Navigating Fair Market Value Under the Healthcare Regulatory Laws

Navigating Fair Market Value Under the Healthcare Regulatory Laws

Speakers Andrew Dick Attorney Hall, Render, Killian, Heath & Lyman John W. VanSanten Managing Director Stout Risius Ross, Inc

Stark Law 42 U.S.C. 1395nn(h)(3) The value in arms length transactions, consistent with the general market value, and, with respect to rentals or leases, the value of rental property for general commercial purposes (not taking into account its intended use) and, in the case of a lease of space, not adjusted to reflect the additional value the prospective lessee or lessor would attribute to the proximity or convenience to the lessor where the lessor is a potential source of patient referrals to the lessee. General market value means the compensation that would be included as a result of bona fide bargaining between well-informed parties to the agreement who are not otherwise in a position to generate business for the other party.

Anti-Kickback Statute - 42 U.S.C. 1001.952(b)(6) The value of the rental property for general commercial purposes, but shall not be adjusted to reflect the additional value that one party (either the prospective lessee or lessor) would attribute to the property as a result of its proximity or convenience to sources of referrals or business otherwise generated for which payment may be made in whole or in part under Medicare, Medicaid, or other governmental health care program.

Anti-Kickback Statute - 42 U.S.C. 1001.952(b)(6) continued FMV should not be adjusted to reflect the additional value the prospective lessee or lessor would attribute to the proximity or convenience to the lessor where the lessor is a potential source of patient referrals to the lessee. CMS example of an orthopedic group and a PT group Set in Advance Does not take into account the volume or value of referrals.

CMS Commentary on Fair Market Value (for Stark purposes) Burden of establishing FMV rests with the parties FMV can be established using any valuation method that is commercially reasonable The appropriate valuation method will depend on facts and circumstances Example of comparables from another geographic area CMS will not create bright-line valuation rules

CMS Commentary on Fair Market Value (for Stark purposes) continued The rental payment can reflect the costs incurred by the lessor to develop, upgrade or maintain the property The entire cost of any improvements that are made for a particular tenant, and that cannot realistically be used by a subsequent tenant, should be charged to the tenant Other improvements that can be used by a subsequent tenant may be charged over the useful life of the improvement

Establishing Fair Market Rental Rates Improper measurement and application of square footage could result in over / underpayment of rent and operating expenses Example $14 RSF / $16 USF FVM: $14.00 / RSF x 10,000 USF = $140,000 $14.00 / RSF x 11,000 RSF = $154,000» $14,000 benefit to physician tenant» $14 USF effective rental rate The user of an opinion of value must be able to apply the per square rental rate to the proper space measurement methodology

Fair Market Value Best Practices Importance of engaging the valuation professional through legal counsel Understand the appraisal or valuation report square footage basis, comparables utilized & necessary adjustments Consult architect or other qualified professional for assistance in space classification and measurement, if needed Importance of an independent valuation evidence of intent? Ask for a range Ask for factors that affect the FMV range Include value of FF&E

Commercially Reasonable What does the term Commercially Reasonable mean under Stark? Look at Language under each Exception Commercially reasonable even if no referrals were made between the parties Reasonable and necessary for the legitimate business purposes of the arrangements Interpretations Subjective A sensible, prudent business agreement from the perspective of the parties involved, even in the absence of referrals. Objective The arrangement would make commercial sense if entered into by a reasonable entity of similar type and size and a reasonable physician of similar scope and specialty, even if there were no potential DHS referrals.

Lease Transactions Fair Market Rent Key Factors Expense Basis Is the subject space to be leased on a Net, Gross, or Modified Gross basis? Location Location has always been a critical factor in real estate.

Lease Transactions Fair Market Rent Key Factors Age/Physical Condition In general, newer facilities that are in superior physical condition will command higher rents. This is especially true for medical space, as changing technologies in healthcare have resulted in a continued evolution of space requirements for physicians. Size Large spaces will typically rent for a lower value per square foot than smaller spaces.

Lease Transactions Fair Market Rent Key Factors Usable vs. Rentable This is a key factor that is often misunderstood by both landlords and tenants. The Dictionary of Real Estate Appraisal, 5th Edition, defines the two measures as follows: Usable Area The actual occupiable area of a floor or an office space; computed by measuring from the finished surface of the office side of corridor and other permanent walls, to the center of partitions that separate the office from adjoining usable areas, and to the inside finished surface of the dominant portion of the permanent outer building walls.

Lease Transactions Fair Market Rent Key Factors Rentable Area The tenants pro rata portion of the entire office floor, excluding elements of the building that penetrate through the floor to the areas below. The rentable area of a floor is computed by measuring to the inside finished surface of the dominant portion of the permanent building walls, excluding any major vertical penetrations of the floor. Common Area Factor (CAF) The difference between Usable and Rentable space in a particular building is typically referred to as the Common Area Factor (CAF).

