Health Care Goes Retail

The increased health care facility need is estimated to be approximately 64 million square feet, and largely focused on community-based outpatient care, which is emphasized in the recent health care reform legislation, as technology outpaces the need for traditional in-patient hospital services and operational efficiency becomes critical. In fact, one consulting firm estimates that the use of outpatient services will grow by more than 21% from 2009 to 2019, while the use of inpatient services will grow by only 1.7% during that time frame.

Increased patient demand and quality of care expectations, coupled with government efforts to control spending, will require health care providers to determine how to best service a growing patient population while simultaneously reducing costs. Notwithstanding the possible repeal of the health care reform law, providers will still need to focus on managing costs and improving the quality of patient care. As the health care landscape evolves, the development of new and more efficient delivery models, such as Accountable Care Organizations (ACOs), is likely to require increased capital expenditures for medical real estate and technology. The shift in the manner health care services are delivered will require the redesign of existing facilities, and strategic location of new facilities. Reduced access to the debt capital markets is challenging health care providers in need of funds to look beyond the traditional methods of borrowing and ownership to maximize the contribution that their real estate assets make to achieve their business and financial goals.

Beyond the Traditional Method

One option health care providers have turned to is the monetization of their existing real estate facilities through a sale-leaseback arrangement or other joint venture-type transaction with third-party partners. The sale-leaseback transaction is potentially an attractive source of capital for providers as health care real estate, now more than ever, is trading at higher values than similarly sized non-medical commercial real estate. The attractive nature of medical real estate has drawn numerous types of buyers and investors to the market ' such as pension funds, private investment funds, and frequently, health care-focused real estate investment trusts (REITs). By engaging in a sale-leaseback transaction with a REIT, for example, providers are able to potentially raise much-needed capital to invest in operations, retire debt, increase efficiency by maximizing the benefits of existing space, acquire physician practices, realize potential tax benefits and, importantly, focus on the core mission of delivering high-quality health care.

Hospital-Type Uses

Hospitals and other health care providers now also are seeking other non-traditional real estate strategies to extend patient market share and provide more cost-effective and convenient medical care by leasing new facilities in community retail locations. For example, a study prepared by the RAND Corporation released in November 2011 found that the use of retail medical clinics increased tenfold between 2007 and 2009. It is increasingly common for health care providers to lease space in community retail centers that are near hospital campuses and more conveniently accessible for patients. Retail health care uses may include walk-in clinics, fitness and wellness centers, ambulatory surgery centers, freestanding emergency departments and primary care physician offices, among other uses. Health care tenants have been able to take advantage of favorable retail lease rates and terms because many retail shopping centers and malls have been hit especially hard by the financial downturn and landlords are eager to fill vacancies. Retail centers may also be particularly attractive to health care providers because the site locations can be designed to accommodate new health care delivery models and provide convenient access points of service to attract patients. Health care leased assets have continued to increase in popularity with investors and landlords as the demand for quality credit-leased properties has exceeded the available supply.

The Advantage for Landlords

Notwithstanding the uncertain future of reimbursements from federal health care programs and private insurers, the increased demand for health care services may make certain health care providers, such as a hospital or health system with a healthy balance sheet, a more desirable credit risk than the traditional retail business owner. Nonetheless, landlords that lease space to health care providers will likely want to scrutinize the credit behind the lease by evaluating the provider's financial diversity, longevity and consistency, as well as its standing with federal health care programs such as Medicare and Medicaid, rating agencies and regulatory boards. If the prospective tenant is a physician group, the landlord may ask for a credit enhancement in the form of a letter of credit, personal guaranties from the individual physicians, or a master lease arrangement with an affiliated hospital.

Health care providers have unique real estate requirements and legal issues in comparison to more traditional retail tenants. A general, but non-exhaustive, discussion of the major distinguishing issues and factors to be considered when negotiating a lease with a health care tenant is set forth below.

