Important Considerations in Understanding Fair Market Value Opinions for Timeshare Arrangements

Medical office timeshares (MOTs) refer to part-time medical office space lease arrangements between a licensor/landlord and a licensee/tenant (“Licensor” and “Licensee”). MOTs have become more prevalent as this type of arrangement between hospitals and physicians provides a cost-effective way for medical providers to serve surrounding markets and improve staff productivity. In the Proposed Policy, Payment, and Quality Provisions Changes to the Medicare Physician Fee Schedule for Calendar Year 2016, the Centers for Medicare & Medicaid Services (CMS) established a new exception under the Stark Law (411.357(y)) to permit timeshare arrangements for the use of office space, equipment, personnel items, supplies, and other services.¹

In its most basic form, a MOT is generally structured as a combined lease of some or all of the following:

• Medical office space
• Medical and office equipment
• Clinical and non-clinical staff
• Medical and office supplies
• Other items and services²

MOTs typically utilize partial space, are part-time in nature and are frequently structured as leases of specified blocks of time.

In general, the Stark Law prohibits a physician who has a financial relationship with an entity (i.e. ownership or investment interest or a compensation arrangement) from making a referral for any of 11 designated health services (DHS) unless one or more exceptions apply. The Stark law is a strict liability civil statute. Fortunately, it includes many available exceptions that can be used to protect a business arrangement between a physician and an entity that provides a DHS from violating its prohibitions. Yet the Stark law’s exceptions are quite exacting and not always easy to fully meet. Moreover, because the Stark law is a strict liability regime, the effect of not being able to fully meet an exception is critical, because, for liability purposes, a near miss is a complete miss. It is important therefore to be familiar with the Stark law’s many exceptions and their common features, such as the requirement of Fair Market Value (FMV). This article highlights important tips for determining and understanding FMV for MOT arrangements.

The following describes the general structures of MOTs, important value drivers, and the key considerations that healthcare attorneys and executives who are tasked with reviewing a MOT FMV should consider. A comprehensive FMV opinion that properly considers all of the costs and terms of the arrangement is crucial in providing the necessary documentation to be compliant with the Stark law’s FMV requirement.

MOT Fee Structures

The two most common payment structures for MOT arrangements are a fixed monthly payment and a variable payment.

Fixed Monthly Payment

A common structure for a MOT payment is a fixed monthly payment dictated by the amount of time the Licensee will utilize the MOT as stated in the agreement. The fixed monthly payment is based on predetermined days and times the Licensee will utilize the MOT throughout the month.

Variable Payment

Another common structure is a variable payment, which allows the Licensee to utilize the MOT on an as-needed basis. The Licensor and Licensee agree on a flat FMV payment per block of time (set in advance), which is usually a payment per 4-hour or 8-hour block, and the Licensee’s monthly payment will be variable based on the number of blocks utilized during the month.

Value Drivers Impacting MOT Payments

There are a few key value drivers that may assist Licensor/Licensee management with the selection of an appropriate MOT payment amount. The following are only guidelines, as both economic and non-economic factors, as well as the facts and circumstances surrounding an arrangement, should be considered:

1. Facility space: This reflects one of the most fundamental components of a MOT, yet it is often the most difficult to define. Since MOTs are often part-time leases for partial space, it is crucial that the utilized space be clearly defined. Generally, the Licensee will have access to both exclusive space and common area space. Exclusive space reflects areas which are designated solely for use during the leased block of time.³ Common area space reflects areas which are shared with other providers on-site. An appropriate allocation of the common area space the Licensee shares with other occupants during the MOT should be included in the defined space. Examples of common area space may include waiting rooms, nursing stations, break rooms, restrooms, and hallways. In addition, if the medical office space is located within a larger medical office building, a common area factor for the building should be allocated to the Licensee.

Once the space has been defined, an FMV appraisal of the lease rate per square foot should be obtained and applied to the defined square footage. If a third party FMV appraisal must be obtained, it is recommended that the brokerage or management company for the facility not be utilized to avoid a conflict of interest. It is noted that most facility rental rates within MOTs are stipulated on a gross basis so that the Licensor bears all expenses incurred in the real estate ownership. This means if a market participant typically leases space on a triple net basis (Licensee pays pro-rata share of real estate operating costs), then this rate must be grossed up.

2. Equipment: Another essential component of a MOT arrangement is the medical and office equipment provided to the Licensee. Equipment generally reflects the assets that are included in the exclusive and common area space being leased. Examples of standard equipment in a MOT may include exam tables, exam stools, patient scales, waiting room furniture, and computers, among numerous others. Even though the Licensee may not need to use the equipment provided during the MOT, if it is made available to the Licensee and the Licensee’s patients, and included under the lease arrangement, then the equipment should be included in the FMV analysis of the MOT. Valuators and parties to the agreement alike can confuse this interpretation of equipment usage, and as such, the parties should be cognizant of use versus availability. For example, if a Licensee is provided with a dedicated ultrasound for its 4-hour block of time, it must include this in the FMV payment, regardless of whether the ultrasound is actual utilized during that specific 4-hour period.

Once the equipment has been defined, an FMV appraisal of the equipment lease rate should be obtained for the defined medical and office equipment.

