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— Health Care Properties Quarterly — September 2016
Broker Insights
A
fter nearly a decade of
efforts to put lease obliga-
tions on the balance sheet,
the new standard for lease
accounting was released
by the U.S. Financial Accounting
Standards Board earlier this year.
While the goal is to put all leases on
the balance sheet, health systems
are significantly – and uniquely –
impacted because of the substantial
amount of real estate deployed in
the delivery of health care services.
And to ensure readiness for this
change, planning needs to start now.
Beginning in fiscal years starting
after Dec. 15, 2018, the new standard
will create new financial obliga-
tions, substantially increase balance
sheets and apparent leverage, while
increasing reported lease-related
expenses at a time when operating
margins of hospitals are under pres-
sure.
The scope of contracts considered
leases will increase dramatically.
Typical real estate and equipment
leases are included, along with cer-
tain service contracts, previously
overlooked, that will be considered
to contain “embedded” leases. Hos-
pitals will need to evaluate arrange-
ments involving vendor-owned clini-
cal or diagnostic equipment paid
for based on usage or consumable
supplies. Short-term leases (with a
term of 12 months or less) will be
excluded from capitalization under
the new standard.
Unique impact on health care.
Hospi-
tal systems will be uniquely affected
by the proposed standard due to
their business. Leases of equipment
and physician office space are stan-
dard operating pro-
cedure for today’s
modern health care
system and have
grown considerably
in number and vol-
ume with the pro-
liferation of ambu-
latory care. Leasing
has become an
important vehicle
for capital forma-
tion for fixed assets
as systems pre-
serve capital for
physician alignment strategies and
electronic health records.
Hospitals have distinctive arrange-
ments, which under FASB’s new
lease accounting standard can shift
the perception of financial strength
as well as compound the admin-
istrative burden and complexity of
financial reporting. Illustrations of
this impact include:
• Higher reported lease obliga-
tion due to the greater likelihood
of inclusion of renewal periods as
certain facilities are viewed as core,
long-term locations for operations.
The hurdle to overcome the certain-
ty of renewal with auditors will be
high for health care providers.
• Common role as a landlord in
owned facilities or sublandlord in
master-leased facilities to physicians
and clinicians. Hospitals will need
to deal with both lessee and lessor
accounting with potential gross-up
of the balance sheet and pro forma
occupancy expense and income,
which are not symmetrical.
• Use of ground leases and air
rights to third parties on hospital
campuses will need to be reported
under the new standard.
• Sale-leasebacks and monetiza-
tion of real estate will be easier to
achieve than under current restric-
tive standards and offer immedi-
ate gain recognition. The standard
does away with restrictions on the
amount of subleasing to third par-
ties and other forms of continuing
involvement. Purchase options or
the right to re-control the asset will
still be problematic and will greatly
affect equipment sale-leasebacks.
• Build-to-suit arrangements will
be easier to achieve operating lease
classification than under current
standards, meaning that more com-
mercial arrangements will comply.
• Equipment leasing and financ-
ing has become commonplace with
health care providers. Virtually all of
these arrangements will be finance
leases and accounted for as acquisi-
tions of property with an accelerated
expense profile. As such, features
like residual guarantees or purchase
options will not alter classification.
How should health care systems
prepare?
Now that the new lease
accounting is a reality, evaluation
of health care real estate portfolios
will come into critical focus. For
organizations with established real
estate departments, these profes-
sionals and their counterparts will
need to be proactive in alerting
finance executives about the upcom-
ing changes and their likely impact.
For organizations with small real
estate groups, the proposed changes
may point to the need to upgrade
the professional focus on real estate.
The requirements for administration
and reporting of leases will become
daunting for health care systems,
which have grown through acquisi-
tion of hospitals and physician prac-
tice groups, each with their own real
estate portfolios and unique opera-
tions.
Organizations will face the formi-
dable challenge of preparing their
existing lease portfolios and reas-
sessing the process for structuring
effective leases going forward. This
reassessment has four essential
components:
• Understand and quantify the
impact – test how negotiated lease
terms drive the balance sheet and
operating expense.
• Communicate with corporate
treasury and accounting about the
changes, decisions and reporting
needs for the future.
• Anticipate and plan for new
financial reporting – identify addi-
tional data acquisition and make
changes to lease administration sys-
tems.
• Re-assess decisions about own-
ership versus leasing of real estate,
much of which has been prompted
by access to capital and liquidity.
Sweeping changes in lease
accounting will give health care
organizations a valuable opportu-
nity to articulate the fundamental
business reasons for leasing. The
value of access to real estate capi-
tal to support the growth of health
care systems will be an important
factor as organizations navigate
through the challenging time ahead
with FASB’s new lease accounting
standard.
s
Terrence Pace
Broker, health care
solutions specialist,
JLL, Denver
