Legal Briefs

Healthcare Headaches

Various issues delay medical real estate construction.

During fourth quarter 2011, real estate investment analysts predicted that demand for medical office buildings and healthcare facilities would continue to be strong over the next decade, due in part to high demand for healthcare services. While demand for healthcare real estate will most likely outpace demand for other property types in the near future, the following financial and legislative issues have caused healthcare providers to take a second look at new construction projects.

Lease Accounting Rules

Recently, the Financial Accounting Standards Board and the International Accounting Standards Board have considered changing how real estate lease agreements are treated for accounting purposes. Existing rules allow healthcare providers to enter into real estate lease agreements for between 10 and 15 years, usually without negatively impacting a healthcare provider’s balance sheet. However, FASB and IASB have proposed rules that would treat a majority of real estate lease agreements as capital lease agreements. For accounting purposes, a capital lease agreement is treated as a liability on the tenant’s balance sheet. This approach is undesirable for many healthcare providers.

When FASB and IASB announced the proposed rule changing how leases are treated for accounting purposes, the response was generally negative. After considering comments in response to the proposed rule, FASB and IASB agreed to reconsider their approach, although a final decision on this matter has not yet been released.

This lack of decisiveness has created uncertainty in the marketplace, causing a number of healthcare providers to place developer-owned projects requiring long-term space lease agreements on hold. Developer-owned projects may not be desirable if the space lease agreement will be treated as a liability on the tenant healthcare provider’s balance sheet. Instead, it may be more advantageous for the healthcare provider itself to own and finance the project.

Healthcare Reform

In 2010, Congress passed the Patient Protection and Affordable Care Act that was later signed into law. Since then, providers have placed new construction projects on hold for a number of reasons. One reason is that the act will be phased in through 2014, and it is unclear how its various programs will be implemented.

Another reason is that key provisions of the act, including the individual mandate, were being reviewed by U.S. Supreme Court. The individual mandate requires U.S. citizens and legal residents to maintain healthcare insurance or pay a tax penalty each year. Real estate analysts are thrilled with the idea of an individual mandate. Most predict that healthcare providers will be forced to expand operations, taking on new space to accommodate the increased population of insured patients. In late June, the Supreme Court upheld the individual mandate and other provisions of the act.

Until the rules implementing the act have been interpreted, healthcare providers will exercise caution when it comes to building new space.

Changing Pay Models

Reimbursement changes as to how providers will be paid for services under the act are also causing healthcare providers to place construction projects on hold. The primary concern cited by providers is the uncertainty created by new or modified reimbursement models.

In 2011, for example, the Medicare reimbursement to skilled nursing facilities was reduced by 11 percent. This was a considerable blow to long-term care providers.

Other healthcare providers will be affected by changing reimbursement models as well. One of the components of the act is the development of a Medicare shared savings program that will result in a new type of provider collaboration, referred to as Accountable Care Organizations. An ACO is a group of providers that joins forces while remaining legally independent, for the goal of improved quality and reduced healthcare costs.

The ACO model will likely change how providers deliver care because it will require participating providers to work together in ways that are uncommon today. Under the ACO model, Medicare intends to reward providers who work together to reduce costs while providing quality care. On the other hand, in certain cases, any cost overruns will be assumed by the provider participants in the ACO.

The reduction in reimbursement rates and the implementation of ACOs or similar models that seek to achieve greater efficiency will directly affect provider-based operations. Until providers have a better understanding of their cash flow projections under these new models, new building projects will be delayed indefinitely.

The upside to the financial dilemma created by the act is that there are areas with positive growth. Healthcare providers will continue to seek opportunities for retail outpatient clinics. With an emphasis on primary care and wellness, healthcare providers will be looking for ways to reach and serve patients in new, more convenient settings. Most likely, this will result in the development of small, clinic-based projects in retail shopping centers or business districts.

Andrew Dick is an attorney in the Indianapolis office of Hall Render, a national law firm representing healthcare providers. Contact him at adick@hallrender.com.

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