Author Archives: MREA

About MREA

Robert S. “Bob" Lowery is the Managing Partner with MREA - Medical Real Estate Advisors. He has 13 years of experience in various aspects of commercial and healthcare real estate including appraisal, management, and brokerage. Mr. Lowery's passionate decision to create MREA was based on foundational experience within leading general commercial real estate agencies such as Colliers International, Marcus & Millichap and Coldwell Banker Commercial. Most recently within his firm, Mr. Lowery was the leading healthcare real estate specialist. His extensive client database and daily interactions with health care decision-makers and investors will set MREA out with a creative, yet clear vision. Mr. Lowery's dedication to his craft, in which he demonstrates a tremendous appetite for knowledge and information regarding the Greater Houston and Texas medical communities, is precisely how he controls the detailed components and negotiations that are essential to a successful deal-making. Mr. Lowery is currently spearheading several initiatives to promote MREA's positioning in several Texas medical communities. A well-recognized figure among his peers, he has been jointly responsible for the management, leasing and disposition of over $1 Billion in commercial and healthcare real estate assets within the Greater Houston area.

Evaluating Real Estate Options When Adding a Physician

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Most physicians who are given the opportunity to join a private practice expect to eventually become partners. Typically, after a few years as an employee, physicians are provided partnership role by way of purchase opportunity. The purchase would be based upon the value of the equipment, furnishings, accounts receivable and goodwill. Most practices tend to lease their medical office space, so no value is attributable to bricks and mortar. However, some practices own the real estate and issues arise as to whether incoming physicians will be provided ownership in the real estate.

The majority of medical practices are still structured as professional corporations. Typically, if the real estate is not leased, it will not be owned by the practice corporation itself for both liability and tax reasons. Rather, the facility or condominium will be owned by a separate entity. This entity is commonly structured as either a partnership or limited liability company, or if a single doctor is involved, the real estate could be owned jointly with the doctor’s spouse. Thus, a physician may become a partner of the medical practice entity without becoming a partner of the real estate entity.

In the past, most physicians showed little interest in becoming a partner in the real estate entity, not having a true understanding of commercial real estate as an investment. Additionally, they may not have been able to produce the financial requirement for buy-in to the entity or felt the location was not suitable. Whatever the reason, it was more likely than not that an incoming physician did not consider the investment. Today, with greater access to information and investment opportunities, physicians are very interested in real estate.

Prior to being added to a practice group, it is important to know the culture and seek like strategies for ancillary or investment opportunities.  As per example, most senior physicians within the practice group may not share access to real estate ownership. Because real estate development, purchase and management is a significant investment of money (and time), it is understandable that incoming physicians would not be allowed access. Because of this, the senior physicians maintain that they will hold on to it as an investment for, or throughout, retirement. We are seeing some leeway here, though.

As an incoming physician, it would be important to take a good look at the real estate piece, no matter the situation of lease or purchase. If it is a lease, there will exist a written lease between two entities. The lease should not be above fair market value rental rate and in place for a reasonable period of time, both to be discussed further. If the rent is too high, perhaps to provide tax benefits to the owners of the real estate, there will be less capital to improve the practice. If the term is too short, you will face renegotiation of the rent too often, which will tends to create more advantage for owners that lease space. If the term is too long, the rent will likely step up each year to become a larger proportionate share of liabilities for the practice group.

In the situation of ownership, if the real estate is owned by one or more senior physicians, the practice will likely seek to relocate if they decide to sell the real estate. In order to avoid this situation, in addition to a long-term lease or a short-term lease with options to renew, the real estate owner(s) could give the non-owner practice partners an option to buy the real estate at an appraised value upon retirement or death, or a right of first refusal.
Now let’s assume that all parties wish to have an incoming physician buy in to the real estate entity. This may either occur at the time as the purchase into the practice entity or at the point the doctor has completed his or her buy-in. If the latter option is pursued, presumably, they will be more able to afford the buy-in to the real estate. In any event, the main issues will become the buy-in price and manner of payment.

