When two suites in the same building show a large rent gap, is it a medical premium or a stale lease

Take a small two-story building in a suburban node with a 2,100 square foot pediatric practice on one floor at $34 a square foot and a 2,000 square foot insurance agency on another at $26 a square foot, same building, same age, same parking lot. An $8 per square foot gap like that raises a real underwriting question: is that a durable medical office premium, or is the pediatric suite simply an older lease signed under different market conditions that will converge with the office rate at renewal. The way to tell the difference is to pull the lease commencement dates and compare them against when each rate was actually market. If the pediatric lease was signed years ago and simply never rolled, the gap says nothing about a medical premium and everything about lease timing, and it likely narrows at the next renewal. If the pediatric rate reflects a recent lease or renewal signed at that level, with comparable medical space in the immediate market also commanding a premium over general office, then the premium is real and the case for eventually converting the office suites to medical use strengthens the value of the whole building. On a 9,400 square foot building asking $2.35M with in-place NOI around $158k, the answer to that question changes whether the offer price reflects a real embedded upside or is simply paying for a story that will not hold at the next lease turn.

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gregpowell66 AC4BPRO 19

The gap is mostly build out cost being paid back through rent, plus a use that can't work from home. A pediatric suite has exam rooms with sinks, a lab area, sometimes a shielded x-ray corner, extra HVAC capacity, and a floor plan that's expensive to build and expensive to change. Whoever paid for that build out is recovering it in the rent, and if the tenant paid it themselves they're stuck to the space in a way an insurance agency never is. That's the part worth paying for, the stickiness. Where your conversion idea gets hard is the cost. Turning that 2,000 sf office suite into usable medical space means plumbing to each exam room, and in a two story building the second floor is worse because you're chasing waste lines down through the ceiling of whoever is below. That kind of conversion typically runs well north of $100/sf once you include mechanical upsizing and permits, and the permit path for a medical use can add months depending on your jurisdiction. At $8/sf of extra rent, $100/sf of cost takes over twelve years to pay back before you've counted vacancy and the cost of your own money. Get the actual lease dates and the escalation history on both suites before anything else. If the pediatric lease was signed in 2019 with 3% bumps, that $34 tells you almost nothing about today's market.

gregpowell66 AC4BPRO 19

When two suites in the same building show a large rent gap, is it a medical premium or a stale lease

1 reply