on free and clear.  I plan on getting 10 year loan on the building of a rate around 5-5.25%.  So some questions to ask:

1.  How do I set the rent?  Is it based on my mortgage plus profit for taking the risk?

2. Will the CAM fees assessed on top of the rent to the office have some operations profit for administering the arrangement?

3. How do I set the cam fees?  Since there is no historical value to start from, do I set a number right away or have a contingency to reset   on the next year since it is a de novo building?

4. Do I need a broker or can I pay an attorney to set up everything, or myself?

Thanks

Hi Brian,

Are you looking to sell this when built out or hold long term?

If this is a dentist office there is generally one NNN lease. With that you do nothing and there is no CAM.

CAM is more for when you have multiple tenants in a building and management in place.

On the 10 year primary term lease try to push it to 15 years as that can make it more valuable. Is this dentist a single unit operator or multiple? Is this a national chain instead? If it is local make sure all locations they have are guaranteeing the lease. Make sure they have to give updated business and personal financials once  a quarter or at least semi-annually to annually. Have a clause in the lease if owner sells that you can request updated financials for business and personal even if they are not due on the regular schedule yet. Have rental increases of at least 2% go up annually each year.

If you are building from the ground up and are not experienced have a fee developer help out but they can cost 100k or so per project.

You could also not even construct the building but have the tenant do a ground lease instead. With the ground lease you are not usually getting any tax depreciation like with a NNN building where most allocate 75% value to building and 25% to land.

Many other factors. A broker would help more with the sale of the property. You should have a commercial attorney that specializes in retail,medical office, etc. do the lease and other components. I am an investor, developer, commercial broker.

I do not offer tenant placement doing leases like tenant rep brokers, developer fee services, or property management. I transact nationally with clients and then I also have passive investors invest with me so my focus is those 2 buckets.

thanks!

We plan on holding it long term.  Also I will get an attorney. But for now...

 So how does one come up the rent price?  For example if the building were to cost $750K do we rent per square foot or some other derivative?  I’ve heard of how people rent based off of Cap Rate is that true? How does that calculate out?  I guess I’m looking for starting points. 

Again, thanks!🙂

@Brian Kraby

1. Like any other thing, rent is based on the market. So if you have a nicer building in a nicer area, you can generally charge more than your competitors. The mortgage doesn't really factor into it from the tenant's perspective.  

2. As @Joel Owens said, CAM isn't really relevant if it's just a building with a single tenant. 

3. Ditto.

4. Hire a lawyer to come up with a proper commercial lease and other documents. This is way more complicated than a simple residential lease. Ideally, you should find one that has experience dealing with medical/dental offices since there are some practical considerations to think about on the legal end.  

Disclaimer: While I’m an attorney licensed to practice in PA, I’m not your attorney. What I wrote above does not create an attorney/client relationship between us. I wrote the above for informational purposes. Do not rely on it for legal advice. Always consult with your attorney before you rely on the above information.

Brian you take your land basis and add in legal costs, labor costs, material costs,usually 10% contingency fund, other fees, etc. to get your overall cost per sq ft.

Then you find out cap rate for sale with a newly minted lease local to your area with 15 years on it. This should give you a cap rate average.

So you have your all in (cap rate to cost) whatever that is and then your market cap rate say 6.5. So if all in is 9.5 and then you have long term capital gains when you sell in 1 year or more and broker commissions then you should have about 200 basis points of gross profit.

285 a foot is extremely high. To even consider before you start construction you would need an executed lease with a large non-refundable deposit upfront to show the tenant is serious and committed to the sight.

If this tenant is not larger corporate but smaller individual or group there could be serious risk to building the project and then the tenant ends up falling out before taking occupancy. If the individual tenant has high net worth with a personal guarantee for the forward commitment lease then that can be better. As a developer you have to try and mitigate risk and give yourself high upside.

Thx!!. Found out from the architect that sf cost is actually $140/sf and gross sf is 2356. So $330k is what is on the budget. 

So based off this is it possible to show how a cap rate of 8 would mathematically play out?  I know I’m not including some costs but just want the nuts and bolts of how to calculate it. 

Example:

Land- .5 acres - 300k

Building - 2200 sq ft at let's say 155 sq ft for contingency since they are saying 140= 341,000

Legal costs - 50,000

Grading and site work- 100,000

Total Cost - 791,000

NNN lease - 2200 sq ft at 30 a foot = 66,000 a year NOI

66,000 / 791,000 = 8.3% cap rate to cost ( break even )

Market resale estimate 6.5 cap rate = 1,015,000

1,015,000 market price

6% broker commission = 60,900

Attorney and legal to sell = 15,000

Stamps, recording fees, etc. - 10k or so (varies by state and county with costs)

929,100 - 791,000 = 138,100 gross profit before long term capital gains tax of holding for more than 1 year time or deferred taxes if you 1031 exchange into something else.

As you can see by the numbers this deal is too thin for all the work involved. Cost per sq ft for a project for improvements is hard to manipulate because labor and construction costs are up. The main variable is rent achieved or acquisition of land costs.

You have to compare a new site versus buying an existing building for less than it cost to build per sq ft and retrofitting. This is why getting the lease ahead of time with non-refundable deposit is important.

Generally you want to be cap rate to cost of 9 to 9.5 minimum so when selling after resale costs you have a 200 basis point spread.   

This is just a basic example and other costs are involved.