• Zoning. The landlord and provider should be mindful of local zoning regulations that may not permit an intended medical use in the desired location. If this is the case, the parties can consider seeking relief from the local land use board. In such an instance, the tenant would want its lease obligations to be contingent on obtaining all necessary approvals for its intended medical use. Municipalities may also require a permit or certificate of occupancy for a new commercial use.
• State and Local Regulations. The landlord and health care provider tenant may need to obtain special permits to operate the health care facility. State regulations also may mandate the staffing and interior design of the medical facility, such as requiring sinks in examination rooms, certain toilets, janitors' closets, soiled linen storage rooms and after-hours patient phone call answering systems. Additionally, many states have specific regulations regarding retail medical clinic-type uses, and other states are in the process of promulgating such regulations as retail medical uses proliferate. For example, Massachusetts limits the types of medical procedures that can be provided at “limited service clinics.”
• Medical Waste. This type of waste will have to be disposed of in a manner consistent with state and federal law, and this may impact the standard terms found in normal retail space leases where the tenant agrees to pay for certain operating expenses.
• Utility Service. Health care tenants must be certain that their retail spaces used for medical purposes have sufficient utility capacity to support their intended use, including electrical and plumbing, which may both be dependent on the types of services offered and equipment housed in the premises. The cost to upgrade these utility services and to maintain the facilities, and the monthly charges associated with the services, are subject to negotiation.

• HIPAA. The landlord's right to enter the premises should be limited due to health care privacy laws. This can include limiting the timing of entry and mandating that a tenant representative accompany the landlord in conjunction with any such landlord entry. Additionally, health care tenants should consider lease provisions that impose obligations on their landlords to protect patient information, such as clarifying that patient records are excluded from any landlord's liens.
• Stark Law and Anti-kickback Statute. In structuring a health care use retail lease, the parties must take precautions to ensure compliance with health care-specific fraud and abuse laws, including the federal Stark and Anti-kickback statutes. The Stark law prohibits a physician who has a financial relationship with a health care entity from making patient referrals to that entity for the provision of designated health services for which reimbursement is sought from Medicare, unless the financial relationship fits within a specified exception. The Anti-kickback law prohibits the payment or receipt (or the offer or solicitation) of any remuneration for patient referrals or ordering services for which payment may be made under a federal health care program. Since the penalties for contravention of these fraud and abuse laws are severe, it is critical for the parties to structure any transaction that implicates either law in a manner that avoids violations. Importantly, the lease should be structured to meet the Anti-kickback safe harbor and/or Stark exceptions, as necessary, applicable to real estate leases. Although the Stark and Anti-kickback laws are codified in distinct statutes and the real estate Anti-kickback lease safe harbor and Stark lease exceptions are not identical, the rules for both have the following general requirements: The leases must: 1) be in writing; 2) be signed by both parties; 3) include a description of all space to be leased; 4) have a term of not less than one year; 5) be for space that is reasonable and necessary for the legitimate business purpose (and, in the case of Stark, be used exclusively by the lessee when being used by the lessee); 6) require rent that is set in advance and is consistent with fair market value, that is, rent that would be charged in an arm's-length general commercial lease, and without a rental formula based on the provider's revenues; 7) not include rent or other charges that are determined in a manner that takes into account the volume or value of referrals; and 8) be for a commercially reasonable business purpose. The importance of careful structuring to abide by these laws cannot be overstated.
• Standard Retail Lease Considerations. In retail leases, as opposed to other commercial leases, additional emphasis often falls on certain specific issues, which will be implicated in the health care use setting as well. These include: non-competition covenants with other retail uses in the center (for example, if the center already has an eyeglass store, its lease may prohibit the landlord from leasing to any other medical uses), hours of operation, trash removal, restoration of space after lease expiration, parking and signage.

Conclusion

In sum, as the demand for quality health care services increases, the need for new and more efficient medical real estate continues to expand, and health care costs continue to rise, physician practice groups, hospitals and other health care providers will continue to seek lease arrangements in more community-based retail locations to keep pace with the rapid evolution of the health care landscape.

Stephen A. Timoni is a partner in K&L Gates' Health Care Practice Group with more than 25 years' experience as a health care lawyer and CPA. He may be reached at [email protected] or 973-848-4020. Daniel A. Suckerman is an associate in the firm's Real Estate Investment, Development, and Finance Practice Group. He may be reached at [email protected] or 973-848-4057. Dean H. Wang is an associate in the firm's Health Care Practice Group. He may be reached at [email protected] or 973-848-4012. All are resident in the Newark, NJ, office.

Few opportunities in niche real estate markets, particularly the medical real estate sector, have been created as a result of the current economic climate and related market volatility, uncertainty and capital constraints. Today's health care real estate market opportunities are being driven by an aging baby boomer population as well as the new health care law, which is expected to result in health insurance coverage for an additional 32 million people living in the U.S.

