Why Medical Practice Tenants Must Be Careful Before Signing a Long-Term Lease in California

For physicians and healthcare providers leasing medical office space in California, the structure and timing of a commercial lease can have significant long-term financial consequences — especially when the property owner intends to sell the building in the future.

One issue that is often overlooked during lease negotiations is how a future property sale can dramatically increase operating expenses under a triple net (NNN) lease. In many cases, a landlord may push for a strong, long-term lease before marketing or selling the real estate because the lease increases the value and attractiveness of the property to investors. While that may benefit the owner, it can create substantial financial exposure for the tenant.

Why Owners Seek Long-Term Leases Before Selling

A medical office building with a stable healthcare tenant and a long-term lease is generally viewed as a highly desirable investment asset. Buyers are often willing to pay a premium for properties that have:

• Long remaining lease terms

• Predictable rental income

• Established medical tenants

• Minimal perceived vacancy risk

As a result, some property owners intentionally secure lengthy lease extensions immediately before listing the property for sale.

From the seller’s perspective, this strategy can significantly increase the value of the real estate. However, the tenant may unknowingly inherit a major financial burden after the sale closes.

The Hidden Risk: Property Tax Reassessment

Under California law, commercial real estate is generally reassessed at current market value upon transfer of ownership. Many medical office buildings have been owned by the same individual or entity for decades, meaning the property taxes may be based on very low historical assessments under Proposition 13.

When the property sells, the county reassesses the building based on the new purchase price — often causing property taxes to increase dramatically.

For tenants operating under a triple net (NNN) lease, these increased taxes are typically passed directly through to the tenant as part of the “additional rent” or “operating expenses.”

This can create a substantial and sudden increase in occupancy costs.

A Real-World Example

Consider a medical office property owned for 25 years with annual property taxes of $18,000 based on an older assessed value.

The owner secures a new 10-year lease with the medical tenant and then sells the property for $4 million. Following reassessment, annual property taxes may jump to $45,000 or more.

If the lease is structured as a NNN lease, the tenant — not the owner — may now be responsible for paying the increased taxes through operating expense reimbursements.

The result is a dramatic increase in occupancy costs that the tenant may not have anticipated during lease negotiations.

Why This Matters for Medical Practices

Medical practices often invest heavily in their locations. Build-outs, patient goodwill, referral patterns, and specialized equipment can make relocation difficult and expensive.

That means once a practice signs a long-term lease, it may have limited flexibility if operating expenses increase unexpectedly.

Many physicians focus primarily on:

• Base rent

• Rent escalations

• Renewal options

• Tenant improvement allowances

But they fail to fully evaluate how future reassessment risk can affect total occupancy costs over the life of the lease.

Important Lease Provisions to Review

Healthcare tenants should carefully evaluate several provisions before committing to a long-term lease:

1. Property Tax Language

Review exactly how property taxes are calculated and passed through to tenants.

2. Reassessment Clauses

Some leases specifically state that tenants are responsible for increases resulting from a sale or transfer of ownership. Others may allow negotiation of exclusions or caps.

3. Expense Caps

Negotiating annual caps on controllable operating expenses may help limit future exposure. Limiting increases to a yearly percentage increase above current rates allows the increases to be integrated slowly with the owner absorbing some of the increase if it exceeds the agreed upon yearly maximum increase allowed in the lease.

4. Audit Rights

Tenants should preserve the right to review and audit operating expense calculations.

5. Assignment and Exit Flexibility

If occupancy costs become unsustainable, flexibility to assign or sublease can become extremely valuable.

A Sophisticated Negotiation Issue

This issue is particularly important in California because long-held commercial properties often carry artificially low tax bases. The larger the gap between the current assessed value and market value, the greater the reassessment risk after a sale.

Sophisticated landlords, investors, and real estate brokers understand this dynamic very well. Unfortunately, many medical tenants do not discover the impact until after the property changes hands.

Before entering a long-term lease, medical practices should carefully evaluate not only today’s rental economics, but also the potential financial consequences of a future ownership transfer.

Final Thoughts

A long-term lease can provide stability and security for a medical practice, but tenants should fully understand how a future sale of the building may affect their occupancy costs.

In California, a property tax reassessment following a sale can substantially increase NNN expenses - sometimes overnight. Physicians and healthcare providers should carefully review lease language and seek experienced legal and real estate guidance before committing to a long-term agreement.

In commercial real estate, the economics of a lease are not limited to the base rent. Sometimes the most significant costs are hidden in the “other rent” provisions that only become apparent after the property changes ownership.

AI Disclosure:  This post was written with the assistance of an AI language model. The human author provided the topic and key points, verified the information, and performed all final editing. The AI (ChatGPT) helped expand on the details and refine the writing. The final content was reviewed and edited by a human to ensure accuracy and quality.