Advice on Medical Spaces

Eight considerations for hospitals serving as landlords

A hospital often serves as the primary owner and controller of medical office real estate on and around hospital campuses. While some hospital systems have divested some of their real estate assets, hospitals generally have been growing and seeking additional space for occupancy.

For the foreseeable future, individual hospitals and health systems will continue their roles as major landlords in the health care real estate landscape. Toward that end, they face many unique hurdles as landlords, including arcane real estate arrangements and complicated regulatory issues.

Major considerations

The legal and contractual issues that hospitals and health care systems must carefully consider include the following:

1 Laws and regulations. Leases of space in hospitals or hospital-owned medical office buildings (MOBs) implicate the federal Anti-Kickback Statute (the Medicare and Medicaid Patient and Program Protection Act of 1987) and the physician self-referral law (known as the Stark Law). These laws place specific limitations on the manner in which hospitals may lease space to physician tenants.

The Anti-Kickback Statute makes it a crime knowingly to offer or receive payment in exchange for referrals for services or goods that are reimbursable under Medicare or Medicaid. The Stark Law prohibits physicians from making referrals for certain “designated health services” (including both inpatient and outpatient services, with very few exceptions) to entities in which the physician has a financial relationship.

The Stark Law is meant to regulate referral payments with possible significant civil penalties if violated. The Anti-Kickback Statute is meant to force providers of health services reimbursable by governmental programs to consider seriously the means and manner of payment; otherwise, criminal penalties may be imposed if violated. These laws significantly up the ante because the ramifications of mistakes in the health care field are more extensive than in a typical leasing transaction.

Health & Human Services (HHS) adopted certain regulatory leasing safe harbors for both the Anti-Kickback Statute, commonly referred to as the “space rental safe harbor,” and the Stark Law, commonly referred to as the “office space rental exception.” There are many variations and modifications with respect to these safe harbor and rental exception parameters. Although there may be some unusual circumstances in which only one of the two laws applies, leases by a hospital to a physician tenant generally must comply with both statutes. It is also worth noting that because the Anti-Kickback Statute is intent-based, a scenario is possible where the space rental safe harbor is not met but the Anti-Kickback Statute also is not violated.

Finally, adding to the regulatory hurdles is HIPAA. This broadly requires a covered entity — which includes most health care providers — to establish policies and procedures to safeguard the confidentiality of protected health information. For example, when hospital landlords contract for janitorial services, reasonable safeguards must be undertaken to protect confidential information.

Altogether, the regulatory and legal compliance issues remain a significant burden on facility managers when leasing to physician tenants.

2 Affordable Care Act. The ACA, regardless of its ultimate political and judicial outcome, will continue to have a profound effect on hospital operations related to leasing.

The ACA requires greater efficiencies in the health care sector. One manner in which hospitals and health care systems have sought to achieve those efficiencies is through consolidation and the acquisition of physician practices.

Hospitals and health care systems are acquiring physician practices to meet increased demand from additionally insured patients and to help streamline health care services through strategies like accountable care organizations.

Moreover, as the streamlining of services becomes more of a reality, relocating physician tenants in nontraditional ways will continue to challenge health facility managers. For example, instead of grouping specialists together, one concept involves grouping disparate specialties together to work toward maximum production and efficiency. This creates obvious challenges because differing specialties have differing office demands. Furthermore, many hospital campuses already are constrained for space, so bringing additional physician practices onto campuses can create problems.

The ACA also has established a mandate to reduce readmissions within 30 days after being discharged from the hospital. Under certain circumstances, if a patient is readmitted within 30 days of discharge, payments to the hospital are adjusted downward. This creates an incentive for hospitals to address patient discharge and follow-up more actively. From a real estate perspective, this creates a need to repurpose space for such readmissions if they do not require hospital beds.

Additionally, physicians often seek to be employed by hospitals or health systems to shift the regulatory burden, enjoy job security and modernize their practices.

Because of these changes, health facilities managers are faced with space challenges and constraints. The manner in which these demands are met will vary, but two meaningful ways in which they currently are being met are repurposing existing unused or underutilized space, and moving into new urban and suburban areas not being served by the hospital or health system.