As a result, there will be an uptick in the demand for new and redesigned health care facilities as health care coverage expands and baby boomers come of age. This includes medical centers of many types of uses, such as physician offices, walk-in clinics, freestanding emergency departments, ambulatory surgery centers, physical therapy sites, fitness and wellness centers, health education facilities and diagnostic imaging centers.

Community-Based Outpatient Care

The increased health care facility need is estimated to be approximately 64 million square feet, and largely focused on community-based outpatient care, which is emphasized in the recent health care reform legislation, as technology outpaces the need for traditional in-patient hospital services and operational efficiency becomes critical. In fact, one consulting firm estimates that the use of outpatient services will grow by more than 21% from 2009 to 2019, while the use of inpatient services will grow by only 1.7% during that time frame.

Increased patient demand and quality of care expectations, coupled with government efforts to control spending, will require health care providers to determine how to best service a growing patient population while simultaneously reducing costs. Notwithstanding the possible repeal of the health care reform law, providers will still need to focus on managing costs and improving the quality of patient care. As the health care landscape evolves, the development of new and more efficient delivery models, such as Accountable Care Organizations (ACOs), is likely to require increased capital expenditures for medical real estate and technology. The shift in the manner health care services are delivered will require the redesign of existing facilities, and strategic location of new facilities. Reduced access to the debt capital markets is challenging health care providers in need of funds to look beyond the traditional methods of borrowing and ownership to maximize the contribution that their real estate assets make to achieve their business and financial goals.

Beyond the Traditional Method

One option health care providers have turned to is the monetization of their existing real estate facilities through a sale-leaseback arrangement or other joint venture-type transaction with third-party partners. The sale-leaseback transaction is potentially an attractive source of capital for providers as health care real estate, now more than ever, is trading at higher values than similarly sized non-medical commercial real estate. The attractive nature of medical real estate has drawn numerous types of buyers and investors to the market ' such as pension funds, private investment funds, and frequently, health care-focused real estate investment trusts (REITs). By engaging in a sale-leaseback transaction with a REIT, for example, providers are able to potentially raise much-needed capital to invest in operations, retire debt, increase efficiency by maximizing the benefits of existing space, acquire physician practices, realize potential tax benefits and, importantly, focus on the core mission of delivering high-quality health care.

Hospital-Type Uses

Hospitals and other health care providers now also are seeking other non-traditional real estate strategies to extend patient market share and provide more cost-effective and convenient medical care by leasing new facilities in community retail locations. For example, a study prepared by the RAND Corporation released in November 2011 found that the use of retail medical clinics increased tenfold between 2007 and 2009. It is increasingly common for health care providers to lease space in community retail centers that are near hospital campuses and more conveniently accessible for patients. Retail health care uses may include walk-in clinics, fitness and wellness centers, ambulatory surgery centers, freestanding emergency departments and primary care physician offices, among other uses. Health care tenants have been able to take advantage of favorable retail lease rates and terms because many retail shopping centers and malls have been hit especially hard by the financial downturn and landlords are eager to fill vacancies. Retail centers may also be particularly attractive to health care providers because the site locations can be designed to accommodate new health care delivery models and provide convenient access points of service to attract patients. Health care leased assets have continued to increase in popularity with investors and landlords as the demand for quality credit-leased properties has exceeded the available supply.

The Advantage for Landlords

Notwithstanding the uncertain future of reimbursements from federal health care programs and private insurers, the increased demand for health care services may make certain health care providers, such as a hospital or health system with a healthy balance sheet, a more desirable credit risk than the traditional retail business owner. Nonetheless, landlords that lease space to health care providers will likely want to scrutinize the credit behind the lease by evaluating the provider's financial diversity, longevity and consistency, as well as its standing with federal health care programs such as Medicare and Medicaid, rating agencies and regulatory boards. If the prospective tenant is a physician group, the landlord may ask for a credit enhancement in the form of a letter of credit, personal guaranties from the individual physicians, or a master lease arrangement with an affiliated hospital.

Health care providers have unique real estate requirements and legal issues in comparison to more traditional retail tenants. A general, but non-exhaustive, discussion of the major distinguishing issues and factors to be considered when negotiating a lease with a health care tenant is set forth below.

