A case worth studying: an estoppel almost derailed a first medical office building in week five

A useful case for anyone underwriting a first medical office deal involves a 3,400 square foot single tenant medical building, built 2004, in a town of about 28,000 with a small hospital four blocks away. A two physician family practice had been in the building since it was built, as the original tenant, and paid for its own build out. Purchase price $1.05M. In place rent $78,200, so $23 a foot, triple net with the landlord holding roof and structure. Four years left on the current term with one five year option at fair market. Going-in cap 6.9% after adding a $6,000 a year reserve the seller was not showing. Financing in a case like this typically runs through a local bank at 25% down, 20 year amortization with a five year fixed period, with a seller carrying part of the down payment on a second note. Getting the primary lender's written approval of any seller carry before signing is a step worth insisting on every time; it is not always assumed and it protects the buyer if the structure is later questioned. The part that can nearly break a deal like this: an estoppel certificate coming back late in the process listing a rent abatement never previously disclosed. Say a prior landlord had given three free months in exchange for the tenant paying for a parking lot resurface, documented only in an email and never amended into the lease. The tenant believes two of those months are still owed; the seller believes it already expired. A signed estoppel confirming the tenant's belief effectively forces the issue, in this example about $13,000. The resolution that tends to work is a seller credit at closing for the disputed amount plus a short lease amendment where the tenant confirms no other unwritten agreements exist, which can typically be resolved within two weeks with one extension of the study period. The lessons worth keeping from a case like this: order the estoppel early rather than at the end of due diligence, interview the tenant directly rather than relying on the seller's file, and request every email between landlord and tenant for the prior several years on day one rather than just the lease file.

tashaford30 SG2CPRO 16

Answer

carlos_nunez AA4APRO 12

The estoppel catch is the useful part of this post and it deserves a line under why it worked, because people read this and hear "order the estoppel early" without hearing the rest. You got the money because you were still inside a study period. If that estoppel had come back in week nine of a nine week diligence window with your deposit hard, your options were closing with a $13,000 liability you had not priced or blowing up the deal and eating your deposit. The seller credited you because it was cheaper than restarting a sale. That leverage disappears the day your money goes hard. So the actual practice is to sequence diligence so the items that depend on a third party responding, meaning the estoppel, survey, tenant interview and title exceptions, all land in the first half of the period. The items you control, inspection, roof, environmental review, can slide later. Most first timers do it backwards because the inspector is easy to book and the tenant is awkward to call. The other thing you did right was making the amendment say no other unwritten agreements exist. Side deals by email are common in single tenant medical because the relationship between a long term physician tenant and a small local landlord gets informal over twenty years. Parking, signage, after hours HVAC, snow removal, a spare storage room. None of it makes it into an amendment. The confirming amendment is what stops the next one appearing in year two. One thing to add for your file: get written confirmation of who owns the generator, if there is one, and any built in casework. Same category of problem, and it shows up at move out.

carlos_nunez AA4APRO 12

6 replies

aliyah_bActivePRO

$23/sf triple net in a town of 28,000 sounds low to me but I have no basis for that other than the numbers I see in bigger markets. Did you get comps, and did you underwrite the option renewal at fair market as flat, up, or down? That option is the whole back half of your hold.

aliyah_bActivePRO

angela_burke CP4CPRO 12

Roof and structure on a 2004 building with $6,000 a year reserved is worth pressing on. What remaining roof life estimate did you get, and is $6,000 a number from a consultant or a number that made the cap rate work?

angela_burke CP4CPRO 12

aaron_fitz10 PU1APRO 13

The seller carry at $75k is the piece worth turning over. Three year term on the second, five year fixed on the first. In year three you are either refinancing or paying off the second out of cash flow. What is the plan there, and what does the debt service look like if you have to roll that $75k into the senior at a different rate?

aaron_fitz10 PU1APRO 13

laurenkim53 PF4APRO 14

This is a useful size of deal to study, so thank you for the real numbers. A question about the town. Two physician practice, both presumably somewhere in their careers. If one retires and the other cannot recruit a replacement, you have a vacant single tenant medical building in a market of 28,000 people. How long did you assume that suite would sit in your downside case?

laurenkim53 PF4APRO 14

renee_dubois PS1APRO 12

That is the question worth answering first, @laurenkim53. Quill, did you ask the physicians their ages or their succession plan? It feels intrusive, and it is the most important thing in the deal. In a single tenant building, the tenant's life plan is the real lease term.

renee_dubois PS1APRO 12

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