Co-Located Pathology Centres Rental Determinations

Mandated Changes to Pathology Centre Rentals & Implications in Practice.

A brief summary of the recent mandated changes surrounding pathology centre rentals, how this impacts valuation practice and a summary of the guidelines for these valuations.

Recent amendments to the Health Insurance Act 1973 have imposed limits on the rents that can be charged by dental clinics, hospitals and medical practices to pathology collection centres. The recent changes, which came into effect on 1 July 2018, prevent landlords from subleasing space to pathology providers at rents that are more than 20% above the market rental value for the area (CBRE, 2020). Whilst collection centres generally only comprise less than 50 sqm, Dahm states that before legislative intervention and enforcement, pathology collection centres typically bring in approximately $15,000 to $25,000 p.a. for every full-time GP in a medical centre (the Guardian, 2020). This meant that rental values were previously significantly above the market rental value of spaces with other commercial uses. The changes have been justified on the basis that without intervention, benefits will create a conflict of interest and increase the costs of pathology services. According to the 2018 Red Book, loss-making pathology collection centres will be targeted, as well as collection centres that are paying higher rentals to keep a competitor out of the space (The Red Book: Guidance to Laws Relating to Pathology and Diagnostic Imaging, 2018). Recent Legislative Changes S 77 of the Health Insurance Regulations (“Regs”) 2018 defines market value as “the amount that a willing purchaser would have had to pay to a vendor who was willing, but not anxious to sell”. General wellestablished legal principles relating to market value are included in this definition, including each party acting ‘knowledgably and prudently’ and entering into an armslength transaction. According to Regs s 76, a payment or consideration given for property, goods or services will be deemed “substantially different” from market value if the difference is more than 20% of the market value.

To limit the rental charged by landlords, the regulations introduced the concepts of “permitted” and “prohibited” benefits. Permitted benefits are intended to allow reasonable commercial leasing and business practices, whereas prohibited benefits are defined as those that “would be reasonably likely to induce a requester to request any of those kinds of services from a provider” (Act ss 23DZZIK(1)). Further to this, prohibited benefits encompass benefits that are “related to the business of rendering pathology services or diagnostic imaging services, as the case requires” (Act ss 23DZZIK(1)). According to the 2018 Red Book, these may include benefits “related to the number, kind or value of pathology or diagnostic imaging requests made by a requester to a particular provider” and consist of “the provision of staff or equipment at the premises of the beneficiary – whether full time, part time or on a visiting basis – for the purpose of providing pathology or diagnostic imaging services”. The implications of these developments are that if rent is over 20% above market value, it will contravene s 23DZZIK(1) of the Act, however there is some ambiguity as to how this should be determined by valuers. The definition of prohibited benefits further extends to outgoings and shared lease costs, and requires that

these do not constitute a prohibited benefit either. Compliance, Enforcement & The Impacts of COVID-19 According to the 2018 Red Book, all new leases must be lodged for review, and breaches will lead to civil penalties of up to $126,000 for individuals and $1.2 million for businesses, and criminal penalties of up to five years imprisonment. Whilst the laws were initially introduced in 2008, enforcement only commenced in 2018. From 1 July 2018, all new leases will be reviewed, and the Department has proactively contacted parties to applicable leases in the form of “please explain” letters. The impacts of COVID-19 on pathology centres have led to companies asking for further rental reductions of up to 50%, which have put further downwards pressure on rents as many practice owners are dependent on them as a key source of income.

Practical Implications & Guidance for Valuers The 2018 Red Book mandates that the rental value must be determined on a market basis, with reference to a willing seller and a willing buyer. However, whilst valuers engaged by landlords can determine whether the price is in line with the mandated criteria, they may only use evidence “based on rents in the area”. There is little clarification or guidance regarding the allowances that valuers have when determining these adjusted rental values, and the inclusion of the definition of “market value” has introduced ambiguity. Whilst all other assessments of rental value for other commercial purposes in the marketplace factor in the benefits received by the tenant, the new law prevents this, contravening all wellestablished principles of valuation. It is undeniable that pathology collection centres have and will continue to receive benefits to renting colocated spaces, however according to the amendments, this can no longer be reflected in the rent that they pay. On one hand, the amendments mandate that the rental value must be based on the “market value” and aim to not interfere with normal business practices, however on the other hand, there is no allowance for the market value of these pathology benefits.

pay was determined before the amendments were enforced. The market rents paid in the past prove that this has been the price that pathology companies have been willing to pay to receive the benefits of renting in a medical centre. As there is no market outside of pathology companies for these spaces, the benefits received as indivisible from the market rents paid for comparable spaces. The legislated control of ACC has interfered with the marketplace for these spaces, now placing a poorly defined constraint on the way that the marketplace now determines rent. Key stakeholders argue that the Red Book should be rewritten so that the current test is removed and the principle of the willing seller and buyer becomes the main test, with other conditions This poses several problems included that will better for valuers. Whilst the 2018 advance the objectives of the Red Book concedes that “some changes (The Australian GP value could be attributed to Alliance, 2020). the convenience of the location”, there is no practical The amendments appear to way to separate this premium have created a grey area of from what would be paid for valuation, whereby valuers the likelihood of increased must exercise a level of revenue. Furthermore, the discretion when applying these definition of market value by rules in practice. Whilst these necessity requires the valuer legal developments purport to to assess the potential market protect patients from increases for the property. No market in the costs of pathology exists for these spaces outside services, it is unclear as to of pathology subtenants, and whether they address the issue the ceiling that this market in a meaningful way, rather was willing to pay was than opening up the potential determined before the for ambiguity. amendments were enforced. The market rents paid in the past prove that this has been the price that pathology companies have been willing to