Lease Transactions Fair Market Rent Key Factors Tenant Improvement Allowance (TIs) Depending on the particular market and terms of the lease agreement, landlords may include a certain dollar amount per square foot for TIs. Lease Term It is not unusual for shorter term leases to result in a rent per square foot that is higher than long-term leases.

Lease Transactions Fair Market Rent Key Factors Rent Escalations Leases typically have some type of escalation clause based on a specific dollar amount or percentage rate. A comparison of lease transactions will require adjustments for differences in rent escalations.

Unique Issues in Lease Transactions Specialized Medical Space Determining market rent for ASCs and similar high-cost medical space can present unique challenges. Often times, truly comparable lease transactions in the local market area are scarce to non-existent. For this type of space, a Return on Cost analysis can be a useful tool in determining market rent. For example: If the total cost of an ASC (land and building) is $350 per square foot, and an appropriate capitalization rate is 8.5%, the estimated net rent for the ASC equals $29.75 per square foot ($350 per square foot X 8.5% = $29.75).

Unique Issues in Lease Transactions Timeshares for Medical Space In some markets, physicians may have a need for space on a part-time basis. In addition, they may require administrative support and/or furnishings and equipment. In timeshare situations, a premium is often applied to a pro rata share of the market rent with adjustments for the cost of administrative support and/or furnishings. Ground Leases Hospitals often lease a site to a group of physicians who then construct a medical building on the site, and these are typically for an extended period of time (25 years or more).

Fair Market Value Purchase/Sale Transaction Cost Approach Income Capitalization Approach Sales Comparison Approach

Real Life Examples United States v. McLaren Regional Medical Center (2002) United States v. HCA (2012) United States v. Tenet Healthcare (2013) United States v. Baycare Health System (2014) United States v. Sacred Heart Hospital executives (2015)

United States v. McLaren Regional Medical Center Plaintiff-Relator unknown Always assume a disgruntled employee or landlord who owns a competing building Plaintiff-Relator brought a claim under the false claims act alleging that McLaren violated the Stark Law and Anti-Kickback Statute by providing remuneration to physician-tenants in exchange for referrals The alleged remuneration involved McLaren paying above-market rent for space owned by orthopedic physicians The federal government decided to intervene and prosecute the case McLaren and the physicians were listed as defendants

United States v. McLaren Regional Medical Center continued Group of orthopedic physicians own a multi-story medical office building with vacant space Physicians use a portion of their medical building to operate their medical practice Patients of the physician practice often require physical therapy McLaren (a hospital) provides a broad range of health care services, including physical therapy services throughout the community McLaren was unsatisfied with its current space and decided to negotiate with the physicians for space in their medical building

United States v. McLaren Regional Medical Center continued After a nine (9) month negotiation period, McLaren and the physicians agreed upon a lease with the following terms: 5 year lease term Approximately 21,315 square feet Space was measured and rent was calculated on a usable basis $17 per square foot full-service 4% annual increases in rent McLaren has the exclusive right to provide PT services Physicians agreed not to provide PT services within 10 miles

United States v. McLaren Regional Medical Center continued The bench trial involved a battle of the experts Government s experts: Two appraisers from the community McLaren s experts: Three commercial real estate brokers from the community One appraiser

United States v. McLaren Regional Medical Center continued Finding for the defendants, the court considered the following: Measurement methodologies and their impact on market rent Usable versus rentable measurements McLaren s rent was set using usable sf = higher rent The comparables used for the assignment Gov ts experts relied on full-services comps Defendant s experts used net and full-service comps The geographic area that was used for pulling comparables Government s experts used comps from small area Defendant s experts used a more logical area

United States v. McLaren Regional Medical Center continued Practical Takeaways: Providers must choose their valuation professionals carefully Opinions of value must account for all of the facts and circumstances of a particular assignment Comparables should be used from a reasonable geographic area

United States v. HCA Plaintiff-Relator was an appraiser engaged by HCA Plaintiff-Relator brought a claim under the false claims act alleging that HCA violated the Stark Law and Anti-Kickback Statute by providing remuneration to physician-tenants in exchange for referrals The alleged remuneration involved HCA paying above-market rent for space owned by a physician practice group on an HCA hospital campus in Chattanooga

United States v. HCA continued The basic terms of the arrangement in the complaint were as follows: Physicians owned medical office space in an on-campus medical office building First appraiser established FMV rent at $8.10 to $10.10 sf for the space HCA agreed to lease 29,204 sf of space from the physicians Term of 5 years Rent was set at $12.59 sf Rent may have been set to cover debt service for the space Second valuation professional engaged to bless the negotiated rate