• Zoning. The landlord and provider should be mindful of local zoning regulations that may not permit an intended medical use in the desired location. If this is the case, the parties can consider seeking relief from the local land use board. In such an instance, the tenant would want its lease obligations to be contingent on obtaining all necessary approvals for its intended medical use. Municipalities may also require a permit or certificate of occupancy for a new commercial use.
• State and Local Regulations. The landlord and health care provider tenant may need to obtain special permits to operate the health care facility. State regulations also may mandate the staffing and interior design of the medical facility, such as requiring sinks in examination rooms, certain toilets, janitors' closets, soiled linen storage rooms and after-hours patient phone call answering systems. Additionally, many states have specific regulations regarding retail medical clinic-type uses, and other states are in the process of promulgating such regulations as retail medical uses proliferate. For example, Massachusetts limits the types of medical procedures that can be provided at “limited service clinics.”
• Medical Waste. This type of waste will have to be disposed of in a manner consistent with state and federal law, and this may impact the standard terms found in normal retail space leases where the tenant agrees to pay for certain operating expenses.
• Utility Service. Health care tenants must be certain that their retail spaces used for medical purposes have sufficient utility capacity to support their intended use, including electrical and plumbing, which may both be dependent on the types of services offered and equipment housed in the premises. The cost to upgrade these utility services and to maintain the facilities, and the monthly charges associated with the services, are subject to negotiation.

• HIPAA. The landlord's right to enter the premises should be limited due to health care privacy laws. This can include limiting the timing of entry and mandating that a tenant representative accompany the landlord in conjunction with any such landlord entry. Additionally, health care tenants should consider lease provisions that impose obligations on their landlords to protect patient information, such as clarifying that patient records are excluded from any landlord's liens.
• Stark Law and Anti-kickback Statute. In structuring a health care use retail lease, the parties must take precautions to ensure compliance with health care-specific fraud and abuse laws, including the federal Stark and Anti-kickback statutes. The Stark law prohibits a physician who has a financial relationship with a health care entity from making patient referrals to that entity for the provision of designated health services for which reimbursement is sought from Medicare, unless the financial relationship fits within a specified exception. The Anti-kickback law prohibits the payment or receipt (or the offer or solicitation) of any remuneration for patient referrals or ordering services for which payment may be made under a federal health care program. Since the penalties for contravention of these fraud and abuse laws are severe, it is critical for the parties to structure any transaction that implicates either law in a manner that avoids violations. Importantly, the lease should be structured to meet the Anti-kickback safe harbor and/or Stark exceptions, as necessary, applicable to real estate leases. Although the Stark and Anti-kickback laws are codified in distinct statutes and the real estate Anti-kickback lease safe harbor and Stark lease exceptions are not identical, the rules for both have the following general requirements: The leases must: 1) be in writing; 2) be signed by both parties; 3) include a description of all space to be leased; 4) have a term of not less than one year; 5) be for space that is reasonable and necessary for the legitimate business purpose (and, in the case of Stark, be used exclusively by the lessee when being used by the lessee); 6) require rent that is set in advance and is consistent with fair market value, that is, rent that would be charged in an arm's-length general commercial lease, and without a rental formula based on the provider's revenues; 7) not include rent or other charges that are determined in a manner that takes into account the volume or value of referrals; and 8) be for a commercially reasonable business purpose. The importance of careful structuring to abide by these laws cannot be overstated.
• Standard Retail Lease Considerations. In retail leases, as opposed to other commercial leases, additional emphasis often falls on certain specific issues, which will be implicated in the health care use setting as well. These include: non-competition covenants with other retail uses in the center (for example, if the center already has an eyeglass store, its lease may prohibit the landlord from leasing to any other medical uses), hours of operation, trash removal, restoration of space after lease expiration, parking and signage.

Conclusion

In sum, as the demand for quality health care services increases, the need for new and more efficient medical real estate continues to expand, and health care costs continue to rise, physician practice groups, hospitals and other health care providers will continue to seek lease arrangements in more community-based retail locations to keep pace with the rapid evolution of the health care landscape.

Stephen A. Timoni is a partner in K&L Gates' Health Care Practice Group with more than 25 years' experience as a health care lawyer and CPA. He may be reached at [email protected] or 973-848-4020. Daniel A. Suckerman is an associate in the firm's Real Estate Investment, Development, and Finance Practice Group. He may be reached at [email protected] or 973-848-4057. Dean H. Wang is an associate in the firm's Health Care Practice Group. He may be reached at [email protected] or 973-848-4012. All are resident in the Newark, NJ, office.