3. Staff and supplies: Staffing, supplies, and other services are commonly included in MOT arrangements, but not always expressly outlined in the agreement and, therefore, may not be accounted for in the lease or valuation. Typical staff in a MOT arrangement may include administrative staff (such as receptionists and medical records clerks) and clinical staff (such as medical assistants and registered nurses). Staffing arrangements should be clearly defined in the agreement and reflected accordingly in the FMV analysis.

In addition to the staff, certain supplies/services such as office supplies, medical supplies, telephone, cable television, and beverage services should be accounted for if they will be utilized under the MOT arrangement. Although these services can be a nominal amount in the scheme of the entire arrangement, it is important to consider these costs in the FMV analysis.

4. Amount of time leased: The amount of time the Licensee utilizes the MOT directly impacts the amount of the payment. The time utilization should be clearly outlined in the arrangement and tied directly to the FMV MOT payment.

5. Timeshare premium: A primary consideration in the analysis of a MOT arrangement is the premium that is recognized in the marketplace for MOT arrangements. The premium should account for the risk factors assumed by the Licensor under a MOT arrangement which may include: 

• utilization risk;
• vacancy risk; and
• the additional burden of marketing and legal costs associated with numerous partial lease arrangements.

The timeshare premium should be reflective of the risk factors noted above. For example, there should be less risk to a Licensor if a Licensee is leasing three full days per week as opposed to a Licensee leasing one 4-hour block per month. As such, the degree of the part-time nature of the arrangement, among other risk factors, should be carefully considered in the FMV.

Key Considerations in Assessing MOT FMV Opinions

The valuation analysis of MOT payments considers both the Cost Approach and the Market Approach. Under the Cost Approach, the costs of the underlying services are considered plus a reasonable rate of return.⁴ The development of market costs for facility and equipment usage often require a separate fair market rent study and fair market equipment lease rate analysis. For staffing and services, if actual or historical cost data is unavailable, the valuation professional may be required to use market research and available market data to develop reasonable costs.⁵

Under the Market Approach, payment rates for similar MOT arrangements in the marketplace are considered. One of the major challenges with use of the Market Approach is identifying available information on existing MOT arrangements and specifically information for MOTs that are similar to the subject arrangement.⁶ Due to the wide variation in facility space, equipment, and services that may be included in the market MOT arrangements, finding a supportable market comparable is extremely challenging. Another obstacle with the use of the Market Approach is identifying untainted MOT comparables that do not reflect hospital-physician relationships.⁷ Although the Market Approach may be used as a reasonableness check to the results of the Cost Approach, it is typically not utilized as the sole basis for FMV of a MOT due to the fact that each arrangement is unique.

The following is a list of questions to help clarify if an FMV analysis has considered appropriate factors:

• Have all components of the MOT arrangement (i.e., space, equipment, staff, and services) been clearly defined in the agreement? The agreement should clearly define the services being provided and should encompass all space, equipment, staff, and other services the Licensee will utilize during the MOT. The valuation should clearly reflect the terms of the agreement and account for all services described.

• Does the valuation analysis rely solely on MOT market comparables that reflect hospital-physician relationships? Since existing MOTs between hospitals and physicians may reflect payment rates that are tainted with referral relationships, it is prudent that the valuation professional rely on additional or alternative approaches in establishing the FMV of the MOT.

• Have the unique aspects of the space or the Licensee’s needs been considered as part of the valuation? There may be other components of a MOT that are unique to the specific arrangement, such as storage space and specialized medical equipment that may be overlooked in the process of constructing and valuing the overall arrangement. These unique services should be specifically identified and included in the FMV analysis.

• Has the degree of the part-time nature of the services been considered? As stated previously, the timeshare premium applied is correlated to the amount of time the Licensee will occupy the space. The premium should be applied/adjusted based on the Licensee’s occupancy and documented appropriately in the FMV analysis.

Conclusion

The inclusion of a new Stark law exception for MOT arrangements demonstrates that these types of arrangements are increasingly more common and it is important that the terms of the arrangement be documented as FMV. Furthermore, the FMV should be inclusive of all services provided by a Licensor to a Licensee. As mentioned previously, a comprehensive FMV opinion that properly considers all of the costs and terms of the arrangement is crucial in providing the necessary documentation to be compliant with the Stark law’s FMV requirement. 

This article is excerpted from the ABA Health Law Section’s new book, The Healthcare Executives’ Simple Guide to FMV for Attorneys, C-Suite, Compliance, and Physicians. The guide will help stakeholders navigate nearly every type of fair market value opinion for transactions and compensation agreements. For more information, go to www.shopABA.org.

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Britt Martin is a manager in the Professional Services Agreement Division of VMG Health and is based in the Dallas office. She specializes in a wide variety of agreements and agreement structures, including: clinical compensation, on-call coverage compensation, medical director/physician executive compensation, management fees, billing and collection fees, and quality incentive compensation. Ms. Martin graduated from the Dedman College of Humanities and Sciences at Southern Methodist University with a Bachelor of Arts degree in Economics. Ms. Martin is a Certified Valuation Analyst through the National Association of Certified Valuators and Analysts and is a Level III Candidate in the CFA Program. She may be reached at brittanym@vmghealth.com.