United States v. HCA continued Practical Takeaways: HCA settled the dispute for $16.5 M Appraisal shopping can create additional risk for the providers Relying on a credible appraisal is crucial Rent in the amount of the debt service for a particular space is not FMV

United States v. Tenet Healthcare Plaintiff-Relator owned an MOB on one of Tenet s medical campuses and had difficulty leasing space in the MOB, which was substantially similar to a Tenet-owned MOB on the campus Plaintiff-Relator was also a prospective purchaser of a portfolio of Tenet real estate and consequently received access to vast amounts of information related to Tenet s MOB leases with physicians, including copies of leases, financial statements and rent rolls Plaintiff-Relator brought a claim under the false claims act alleging that Tenet violated the Stark Law and Anti-Kickback Statute by providing remuneration to physician-tenants in exchange for referrals

United States v. Tenet Healthcare continued Tenet charged physicians below market rental rates Plaintiff-Relator s MOB was not materially different than Tenet s MOB on the hospital medical campus. Rental rates were approximately $10.00 per square foot lower in Tenet s MOB than in Plaintiff-Relator s MOB. Tenet understated the rentable area of the leased premises A physician-tenant s rental rate was based on $18.50 per Rentable Square Feet ("RSF") The area of the leased premises was described as 932 square feet The space was measured using a BOMA standard as part of a proposed sale and the area of the leased premises was actually 1,000 RSF The physician-tenant received the benefit of approximately 68 RSF of free space to the tune of approximately $1,258.00 per year

United States v. Tenet Healthcare continued Tenet failed to charge tenants and/or charged below fair market value for expenses associated with the leased premises Tenant was allegedly charging below fair market rates or not charging at all for building office services, including medical waste and sharps disposal, use of paper goods, etc. Tenet offered extravagant tenant improvement allowances Three (3) year lease term with a base rental rate of $15.00 per RSF for 2,053 RSF or $30,795.00 per year. Total tenant improvement allowance was $31,998.00 which is greater than the annual rent amount. Note: Not a per se violation to have large TI allowances but arrangement must be commercially reasonable by recouping the allowance in rent over the term of the lease

United States v. Tenet Healthcare continued Proposed sale of Tenet owned buildings with strings attached. As part of the proposed sale, Tenet stipulated that physician leases could only increase at the lesser of 3% or the CPI increase over the previous twenty four (24) months if a renewal period occurred within the first twenty four (24) months of the sale of the property A market rent would apply to all vacant space and space Tenet leased back from the buyer

United States v. Tenet Healthcare continued Practical Takeaways: Case settled for approximately $4,000,000, plus attorney s fees Tenet subsequently purchased Plaintiff-Relator s MOB on the hospital campus for more than the Plaintiff-Relator purchased the building Secure an appraisal or opinion of value for space leased to providers Space measurements are extremely important to establishing FMV rental rates Lease terms must be commercially reasonable

United States v. Baycare Health System Relator is a health care appraiser with no inside information Relator previously benefitted from a multi-million dollar settlement for an alleged non-compliant real estate arrangement Relator alleged in his complaint Physician-tenants benefitted from free use of the hospital-owned parking garage Physician-tenants benefitted from the property tax exemption the hospital secured on the ground leased real estate Survived motion to dismiss

United States v. Baycare Health System continued Practical Takeaways Sophistical real estate professionals are looking for questionable arrangements between providers Be a skeptical analyst when reviewing real estate arrangements between providers Ask the question Does the arrangement include a benefit that could be misconstrued by a government investigator or a whistleblower?

United States v. Sacred Heart Hospital Executives In 2013, after an undercover investigation, several Sacred Heart executives, along with several physicians were charged with health care fraud under the anti-kickback statute Allegations involved structuring sham arrangements that involved the hospital paying physicians based on the volume or value of referrals One arrangement involved a sham leasing arrangement where the hospital agreed to lease medical office space from a physician without a legitimate business purpose for the space Rent varied from $2,000 per months to $5,000 per month based on the volume of referrals

United States v. Sacred Heart Hospital Executives continued Practical Takeaways: Executives were convicted in March 2015 CEO sentenced to 4 1/2 years COO sentenced to 21 months Several physicians convicted Personal criminal liability exists for health care fraud Hospitals can be closed and excluded for violating federal health care fraud and abuse laws

Personal Criminal Liability Emphasized Emphasis on personal criminal liability for corporate misdeeds Fraud Alert June 9, 2015 Physicians may have personal liability under AKS for entering into improper compensation arrangements Yates Memo September 9, 2015 Personal criminal liability for corporate misdeeds

Question and Answer Session Andrew Dick 317.977.1491 adick@hallrender.com John W. VanSanten, CRE, MAI, MRICS 312.752.3384 jvansanten@srr.com