It is not unusual for a medical group that is building a new facility to partner with the Developer on the project. In those cases, the Developer and the doctors generally take ownership interests proportional to the equity contributed. The Developer, however, will also charge development fees for its services while the doctors charge nothing for the brokerage fees saved by bringing the lease. Those days may soon end as CMAC and other physician-advocates become involved early in the Joint Venture (JV) formation.

Let’s put this in context. A development company (“DC”) and a practice group (“PG”) decide to build a $20 million medical facility. It is agreed that the DC will act in the role of a Developer and charge a 4% development fee, or $800,000. That is the same fee that would have to be paid to any other Developer for its services. The PG agrees that it will sign a 10-year lease having a value of $1.2 million and would routinely incur a broker’s fee of 5%, or $600,000. Historically, however, the PG has not received credit for the broker’s fee that it just saved the JV on bringing the lease. The fact is that the value created by the PG should carry the same weight as the services brought by the DC.

In this case, the respective equity for services from each partner should be accounted for and the project cost for the PG will have been reduced from $400,000 to $100,000.

• Development fees only $800,000 @ 50% interest = $400,000 cost to PG
• Development fees ($800,000) less credit given for saved broker fees ($600,000) = $200,000 @ 50% interest = $100,000 cost to PG

When Larry Page and Sergey Brin founded Google in 1998 it was completely free. They focused on delivering accurate and relevant search results. At the time, only 3.6% of the world’s population were internet users and therefore, it was initially more of a computer science project. They really hadn’t considered if or how they would create revenue from their idea. The current method of monetizing the value, Google AdWords, hadn’t been invented yet. Once Google AdWords was launched in October 2000, it allowed businesses to promote their services in a way that was incomprehensible at the inception of the internet age and provided Larry and Sergey their first monetization opportunity.

The point being, the Google founders spent a long period of time providing a valuable service, for free, before 1. Recognizing the value and 2. Creating a structure to harness it. Physician practices across the country are following in Larry and Sergey’s footsteps. They are creating significant value without the tools to monetize and harness that value which the following scenario aims to outline.

When Landlords and Developers have vacant space in existing or to-be-built locations, they often seek the services of a real estate broker to fill that space. As part of this service, the standard commission rate for a commercial lease is 4-6% of the total lease expense. Let’s do some quick math to quantify the broker fee on a $10MM building.

For new construction projects, the inaugural lease usually carries a length of at least 10 years. With a starting ROI of 8% ($800,000 of annual rent), assuming no escalators, a 10-year lease and a 5% broker commission, the fee to the broker would be $400,000. A 15-year lease with 2% escalators increases that fee to $691,000.

In these kinds of joint ventures, it is very standard for a Developer to include its development fee as part of the equity contribution. A typical development fee is anywhere from 4 – 6% of the construction budget. On a $10MM building, that is roughly $500,000 (5%). In consideration that the physician practice is bringing a long-term lease and the developer is bringing development services, of almost equivalent value, it would seemingly make sense that these two services roughly cancel one another out. But they typically don’t!

What often happens is the value which the physician practice brings through its own lease is not recognized and results in the physicians sourcing a disproportionate amount of cash equity to the deal. Ultimately, the long-term lease a physician group signs carries significant value and should always be part of the negotiation to ensure a more equitable deal with its development partner. Like when Google created AdWords, the broker fee argument aims to provide a tool to 1. recognize the value and 2. monetize that value. To discuss the best methods of navigating that negotiation, send an email to solutions@cmacpartners.com.