The price can be determined in a few ways. One is simply by mutual agreement of all parties. Another method is simply using the original cost of the real estate if it was recently purchased, or the original cost plus annual CPI (Consumer Price Index) increases. The most common method, however, is by means of an an appraiser or broker opinion of value through appraisal or our brokerage entity. The fees could be as low as $500.

Once the price is determined, the manner of payment needs to be approached. One option is to simply pay each owner his or her share up front. If that is not possible, a promissory note could exist in favor of each real estate partner with payments made over time with interest.

A common method exists for partners to refinance the mortgage to as close to 100 percent financing as possible. The new partner would simply sign the new mortgage and be equally responsible for the debt without having to pay any out-of-pocket buy-in. The existing partners are able to pull out the cash equity at that time to realize a return on their investment. When interest rates are declining, refinancing is more likely to occur. A caveat is, if interest rates increase, the existing partners may not be willing to choose the method of refinancing due to larger interest payments, and, presumably, lesser real estate value.

Should a partner leave or retire from the medical practice, will they become obligated to sell his or her interest in the real estate and should the remaining partners be obligated to purchase his or her interest? If so, at what price? Thus, it is important to have the document treated carefully or via retainership of legal counsel.

Often times the inclusion of a physician to a practice group involves several items, including real estate, that should be addressed with business intelligence. MREA is capable of assisting in your next physician addition, partner acquisition or real estate transition. Contact your local representative for assistance.

Ambulatory Surgery Center: From Concept to Reality

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In our continued expansion throughout the State of Texas, we are regularly posed questions pertaining to financial feasibility and cultivation of an ambulatory surgery center. We would like to respond by providing a few feasibility studies, to include financial summaries, in a later post. This post will be dedicated towards setting up the ASC entity, determining consultants, bidding to preparation for construction.

1.  Once you have determined that it is feasible to build an ASC, you must first consider its legal structure. Will you consider owning the ASC with partners outside of your medical practice? Many physicians adopt others when building an ASC. But, prior to making this decision, it is important to determine the legal risks associated with joint ownership of an ASC. Many are familiar that Stark Law has limited scope for operations within a surgery center, yet several other legal issues such as non-compliant physicians, indirect referrals, and billing matters may arise and should be considered and should be explained to avoid contagion within an ASC.

If the ASC is going to be built on existing land investment, it is important to determine how the land should be owned. Should it be in its own legal entity or part of the ASC entity? Will all of the owners of the ASC own the real estate? Owning the real estate in a separate entity may make the cost of the ASC more affordable for others. Separate ownership of the real estate may also provide an income stream for years to come. If your ASC is owned in a separate entity, you should consider the tax implications with receiving income from more than one employer.

Your legal counsel should review with you the issues surrounding the building of an ASC. They include, at a minimum, HIPAA, Anti-Kickback Statute issues, fraud and abuse issues, and antitrust considerations.

Once you have evaluated the legal considerations and determined the structure of the organization, your legal counsel should prepare a number of organizational documents. Within this packet, you should have an Operating Agreement which details how the business of the ASC will be run. The Operating Agreement will clearly define the initial and supplemental capital contributions of each member of the ASC as well as how contributions will be required. The Operating Agreement may also contain a non-compete provision prohibiting investors in the ASC from owning an investment interest in a competing ASC within a specific geographic area. You should consult with your attorney regarding the enforceability of non-competition covenants. The Operating Agreement will also determine how new partners are admitted, and the buy-out of existing partners. A valuation formula for the Member’s ownership interest should be included in the Operating Agreement. The Operating Agreement should also contain a conflicts of interest provision which requires members of the ASC to disclose potential conflicts or business opportunities to the ASC.

2.  Moving forward, now that a viable project exists, it is time to turn the attention towards the next step, which is to contact the state where the facility will be constructed to determine the steps necessary to complete the project and comply with the necessary state and federal requirements. Texas will send you a packet of information detailing this process and advising you of the significant building requirements.

