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.
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
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
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.
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.
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