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Unique Issues with Healthcare Leases
Brooks R. Smith
Brooks R. Smith
is a partner with Bradley Arant Boult
Cummings LLP in Nashville, Tennessee.
He represents clients across a broad
range of commercial real estate and
finance transactions including healthcare leasing. For more information on
the author, visit BABC.com/BrooksR-Smith. Brooks can be reached at
[email protected].
HEALTHCARE CONTINUES to grow as one of the
largest single aspects of our national economy. Though
some may view healthcare real estate as a niche market,
it has an established record and has evolved into a significant real estate sector, alongside office, retail, industrial
and multi-family. Healthcare real estate includes not only
medical office buildings, and real estate practitioners are
likely aware of some of the numerous types of facilities
falling under the healthcare real estate umbrella, for example, ambulatory surgical centers, long term acute care
hospitals, assisted living facilities, wellness centers and rehabilitation hospitals.
Unless one regularly represents healthcare clients, the
unique aspects of healthcare leasing may elude the general real estate practitioner. Depending on the circumstances, a number of statutory and regulatory barriers may necessitate additional care, consideration and structuring of
leases.
Hospitals remain the primary owner and thus controller of medical office real estate on and about hospital
campuses. While some hospital systems have elected to
dispose of certain of their real estate assets, in general,
hospitals have been growing and continue to seek additional space for occupancy. Accordingly, individual hospitals and healthcare systems apparently will continue their
role as the predominant landlord in the healthcare real
estate landscape.
Outside of the statutory and regulatory hurdles, the
real estate practitioner must be aware of numerous other
unique issues facing his or her landlord or tenant clients
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24 | The Practical Real Estate Lawyer in the healthcare context. Statutory and regulatory
compliance is the most obvious, and unfortunately,
the various laws and regulations can be the most
difficult to grasp. But, because healthcare treatment
in the United States appears to remain in a constant
state of change, broadly understanding the current
leasing trends and practices is necessary.
Affordable Care Act
The Patient Protection and Affordable Care Act
of 2010 (“ACA”), regardless of the ultimate political and judicial outcome, has and will continue to
have a profound effect on the leasing of healthcare
real estate. Among many goals, the ACA requires
greater efficiencies in providing healthcare. One
consequence of this goal to achieve efficiency has
been the consolidation and acquisition of physician
practices by hospitals and health systems.
Anticipating increased demand resulting from
the additional insured because of the ACA, healthcare systems and physician practices are growing
to meet this predicted demand. As a result, many
leases are being consolidated and expanded, or terminated and abandoned. Also, as the streamlining
of services becomes more of a reality, relocating
physician tenants in non-traditional ways will continue to evolve. For example, instead of grouping
specialists together, one concept seems to be that
disparate specialties working toward maximum
production and efficiency would be located together or very nearby. This creates challenges because
differing medical specialties have differing office demands. Furthermore, many hospital campuses are
constrained for space, so bringing additional physician practices onto campuses can create problems.
Perhaps as a result, retail healthcare— providing
healthcare services in locations more accessible to
client patients usually off campus — is increasing.
The ACA has established a new mandate to reduce readmission of patients within 30 days after
being discharged from the hospital. Under certain
circumstances, if a patient is readmitted within 30
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days of discharge, payments to the hospital are adjusted downward. This creates an incentive for the
hospitals to address patient discharge and followup more actively, and from a real estate perspective also creates a need to repurpose space for such
readmissions assuming they do not require the care
associated with a hospital bed.
Physicians, for their part, may seek employment
by hospitals or hospital systems to shift the regulatory burden. The stability of hospitals also contributes to their desire to be employed by such a health
system. Also, the ACA ostensibly requires physicians to modernize many aspects of their practices,
which may be an expensive technological upgrade.
Together, these suggest that the economies of scale
within a hospital or health system are a financially
wise move for some physicians.
Hospital-Driven Monetization
With the evolving healthcare landscape, increases in hospital or health system driven sales
of on-campus medical office buildings have been
anticipated by the real estate community for many
years. Values of on campus medical office buildings
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 over their campus versus
having cash to support some other capital expenditure.
Hospitals may elect to monetize their medical
office buildings by selling to third parties to relieve
themselves of some regulatory burdens as well as
the burdens of property leasing and property management. But, for the foreseeable future, hospital
systems will continue their role as the primary landlord in the healthcare real estate landscape. As such,
healthcare leases will have to be approached from
this perspective and the one uniquely significant aspect of healthcare leasing prevalent because of the
type of parties involved—hospitals and healthcare
providers—is the legal and regulatory framework.
Healthcare Leases | 25
Laws and Regulations: Stark Law, AntiKickback Statute and HIPAA
It should be axiomatic that any “pay to play”
or other referral payment for healthcare services is
unethical because the best interest of the patient
should be paramount, not whether a referral payment is made to the referring healthcare provider.
To codify this, the federal government has enacted numerous laws and regulations, specifically the
Stark Law, the Anti-Kickback Statute and the False
Claims Act.