In conjunction with this, it would be advisable to interview architects. In the process of interviewing candidates, be sure to qualify each one based on their experience designing ASCs within Texas. ASCs can be complex structures with significant engineering involved. Do not proceed without a qualified architect and engineer who commit to providing you with a fully engineered plan. As a caveat, if the architect advises you to proceed on a “design build basis” where the contractor and his subcontractors provide the engineering, you may be inviting delays in getting the center built.

The basic decision of what is to be built is largely based on what procedures will be performed at the ASC. If a constructing a single specialty ASC, it is common for physician to assist in direction for the layout of the ASC. Certain spaces are required inside the ASC to support the surgical procedures you intend to provide. The list of all of this space is called the program. Once a program has been developed, the floor plan layout can be done.

For purposes of certification, Texas requires floor plan review prior to proceeding with formal construction planning. Once the floor plan has been approved, your architect can proceed with the construction drawings. A significant period of time for this should be alotted, as most projects sit in idle during this phase.

Most owners want control of bidding for their projects. However, because the industry is seeing a greater number of projects moving forward, some are being performed within a construction management agreement. The advantage to construction management is that if you have advisory through experienced general contractor, or knowledgeable advisory, the process can ultimately save money within in the design process. The contractor can provide a valuable engineering function by recommending less expensive ways to construct the building or less expensive materials for the project.

3.  If you decide to bid out the ASC project, we recommend you get bids from multiple contractors. Your architect and consultants should make a recommendation as to which bidder wins the contract. Ultimately, it should be the owner’s decision, although the architect and consultant’s recommendations will remain of serious consideration.

Once the contract is awarded, be sure to sign a contract for the construction of the project. Also be sure to set out expectations for payment to the contractor at the start of the project so everyone knows what is expected of them. You should expect multiple requests for payment during the project based on a percentage of the project that is completed.

The architect and consultants should provide regular onsite visits. A report should be available on a bi-weekly basis to keep the owner apprised of the progress being made. Construction meetings with the subcontractors, general contractor and the owner’s representative should be held along these same scheduled intervals.

Please look forward to subsequent posts regarding feasibility studies, equipment, or licensing of an ambulatory surgery center.  Contact Robert S. “Bob” Lowery of MREA for any questions during any part of the planning or implementation process of your Texas ASC.

Joint Ventures for Outpatient Facilities

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Historically, hospitals have entertained reliable income streams from the their surgical and diagnostic imaging components. Now, because patients have greater access to physician-owned surgery centers, coupled with advancements in imaging technology, it is increasingly difficult for hospitals to have income certainty from these procedures within a hospital setting.

On the other hand, proposed and already implemented changes to the Medicare payment system suggest that physician providers face the threat of losing a greater percentage of revenue. Thus, many are seeking partners with hospital systems from a joint venture perspective.

1. The most common form of joint venture is the division of ownership between the hospital and physicians. In this agreement, the hospital and participating physicians form a new entity and each contribute funds or lender approved interest equal to their pro rata ownership in the new entity. The equity investment model has proved to be a “win-win” situation for both the hospital and the participating physicians. The hospital better secures a long-term relationship with referring physicians, builds loyalty and trust, and recaptures a lost revenue stream. The physicians are better positioned for a positive ROI and can focus on patient care rather than highly detail-oriented tasks and risks that exist in real estate ownership and management. A potential drawback under the surgery center setting is that the payment received under this form of joint venture can be significantly less than what the hospital would receive for the same procedures performed on a hospital inpatient basis.

2. The healthcare industry has seen more “under hospital arrangements” over the past decade, although many have been recently banished from hospital settings. While this model can take on many variations, several characteristics are in common. The participating physicians provide to the hospital a certain ancillary service (from the use of primary equipment to turn-key management).The hospital purchases that service on a “per-click” or “per-use” basis. The hospital is the billing entity and is paid under the hospital ambulatory payment classification codes. The primary advantage of an under arrangements model is the higher payment received by the hospital as a result of the hospital billing under the hospital payment system. Moreover, the hospital bills under its managed care contracts, which commonly provide for higher payment than what is received by freestanding outpatient facilities. A few potential drawbacks to the under arrangements model are the increasing regulatory scrutiny of hospital and physicians transactions. Also, because the hospital performs the billing of the surgical procedures, the Stark law is in effect.