3 Time-shares and subleases. Consistent with the expansion of hospital services to meet consumer demand, office-sharing arrangements are more convenient for physicians and for consumers. However, the regulatory hurdles for time-shares and subleases, including per-unit-of-service (“per click”) space and equipment leases, are formidable.

The Centers for Medicare & Medicaid Services (CMS) has paid close attention to these leasing arrangements, and regulations now in place present significant risks and challenges for hospitals and health systems. The space and equipment lease exceptions provide that space and equipment leases that include per-click rental charges are not permitted “to the extent that such charges reflect services provided to patients referred by the lessor to the lessee,” regardless of whether a physician holds a direct or indirect ownership interest in leased space or equipment.

In addition, CMS indicated that the prohibition is not limited to circumstances in which the lessor is a physician or physician organization — it also applies to any lease in which a lessor-designated health services entity is in a position to refer patients to a lessee physician or physician organization. With increased scrutiny by regulators, compliant time-share arrangements require continuous administration of schedules and accounting for services and materials used by the tenant during his or her leased period.

4 Termination rights. Over the past few years, termination rights have become significant issues for tenants, whether as a means to hedge risk, plan for future practice changes or to assure the ability to grow in the future. Likewise, with medical leases, termination rights are an important consideration for both hospital and health system landlords and tenants, which need to be addressed during lease negotiations.

When a hospital or health system is leasing to a third party, the tenant is often a sole practitioner or a physician group with a few physicians. As a result, the retirement, death or disability of one or more physicians likely will have a significant impact upon the subsequent performance of the tenant. If the tenant health care provider consists of three or fewer physicians, a landlord may make the death or disability of one of the physicians an event of default under the lease. Termination rights also must be structured to maintain regulatory and legal compliance, including whether they are consistent with fair market value determinations, especially when considering termination fees.

5 Guaranties. In most leases, the issue of the guaranty is dependent on the perceived financial strength of the tenant, whether there is other security for the performance of the obligations under the lease (e.g., letter of credit), and the trust relationship between the landlord and tenant.

These remain true with health care leases. Because a guaranty is a credit enhancement, additional care must be taken to confirm compliance with applicable laws and regulations and consistency with the general market and fair market value. It is always difficult to discuss with a tenant consisting of older physicians the prospect of the loss of an individual guarantor through death. But hospital landlords must consider substitute guarantors if intending to remain within the confines of the market.

6 Repurposing real estate. Repurposing other types of buildings for medical use is an efficient manner in which to create reasonably inexpensive space, but in generally accessible locations. For example, abandoned grocery stores, movie theaters, fast-food, stand-alone sites and even older or underperforming shopping malls have proven to be excellent opportunities into which hospitals can expand their services and their brand.

On-campus repurposing of space also is critical to a hospital’s efficiency. Facility managers have to weigh the benefits of repurposing existing space against the costs of doing so and also the disruption to other parts of the health care campus. Although unfortunate, often the most effective strategy is to tear down and build new. The end result is that the space provided for patients and consumers of health care services must be pleasing to the patient and suggest a warm and healing environment.

7 Religious directives. Many hospitals and health systems are owned or operated by nonprofit religious entities. These religious entities understandably have specific faith-based directives that do not allow for certain uses. For example, some Catholic-owned MOBs may prohibit the tenant from performing procedures contrary to Catholics’ ethical and religious directives. Insuring a continuum of care may require creative leasing arrangements or even condominiumization of campus property.

8 Hospital-driven monetization. The real estate community has anticipated increases in hospital- or health system-driven sales of on-campus MOBs for many years. Values of on-campus MOBs continue to rise. As values rise, the impetus to realize profits on the sale of hospital-owned real estate increases, and hospitals are faced with the dilemma of losing some control versus having cash to support other capital expenditures.

Another reason hospitals may elect to monetize their MOBs by selling to third parties is to relieve themselves of some regulatory burdens as well as the burdens of property leasing and management. Until that happens, however, hospitals and health systems will continue their roles as primary landlords in the health care real estate landscape.

Republished with permission. This article first appeared in Health Facilities Management on April 1, 2015.