Because medical office leases are often entered
into between potential referral sources and the
parties who may benefit from such referrals, these
healthcare leases require special scrutiny in order
to comply with the applicable healthcare laws. For
example, when hospitals act as landlords to physician providers, leases between such referral sources
and the potential beneficiaries of such referrals can,
and most likely do, implicate Stark Law, the AntiKickback Statute and the False Claims Act.1
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. For real estate
practitioners, when healthcare providers lease space
to and from other healthcare providers the lease arrangement is considered a financial arrangement
implicating Stark Law.
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 False
Claims Act makes it illegal knowingly to present a
false claim for payment to the government or retain
A referral includes actual written orders or prescriptions
by physicians, but can also be triggered if a party is in the
position to influence such a referral. Physicians and certain
other professionals are referral sources within Stark Law;
most healthcare providers are referral sources within the
Anti-Kickback Statute.
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a payment from the government to which the party
knows it is not entitled. Penalties for violations of
these laws can be severe, including criminal penalties for the Anti-Kickback Statute and the False
Claims Act. A violation of the Anti-Kickback Statute or the Stark Law can implicate the False Claims
Act. For example, if a leasing arrangement violates
the Stark Law and the non-compliant healthcare
provider submits claims, then each claim submitted
would be a violation of the False Claims Act.
Real estate practitioners should take some
comfort that the U.S. Department of Health and
Human Services (“HHS”) has adopted certain
regulatory leasing safe harbors for both the AntiKickback Statute, referred to as the “space rental
safe harbor,” and the Stark Law, referred to as the
“office space rental exception.” When Stark Law or
the Anti-Kickback Statute are implicated in a leasing arrangement, it is important strictly to comply
with these space rental requirements. They are:
• The lease agreement must be in writing and
signed by all parties;
• The lease agreement adequately describes all
of the leased premises;
• The lease agreement must be for a term of at
least one year;
• If the lease agreement is intended to provide
the physician tenant with access to the leased
premises for periodic intervals (instead of on a
full-time basis) the lease agreement must specify
exactly the schedule of such intervals;
• The rental rate is set in advance, is consistent
with fair market value, and is not determined in
a manner that will change based on the volume
or value of referrals flowing between the parties;
• The lease agreement would be commercially
reasonable even if no referrals were made between the parties; and
• The leased premises must not exceed that
which is reasonably necessary for the legitimate
26 | The Practical Real Estate Lawyer business purposes of the physician tenant and
is used exclusively by such physician tenant.
It must be noted that 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, in general, leases by
a hospital to a physician tenant must comply with
both. It is also worth noting that because the AntiKickback Statute is intent based, a scenario is possible where the space rental safe harbor is not met
but the Anti-Kickback Statute is also not violated.
“Fair market value” is one of the most important aspects of the foregoing safe harbor requirements. HHS broadly defines fair market value as
the value in an arm’s length transaction, consistent
with the general market value, including charging
physician tenants for all of the space that they use,
including their pro rata portion of all common areas. “General market value” means the rate that
would result from bona fide bargaining between wellinformed parties who are not otherwise in a position to generate business for the other party on the
date of the agreement.
For purposes of the office space rental exception, HHS adds that fair market value means the
price of rental property for general commercial
purposes (not taking into account its intended use).
In other words, the fair market value for the rental
of a medical office building cannot be based solely
on the rental rate for other medical office buildings.
The rate must be based on the broad category of
similar properties used for general commercial purposes. There is no rule of thumb that will suffice
in all situations to determine the amount of documentation required to confirm fair market value.
Whether a lease rate is consistent with fair market
value is a question of fact that must be determined
on a case-by-case basis.
For example, commercially reasonable methods of establishing fair market value might include
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providing a list of comparables or obtaining an appraisal from a qualified independent expert. In rural areas where inadequate direct comparables exist, a reasonable alternative may involve comparing
institutions or entities located in different, but similar, areas where property is zoned for similar use.
In other cases, where the only comparables involve
transactions between landlords and tenants in a position to refer or generate business (e.g., where the
only comparable is another medical office building
owned by a competing hospital), HHS presumably
would consider alternative methodologies, including for example, cost plus a reasonable rate of return on investment.
But, however it is established, fair market value
is to be assessed at the time of the lease agreement.
Accordingly, it is critical to document the methodology used to establish fair market value at the time
the lease agreement is entered into. If, years in the
future, the hospital or health system is required to
demonstrate compliance with the safe harbor and
the exception, it will likely be difficult to reconstruct
the methodology used to calculate fair market value
if the hospital has not created and maintained such
documentation.
Some anecdotal examples of when these healthcare laws and regulations pose problems in the leasing context are with expired leases and holdover
tenants, failing to enforce operating expense passthroughs, failure to implement annual rent increases required by lease terms, providing tenant services
not addressed in the lease and the leased premises
not accurately matching the space used. Real estate
practitioners should pay careful attention to all of
these prospective issues, but lease administration of
healthcare leases is particularly important and the
real estate practitioner should take specific note.
The Health Insurance Portability and Accountability Act of 1996 (HIPAA) adds to regulatory hurdles when working with healthcare related leases.
HIPAA broadly requires a covered entity (which includes most healthcare providers) to establish poli-