3. A standard block lease is where the hospital leases ancillary equipment or management responsibilities to participating physicians in return for a fair market value lease. Each participating practice bills under its own group number. The primary advantage of a block lease arrangement is its ease to initiate and terminate. Since a participating practice does not have ownership of the equipment or facility, the hospital or physician practice can quickly terminate the relationship. One major disadvantage to block leasing arrangements is that the physicians do not feel like ownerHistorically, hospitals have entertained reliable income streams from the their surgical and diagnostic imaging components. Now, because patients have greater access to physician-owned surgery centers, coupled with advancements in imaging technology, it is increasingly difficult for hospitals to exercise income certainty from these procedures within a hospital setting.

4. The shared expense model is a variation of the block lease model, except that instead of each practice leasing blocks of time, it would assume a commercially reasonable proportion of the costs of the diagnostic business and utilize the imaging equipment on a first-scheduled, first-served basis. From a regulatory perspective, the shared expense arrangement may be considered more aggressive than a block lease arrangement because it will not qualify for safe harbor protection under the Anti-Kickback Statute. However, many physician practices may still prefer this type of an arrangement due to its added flexibility of being able to schedule patients on a first-scheduled/first served basis and paying expenses in a manner that more closely reflects the actual use of the imaging equipment.

MREA is a truly comprehensive medical real estate platform that plugs the gaps from that of traditional buy-sell-lease-manage commercial real estate companies. To receive a complete package of our healthcare services, real estate offerings, consulting assignments, or merger/acquisition successes, please contact Robert S. “Bob” Lowery at 713-701-7900.

Texas Healthcare Mergers and Acquisitions

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Amid an improving economic climate, and provided that a long-term reorganization of health care insurance and delivery model remain active, mergers and acquisitions will continue to increase rather noticeably.

While the healthiest corporations and service providers from the broader industry are consolidating and shifting the majority of their investment dollars overseas, many medical providers have built stand-alone facilities that are too enormous in size and cost to simply serve their niche within a locale, larger community or city. While not all regions are alike, especially when considering that of Texas’ strong population influx,  international investment and patient demand, many large physician groups and systems in the United States are weary of growing outside of physician boundaries and are awaiting coercive change to help define their future.

The reasons for staying local are many, as suggested by several insiders. One is the contention regarding regulatory influences located in municipalities, cities and states and the inability to structure same healthcare delivery models state-by-state. Another is that, commonly during stronger economic times, organizations tend to compete over the same clients, or patients for the sake of this article. As such, nearby outpatient facilities and surgery centers will continue to be a viable growth strategy. Another factor has to do with the influence of key physicians within the hospital system who would much rather drive to their practice, or investment, than fly. The last reason that a business model may remain local is due to the lack of familiarity and partnership with qualified business professionals to support and grow operations outward, rather than upward and around.

How Quality Leadership Creates Long-Term Synergies for Healthcare Mergers and Acquisitions

Mergers and acquisitions will grow and will affect healthcare providers and physicians.

During a healthcare merger or acquisition, the feelings of physicians and employees involved usually swings one of two ways. Sometimes physicians are excited about the prospect of working for a larger, stronger post-merger organization, especially if it creates opportunities for ownership, seniority or stability. More often, though, the physicians and staff see themselves at odds with new ideas, management styles or facility relocation.

Without third-party leadership, the nightmares that may occur with existing administration, especially if undersized, have the potential to create potentially undesirable circumstances that could jeopardize the transaction simply through association. Working with the conflicting interests of two cultures to form one means standardizing policies, procedures and systems. In this case, facility administrators have to reach out to coordinate with other real estate administrators, executives and physicians to determine whether to consolidate facilities with overlapping functions, and if so, how that should be done and which buildings should be divested. The exact criteria varies and the process must be handled appropriately so that all interests remain confidential, costs are minimized and physician continuity is ensured.

