Overlooked Items in a Medical Office Lease

As tenants of medical office buildings, medical users create unique leasing issues. They handle hazardous materials, produce biomedical waste, require confidentiality in patient recording, and are in the watchful eye of safety/regulatory bodies. While medical professionals are familiar with these inevitabilities, most of what makes their business unique are rarely found on a medical office lease.

After location identification, the majority of our time is spent negotiating the lease. It has been our observation that many physicians will negotiate and sign lease agreements without the benefit of educated real estate advisory or legal counsel. Commonly, this medical tenant is simply concerned with the general business terms (including the term of lease, rental rate and commencement date) and rarely gives the lengthy document  a second look.

While it is tempting to sign the lease to reduce the amount of time spent towards negotiating or communicating real estate interests, a few select studies have documented that tenants who solicit real estate advisors for their business negotiations tend to have greater business longevity. Because a medical office lease is an expense that often requires a multi-year commitment, tenants should not want to be party to any agreement that is not reflective of their own interests. Below are a few examples of where real estate advisors or legal counsel may be requested:

  • Medical office leases typically offer one of two approaches in which a physician can make improvements or alterations to the rented space. Either the tenant is required to remove all improvements installed during the lease term or all improvements simply become part of the property. While the lease may variably contain language that references one of these two approaches, the fact is, knowing additional expenses are tucked within the lease is unsettling to our clients.
  • Too often, physicians assume that a landlord will provide certain basic services for their tenancy. It should be known that landlords only provide the services that are expressly stipulated within the lease. Often, for example, landlords turn off a building’s air conditioning “after hours”, designated as evenings and weekends. If a medical tenant requires extended evening or weekend hours, advisors may assist, in the very least, by educating the tenant on what can be done to facilitate this request. Similarly, medical practices rely on certain types of equipment that consume significant electrical resources. In this case, an advisor should be able to make certain whether the landlord will furnish the necessary amount of electricity or will charge separately for such extensive use.
  • As a tenant, you want clarity for all financial obligations. Some medical office leases require you to simply pay the established monthly rental rate. Others require pro rata payments of some, or all, of the landlord’s operating expenses and real estate taxes associated with the property, in addition to the monthly base rent. In the past, we have noticed where operating expenses have been interpreted loosely by landlords, which may come as a shock to some. Overall, though, the majority of medical office landlords will adhere to the strict guidelines as set forth by educational bodies that attempt govern building use metrics. But, without proper advisory payment, especially the fluctuated amount, may easily become misrepresented. In order to minimize the financial responsibility for operating expenses, tenants should verify that the landlord’s operating expense calculations are correct and not being overcharged. If the operating expenses include real estate taxes, tenants should request an annual copy of the tax bill. In addition, within the lease, tenants may have the opportunity to verify that the operating expense charges have been accurately calculated.
  • Lastly, while you may think you will never default on your lease, it is hard to ignore default provisions. Remember, defaults may not necessarily be the result of bad faith or bad action. A non-monetary default may include failing to maintain the premises or violation of one specific clause within the complete document as written by the landlord’s counsel. Some leases provide a certain time period to “cure” the default, but some do not. It is necessary to identify the potential for violations or default and discuss each one.

It is of great importance to seek the guidance of experienced healthcare real estate advisors or counselors to negotiate the lease in an effort to meet the tenant’s professional needs and insure the continued health of their medical business.

Ambulatory Surgery Center: From Concept to Reality

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.

The Stark Law and Healthcare Real Estate

Everyone working in the healthcare real estate sector should have some basic knowledge of the Physician Self-Referral Act, otherwise known as the Stark Law. In a nutshell, the Stark Law prohibits a healthcare service provider, such as a hospital or outpatient facility, from submitting claims for Medicare/Medicaid reimbursement for services rendered to a patient referred by a doctor with whom the service provider has a financial relationship unless the relationship fits within certain exceptions. The public policy rationale was to discourage physicians from allowing financial considerations to influence their professional judgment.

How does Stark impact medical office building leasing and development? When a physician leases office space from a hospital to which he refers patients or when a hospital leases space in a building owned by a referring doctor, the lease is considered a financial arrangement subject to Stark restrictions. As long as a specific lease transaction between a hospital and a physician continues to satisfy a few conditions, no Stark violation will result. These lease exception criteria include: a written lease that is signed by both parties that adequately describes the leased premises; a term of at least 1 year; premises that are commercially reasonable for the intended purpose (the intended purpose must be legitimate from a business standpoint).

