Compliance Implications of Different Lease Structures in Healthcare Leases with Physicians

Deciding which type of lease structure to use in a healthcare real estate lease between physicians and health systems may seem to be strictly a business decision. And while choosing whether to utilize a full-service gross (“FSG”), modified gross (“MG”), or triple net (“NNN”) lease structure is a business decision as it pertains to how to most effectively allocate real estate operating expenses between the landlord and tenant, the decision also has significant impacts on lease compliance under the Stark Law and Anti-Kickback Statute.

The Stark Law prohibits a physician from making a referral to an entity for the provision of a designated health service for which Medicare payment may be made if the physician (or an immediate family member of the physician) has a financial relationship with the entity unless a statutory exception applies. For healthcare real estate leases, the Rental of Office Space exception is often utilized. For this exception to apply, one of the requirements is that the rent under the lease must be consistent with fair market value (“FMV”). The Anti-Kickback Statute prohibits the exchange of anything of value in an effort to induce/reward referrals (i.e., “kickbacks”). While kickbacks may be remuneration in cash or in-kind, kickbacks may also consist of lease payments below or above FMV. Like the Rental of Office Space Exception to the Stark Law, the Space Rental Safe Harbor to the Anti-Kickback Statute requires that the rent under the lease is consistent with FMV. A physician lease that utilizes an FSG lease rate will necessarily be valued differently than a physician lease that utilizes an MG lease rate or an NNN lease rate, and therefore these physician lease structures will each have an impact on how the FMV rent rate for the lease should be determined; a hospital landlord that fails to properly account for these nuances may fail to satisfy the applicable exceptions under the Stark Law and the applicable safe harbors under the Anti-Kickback Statute by utilizing a rent rate that is not consistent with FMV.

Any FMV report that is obtained for a healthcare lease in order to satisfy the FMV requirements of the Rental of Office Space should opine as to the valuation for the specific lease structure in order to ensure compliance with the Stark Law and Anti-Kickback Statute. In other words, if the lease is going to be structured as an MG lease, the party providing the FMV report should opine on the MG lease rate range, e.g., $20.00/RSF – $25.00/RSF (it should be noted here that it is similarly important to have an FMV report provide a rate based on the appropriate square footage type, rentable or useable). This rate for an MG lease is not interchangeable with the rate for an FSG lease; a landlord that obtained an FMV report for an MG lease cannot then use that rate for an FSG lease. While using an MG rate at the top of the MG range provided for in the FMV report for an FSG lease may be consistent with what the FMV report would provide for an FSG lease rate for the leased premises, companies or individuals taking this approach for their healthcare leases undertake the risk that (i) their internal policies on structuring rent (e.g., rent to tenant’s should be within the top 25% of the FMV rent range) are violated and (ii) if challenged, the company or individual will have to possibly spend more money to clarify that the rate being used would actually be FMV if the initial FMV report did not also opine as to FSG healthcare leases. The reason for this distinction is that, in determining FMV for a lease, an appraiser or valuation expert must utilize certain assumptions to formulate a valid opinion.

When formulating a valid opinion as to FMV for a MG lease, the appraiser or valuation expert is assuming that the tenant will be charged a base rent plus additional rent – typically a pro-rata share of certain utilities and other operating costs. In an FSG lease, the assumption is made that all costs will be accounted for and factored into the base rent number. Therefore, an FSG lease rate range is always going to be higher than the MG lease rate range for the same premises. Using a MG rate for an FSG healthcare lease can potentially result in the tenant paying below FMV which could lead to a violation under the Stark Law since the Rental of Office Space Exception requires that rent be consistent with FMV when a physician makes a referral to an entity for the provision of designated health services. This scenario could potentially violate the Anti-Kickback Statute since a reduction in the rent rate could be seen as a kickback from the landlord to the tenant in exchange for referrals or other business. Again, the Space Rental Safe Harbor of the Anti-Kickback Statute requires that a healthcare lease arrangement be consistent with FMV.

Realty Trust Group provides a full spectrum of healthcare real estate compliance services and has extensive experience in assisting clients with drafting policies and analyzing existing reports to ensure that the FMV reports they procure are consistent across their portfolios, aligned with the terms of the lease at issue, and relevant to the transaction itself.  For more information on our healthcare real estate advisory and compliance services, visit our Innovation Center.