No matter with whom the provider chooses to work, every merger or acquisition is different, and therefore each requires a separate strategy to reduce heavy cost and reduce or eliminate potential redundancies. Our due diligence and merger planning team is responsible for looking at every aspect of business side of the transaction, from financial data and corporate philosophies to real estate holdings, and then work to construct a plan for the transition into the post-merger environment.

As cumbersome as this appears to be, it is very surprising to note how most large practice groups and healthcare providers in the past rarely sought such assistance. This expertise is very common within the corporate real estate world to eliminate conflicts of interest and provide confidentiality and goodwill among employees. Today, it is imperative for healthcare providers to seek third-party facility transition executives that are responsible to the healthcare industry, have the resources and capability to provide informative research and comprehensive reporting, maintain a quality reputation within the sector without conflicts of interest, and can intelligently advise across business, real estate and merger or acquisition activities.

A Healthcare Real Estate Success Story

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Given economic and regulatory uncertainties, a provider of healthcare services retains our firm to improve relationships with the physician practices that occupy several medical office properties around their hospital campuses.  This essentially enables the provider with an opportunity to obtain positive economic outcomes such as tenant retention, property referral, good will and financial clemency.

Additionally, the provider wants to measure its own operations through the simple method of acquiring physician input regarding service delivery, as well as report on the present adequacies when compared to other like providers so as to audit possible tenant separation.

MREA collaborates with the client to coordinate a proprietary satisfaction assessment specifically geared towards to medical tenants.  This includes:

  1. Tenant survey of satisfaction with building services, property management performance and lease renewal intentions
  2. Action planning reports for each hospital campus, region, service provider and the national portfolio, highlighting performance trends, strengths and weaknesses
  3. Comparative performance analysis of year-over-year results and versus report
  4. In-depth, statistical analysis of property and tenant characteristics influencing satisfaction, retention and relationships
  5. Recommendations for the enterprise and each service provider to improve customer service delivery, strengthen relationships and boost retention
  6. Customized presentation of the results and recommendations to each service provider’s national account management personnel and property management teams

While we will keep our results confidential, based on assessment the client:

  1. Targets improvement initiatives toward highly influential property management practices, such as frequency of proactive communication with tenants
  2. Requests action plans for improvement from each hospital campus and service provider
  3. Increases tenants’ satisfaction with management by 10% to exceed benchmarks
  4. Improves tenants’ likelihood of renewal rate by 5%
  5. Identifies “at-risk” tenants whose lower satisfaction level and higher likelihood of defection warrants immediate property management follow-up
  6. Strengthen physician relationships with property management and hospitals

We are proud to offer this service as part of a growing list of healthcare real estate competencies located here.

Effect of Rising Interest Rates on Commercial Real Estate

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We admit it is dangerous territory to write about rising interest rates, especially when predicting a potential up or down movement. We have not come anywhere close to the topic over years of participation in the sector.

Around 2005, there was heightened speculation that treasury yields would rise and the undoing of commercial real estate would begin. It never happened, and 7 years later some of same properties are trading at double that of 2005 prices, an approximation that can be cited with hundreds of local examples.

So, why are we touching on this subject today, especially given the number of forecasters whose predictions have laid years of waste pouring over the topic? Well, with the stock market improving without real improvement in bond yields, due in part by the Fed buying bonds and keeping rates artificially low, one of two things will likely occur; the stock market will need to drop or treasury yields (and their direct correlation with mortgage rates) will move higher.  Both should be moving in tandem, yet, they are not.

Interest Rates and Cap Rates

When talking about the potential for rising mortgage rates, we would be lax in our responsibility not to mention it impact on capitalization (cap) rates, a simple measure of return that fuels commercial real estate investment demand.

Follow me here…If you are to consider the cap rate equation from the perspective of a math or economics professor, high cap rates or high investment profitability is a result from high net operating income (NOI), usually a product of higher rents and/ low relative property values.  Low cap rates and low profitability is a result from lower rents and/or high property values.