Unfortunately under Stark there is no such thing as a permissible “technical violation,” that is, any violation, however insignificant or inadvertent, is a violation of a federal statute that carries stout sanctions imposed by the Centers for Medicare/Medicaid Services. These Stark sanctions include civil monetary penalties (up to $15,000 per claim submitted to CMS while the violation existed), exclusion from the federal Medicare/Medicaid programs, and exposure to whistleblower lawsuits. The reality is that most hospitals and hospital systems that own physician office space likely have dozens if not hundreds of technical, inadvertent violations of the Stark Law related to their leases with physicians or other referral sources. Until now, hospitals have dealt with this potentially serious situation by correcting any violations and moving on. The correction might take the form of executing a lease amendment extending a term, obtaining a missing signature or attempting to collect back rent.

The impact from the new Stark self-disclosure rules could be significant. From the perspective of a hospital buyer, there may be a dampened enthusiasm for new transactions involving the purchase of MOBs, especially where the seller is an asset-challenged, not-for-profit system whose offer of  indemnification against Stark liability is not exactly gold plated. It is not unusual for Stark violations, both technical and substantive in nature, to be discovered during the due diligence phase of such transactions.  Potential hospital buyers will be less willing than ever to pull the trigger. From the hospitals’ standpoint, however, the changes could enhance the motivation to monetize their MOB portfolios. Monetization could accelerate in an effort by these service providers to shield themselves from the perceived arbitrary nature of CMS-enforced settlements following the now mandatory self-disclosure laws and the obligation to refund payments to CMS.

Time will tell with regard to the approach CMS decides to take, but in the interim, the name of the game should be reducing exposure to risk. This desire to reduce risk will have ripple effects through the healthcare real estate sector of the market.

7 Strategies to Implement Prior to a Lease Renewal

Be Prepared To Walk Away

The biggest mistake many tenants make is not developing legitimate alternatives to their first choice, whether a new space or a lease renewal. If a landlord believes you’re not willing to relocate to a comparable property, you lose your negotiating leverage.

Begin the Process Early

Time should be your ally, not your enemy during negotiations. Landlords know that the managers of other buildings can take six to nine months to create a space plan, obtain construction pricing, agree on a rental rate, prepare a lease document and ready the space for occupancy. If you wait too long before asking for a renewal proposal, you’re telling the landlord that you’re not considering any other options.

Capture the Big Picture Before You Start Negotiating

Is the building being sold? Is the largest tenant moving out? How much free rent did the last tenant get? Does the building have HVAC or parking problems? What is the landlord’s financial situation? Candid, complete answers may not be forthcoming from the landlord or landlord’s broker. A large commercial brokerage that has access to such items is mandatory, as they will impact your lease decision and negotiation.

Make Sure Landlords Are Competing For Your Business

The key to a successful negotiation is creating competition between your current landlord and other landlords in the area. You should have an experienced adviser providing the comparable market research, lease comparables and the negotiating expertise to create a competitive advantage.

It’s In Your Best Interest To Have A Professional Negotiate On Your Behalf

Unless you’re a commercial real estate professional, it’s not a good idea to negotiate a lease deal directly with the landlord’s broker. An experienced tenant representative will help ensure that you receive the best possible rates, terms, incentives and lease clause protections. Remember, the landlord’s representative negotiates leases every day; you may do it once every 5-7 years!

Hire A Tenant Representative

Occasionally a landlord will “try to save you some money” by discouraging you from engaging a tenant representative. Don’t be fooled. He’s not doing this out of the goodness of his heart. He knows that without a tenant representative you’re more likely to be in the dark about market rates and complicated attorney drafted lease items.  Also, you are far less likely to shop the market or consider other lease or purchase alternatives. This equates to more money in the landlords pocket.

Make Sure You Are Comparing Apples To Apples

Business owners who are not experienced with commercial real estate often find it difficult to perform a true “apples to apples” comparison of different facility choices. Lease terms such as full service gross, modified gross, triple net, tenant improvement allowances, rental abatement, escalations, base years, operating expense stops and loss and load factors can obscure the true amount you’re paying and make legitimate comparisons difficult. A good tenant representative will sort through all this for you.