Report on Medicare Compliance Volume 28, Number 21. June 10, 2019

Ground Leases May Lack FMV Support

Ground leases may be vulnerable to allegations of Stark violations. This comes up when a hospital owns land and leases it to a developer with physician ownership to build a medical office building (MOB). “Hospitals want to control the real estate asset, but they don’t necessarily want to have all their money tied up in real estate,” Musinovic explains. After the building is built, the hospital and independent physicians often lease space from the developer, he says. If the developer has physician ownership, the ground lease rates have to be FMV and take into account all the materials terms of the lease. “We have seen hospitals enter into ground lease arrangements with developers for nominal sums (e.g., $1 per year) and long lease terms (e.g., 50-100 years) without having any FMV support,” he says. “There are a lot of risks there if the developer has physician owners because the ownership by those physicians could trigger the Stark Law, in which case the ground lease would have to meet an exception under Stark, such as the indirect compensation arrangements exception.”

Just like a mall developer, the MOB developer wants to attract marquee physician tenants, such as a high-profile cardiology group, and may be tempted to offer terms that may not be the average rate for other space in the MOB, Wade says. For their part, the physicians know they have bargaining power and will try to get the best deal possible. As a result, the developer, which may be the hospital or a joint venture, offers the bottom of the FMV range, which may be, for example, 10% below the average rental rate in the MOB, he says. “They don’t want to build an MOB on a hope and a prayer they will fill the building, so they take the risk,” Wade explains. But the developer better have solid documentation to try to justify offering less than the average rent to lock in the high-value tenant.

Lease creep is another risk under the Stark Law. Suppose there are two physician practices on the same floor, and when one moves out, the remaining practice takes over some of the vacant space without paying more rent. “If the hospital knows about it or condones it, it’s a compliance problem,” Wade says. Although the director of real estate may insist it’s not a problem until another tenant moves in, he or she would be wrong. “The hospital has knowledge the practice is creeping into that space and isn’t charging for it,” he says. However, if the hospital is unaware of the lease creep, “I don’t believe you have a per se Stark violation. It’s not an approved use by the administration. That’s theft of that space,” Wade says. “I don’t think you have a Stark violation until you reach the point of knowledge.” He likens it to an anesthesiologist who steals narcotics. “Is that a financial arrangement that implicates the Stark Law?” Doubtful, because it’s stealing. “The only caveat is if the hospital fell asleep with respect to the management of the medical office building,” Wade says.

Tips for Improving Real Estate Compliance

There are other ways that hospitals could run into trouble with leases, Musinovic says. For example, hospitals may not collect all the rent due from tenants who are referring physicians. Maybe the hospital doesn’t accurately escalate rent, or physicians pay rent late and the hospital doesn’t collect late fees that must be collected per the terms of the applicable lease arrangement. Or the two parties have a dispute about the lease, and the physicians withhold rent, and after they come to terms, the physicians pay a sum less than they should have paid under the lease. In all these situations, rent can fall below FMV, pushing the lease outside the Stark exception, “or the parties may be entering into a new financial arrangement that does not satisfy an applicable Stark Law exception,” he explains.

Hospitals also have to be careful of off-lease benefits, including sharps collection services and disposal of hazardous waste, Musinovic says. They can be expensive, and if they’re not reflected in the rent, the stated lease rate may no longer be FMV.

Here are his tips for health systems to improve real estate regulatory compliance (see checklist, below):

• Take an inventory of all leases with referral sources. “Then you can begin to wrap your head around the universe of leases that can expose you to liability,” Musinovic says.

• Develop processes and procedures specific to real estate. That includes a process for entering lease arrangements and renewing them, and a document-creation process. Hospitals also need a rent collection policy requiring all rent to be collected in accordance with the lease terms and outlining a process for collecting rent, which should include escalating the issue to the hospital’s legal department if the real estate department is unable to collect the rent.

• Set forth the requirements for obtaining fair-market valuations for leases and the qualifications for the experts who will perform them. “At a minimum, you want to obtain a narrow fair market value range for lease rates for each building in which you are leasing space” that will account for all the material terms of the transaction, such as tenant improvement allowances and off-lease benefits, Musinovic says.

Contact Wade at bob.wade@btlaw.com and Musinovic at gmusinovic@realtytrustgroup.com. ✧

Checklist for Evaluating Health System Real Estate Compliance

Here is a checklist to help health systems assess the quality of their real estate compliance program (see story, above). It was developed by Goran Musinovic, vice president of Realty Trust Group. Contact him at gmusinovic@realtytrustgroup.com.