In recent years, cap rates have trended parallel to interest rates. And, with interest rates (and mortgage rates) at all time lows, cap rates have moved below where investors are comfortable for necessary returns on a commercial real estate investment. Thus, cap rates are now in limbo.  So, if bond yields and mortgage rates move higher, we could see where this will not have an immediate impact on investment.  Actually, it might spur ‘real’ investment back into commercial real estate.

Historically, a decline in interest rates and cap rates affected the commercial real estate market where property values improved; rents, or income, remained stable or fell.  The upward climb of property values from the availability of lower rates typically had a direct correlation to a period of low to modest stock market returns and significant move into commercial real estate.

To supplement, cap rate values have remained higher than prevailing 10-year treasury bond yields.  The simple reason is that if bond yields were to rise above the cap rate return of the property, any property would be difficult to sell.  This is because the return is less than the bond yield.  Why would you own real estate if you could just own a treasury bond.  Similarly, if you buy a bond at 4% and the value of the bond goes up to 6%, not many are willing to buy your bond back at face value.

Conclusion

In a period where mortgage rates could potentially rise dramatically, owners are hoping for an increase in income (rising rents and/or rising demand for space) to offset the damage incurred by higher financing costs and, most recently, inflationary concerns.

Medical Office Performance Update

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Understanding the advantages of a medical office property can provide stability to an otherwise risky real estate investment portfolio. The uniqueness of this commercial property type makes it a favorable investment, especially throughout ‘down’ economic cycles when stability, rather than overexposure, is sought to balance a portfolio. This, as evidenced by investments in 2008 and 2009, a few of the strongest years for medical office investment in decades and, notably, the worst for other commercial sectors happens to be the most recent phenomenon.

As for today, when greater threats appear to loom on the horizon and political strife sits at its highest plateau, and as office and industrial properties attract greater attention due to an improved economic position in the U.S., the healthcare sector’s investment has seen a moderate decline in volume of transactions. Most experts suggest that early-to-mid 2013 will see a resurgence of capital into the medical office property as hospitals seek to monetize real estate to offset costs associated with administrative growth, a precursor to healthcare reform.

So, depending on the current status of the property, and given a 12-month window with which to lease, redevelop or stabilize the property, the direction chosen today will likely determine if the property has the potential of resale during the next cycle.

What should you be familiar?

It starts with our research. Keen insight begins with dedicated research resources that provide for the persistent investigation into changes in physical relocation and current and future regulatory implementation. Our employed fact-finding & intelligence unit corroborates their mined data with paid, less reliable online resources and government data. While the cost of obtaining information remains high when paired to its return on investment, the overall collaboration of multiple data channels remains essential for the specialist whose clients require the most candid data for appurtenant decision-making.  So, investigation into your premises is a first step to understanding potential referral patterns and tenant mix to maximize valuation.

Second, and of greater importance to sale of the asset, the medical office opportunity should have a hospital nearby that demonstrates economic strength mainly through specialized services that provide for in-house referrals, physician growth and collaboration. Orthopedic, Cardiology, Women’s Services and Gamma Knife procedures have been lucrative hospital services and, in turn, have provided for higher effective rental structures throughout these medical office buildings. While a property will fluctuate in transacted sales price, such services attract higher capital investment because of hospital’s strength from physician services and specialties. Thus, you can see where healthcare reform, and its proposed focus on volume, rather than profitability, has the potential to water down hospital revenues and, ultimately, potential sales prices.

Another factor to consider is the area’s residential growth of the 3-mile radius. What is the rent to own ratio? Younger or older demographics? Household income? Over the past few years, investment has sought properties that provide for economic stability through employment and demographic growth. This trend will continue until it is known whether healthcare reform provides to be a viable investment alternative or an epic failure in a time of the state’s and nation’s budgetary complications. Remember, older and wealthier populations still utilize the majority of healthcare services and are more likely to see a physician out of want, rather than need, which will continue to guide investment.

When analyzing how a medical office property will/can perform, it is essential to seek guidance from a qualified professional team dedicated to the industry.  Our associates maintain years of exceptional, professional service to the Texas medical communities and with an expansive proprietary database, widely recognized as the best in the business, we hope you will seek out our firm for your medical office building needs.

This post was written by Robert S. “Bob” Lowery, Managing Partner of MREA | Medical Real Estate Advisors.

5 Healthcare Real Estate Recommendations From MREA

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The most comprehensive weekly market report is specifically designed for healthcare providers, owners and investors. Our research staff is professionally dedicated to providing the most accurate summary of the week’s events. We are excited to say that over 11,000 readers have personally subscribed! Sign up here.

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Will Lease Accounting Changes Affect Healthcare Providers?

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Just when our clients were becoming comfortable with the general premise of healthcare reform and the likelihood of declining medical reimbursements for years to come, enter the August 2010 Financial Accounting Standards Board proposed accounting rules for real estate and equipment. These changes have the potential of tremendous impact on equipment and real estate via the composition, execution and implementation of leases.  In its current form, and depending on the breadth of an organization’s lease commitments, this has the effect of throwing tens of thousands to millions of dollars of lease commitments onto each balance sheet.

Speaking specifically to the healthcare industry, real estate and equipment leasing has been utilized extensively to assist with several business pressures, whether it be administrative, technological, competitive or regarding growth plans. This has been the preferred method, and a substitute to purchasing which requires significant cash outlays, among other prohibitive items.

Lease Accounting Changes

To explain where we are potentially going, we should address where we are currently. The Generally Accepted Accounting Principles (GAAP), which is code for how CPAs and businesses prepare financial statements for income and expenses, assets and liabilities, draws a line between an operating lease and a capital lease. Under the new guidelines, the difference in classification will be deserted.

It might surprise you, but, according to several sources within the accounting industry, the distinction should be abandoned. This is because the current trend has been where businesses place lease commitments off of the balance sheet, whereby financing new transactions without recording existing lease commitments as liabilities.

It has been suggested that the effect of adoption will add an estimated $1.3 Trillion onto balance sheets of businesses, significantly impacting both assets and liabilities of companies, which is to include private and non-profit organizations. Under the proposed standards, long-term real estate and equipment leases will be required to be disclosed, similar to that of a purchase.

The greatest impact would be that of dumping your equipment and real estate onto the balance sheet, but, even more complicated is that it would be necessary for lessees to calculate what is known as an ‘expected outcome analysis’. This can be defined as the present value of future lease payments. As each lease seems to differ from one other, under the rules it will be required by the lessee to determine potential financial outcomes within leases, including extensions, CPI adjustments and expense reimbursement items such as improvement amortization.

The new measures would require revisions at each reporting period. For each period, the changes stipulate that the income statement be revised to reflect the interest expense component, as well as losses to the asset.

Concerns are certainly mounting. Many are not sure how dramatic of an impact the shift will be, as well as their difficulty in determination of long-term forecasting models for relatively unpredictable financial outcomes. This uncertainty would create a deterioration of the use of lease term variables, to be explained further. Other criticisms include that of the time and costs transferred to real estate owners and businesses to implement such change.

As for impacts of leasing changes with regards to the healthcare industry, there are several as well. As was evident by medical real estate development growth that has occurred on and off the hospital campus, leasing has been a very effective tool for hospitals, now referred to as medical centers.  These systems developed facilities to provide for favorable referral situations with physician groups to provide for and offset the enormous costs associated with operating a hospital. As for equipment leasing, most of these institutions have levered improving medical and technological advances by leasing equipment, so as to not become tied to the purchase of vital items, essential in patient satisfaction, that may become extinct within a short period of time.

The potential effects on real estate could have significant impact for systems and physician practices that have used lease transactions to add assets or expand in geography, now essentially having to make room on the balance sheet for all of it. Quickly, some will find themselves flirting with the line of allowable leverage that demonstrates necessary stability for the purposes of future investment. Arrangements such as ground leases or subleases have the potential to become negative consequences, rather than the opposite. It is no doubt that many healthcare providers are in their respective war rooms developing strategies designed for lease administration changes. MREA is currently working with hospital systems, large and mid-size physician groups to educate about such changes.

As for modifications to these proposed, monumental changes to accounting principals, please contact our firm.  A new exposure draft is to be made public in the second quarter of this year.

MREA – Medical Real Estate Advisors was strategically designed to assist healthcare providers via our ‘healthcare business meets real estate’ mission statement. The firm’s owners are actively licensed CPAs, principals and real estate practitioners that, when utilized properly, have the ability to provide streamlined solutions to complicated business and real estate items that otherwise would absorb valuable time, multiple contacts and resources to remedy. Contact your representative today or go to http://mreausa.com.

Healthcare Facility Leasing FAQs

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We are commonly asked questions that pertain to concerns which are healthcare industry-specific, yet we can always find a way these issues relate back to the contractual obligations of real estate commitments.  As a courtesy to those that are seeking guidance explicitly for when the rubber meets the road (real estate meets healthcare), we have provided some fairly uncomplicated scenarios that will likely exist in a health facility lease transaction.

Landlord Vs. HIPAA
Commonly, a lease agreement will allow the landlord entry onto the premises for the purposes of inspections and repairs.  HIPAA provides guidelines to protect medical records and personal health information.  A lease within a medical facility will typically provide that the landlord may not enter an exam room with patients present.  Further, most leases will indicate that any location within the spatial premises leased by the tenant, if entered, will have the potential to breach privacy or confidentiality of patients or medical records.

Tenant Vs. Medical Waste
A medical lease agreement will typically include a provision that prohibits a tenant from using or storing any hazardous materials on the property without the consent of the landlord.  If the tenant will require the use of such materials, the lease will commonly indicate that the materials commonly used in concert with the permitted use of the leased premises will be allowed, as long as the materials are stored in compliance with strict regulatory commitments.

As for the disposal of hazardous waste, leases commonly provide that the landlord will be responsible for janitorial services, but will require the tenant to arrange for its own disposal of medical waste.

Stark Law Vs. Landlord/Tenant
It is important to consider if a relationship exists that has the ability to breach Stark laws, or potentially, Texas law.  The Anti-Kickback Statute deems it a felony to offer, tender or receive fee, or compensation, if the payment is determined to influence referrals for patients.  So, it is important for a lease to exist and to comply with the following:

  1. Be in Writing
  2. Identify the Premises
  3. Term of Lease at Least 1 Year
  4. If Interval (Time Share, etc), Lease to Specify Schedule and Rent for Interval
  5. Rent must be Fair Market Value

Permitted Use Vs. Technology
A lease agreement will include a permitted use provision that restricts the use of the space to certain business operations.  Yet, a tenant wants to maintain flexibility, especially with the newly minted technological changes that are required to adapt and compete within a specialty.  So, a tenant wants the provision to be as broad as possible, while a landlord seeks to restrict the use to improve tenant mix and provide other tenants with exclusive rights.  While a rare bone of contention today, technology will eventually force tenants to seek very general, or highly specific opportunities.

Building Vs. Equipment
The medical industry has some of the most cumbersome and demanding equipment.  It requires specific attention when placing on the premises of a multi-story structure.  Thus, some buildings have special provisions for weight distribution or electrical capacity.  The location and installation of necessary landlord and tenant is commonly addressed in lease.

Improvements Vs Landlord/Tenant
The lease agreement will provide how each party will become responsible for design, materials and installation of the tenant’s improvements.  While a highly negotiable item within the lease, it should determine the control of implementation and ownership of improvements.

Lease Vs. Physician Practice
A greater number of leases are requiring personal guaranties from key members within a physician group for the purposes of adherence to contractual obligations.  With more physicians defecting to hospitals, merging practices, or even leaving certain jurisdictions, we are noticing considerations for physicians to be released from guaranty if the leave the practice, while including those that enter.  Other limits include guaranty amounts proportionate to ownership share of practice.

These are abbreviated responses to a few common inquiries pertaining to medical real estate, none of which constitute legal advice.  Please make sure to contact Robert S. “Bob” Lowery for guidance with your healthcare real estate decisions.