Property, plant, and equipment occupancy costs are typically the third largest operating expense and represent almost 40 percent of a hospital’s balance sheet. Reducing them not only improves flexibility, but frees up more funds for clinical improvements.

The Affordable Care Act (ACA) has had considerable financial, operating, and regulatory impact on hospitals and health systems. There is no real dispute among executives to its influence on patient accessibility. Yet there has been little attention paid to its effect on providers’ real estate portfolios.

The following are critical issues and trends related to the ACA and important questions to ask from a real estate perspective.

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Reimbursement Changes and Cost Control

A variety of factors are converging to change healthcare payment processes and generally lower rates from Medicare/Medicaid, the public and private exchanges, and commercial payers. There is an unprecedented need to restructure healthcare organizations to meet demands by consumers, employers, and the government to provide greater value, but at a lower cost.

Property, plant, and equipment occupancy costs are typically the third largest operating expense and represent almost 40 percent of a hospital’s balance sheet; so they impact finances tremendously. Reducing them not only improves flexibility, but frees up more funds for clinical improvements.

Healthcare organizations are collaborating and forming alliances to increase purchasing power, consolidate services, and cut costs. The same can be done for real estate. By streamlining and restructuring operations through centralization and standardization of real estate practices and processes, providers can reduce risk and increase efficiency.

For example, Adventist Health developed a strategy to reduce the number of vendors for soft services (e.g., environmental services, security, grounds/landscaping, linen, and supplies) by partnering with vendors who are leaders in their respective industries. Adventist Health’s spend for these soft services is approximately $60 million annually. By building a consistent program in each area with the same protocols, products, and methods, the health system will not only achieve a 15-25 percent savings when fully implemented, but quality will improve and compliance risks will decrease.

With 545 properties spread across four states, there are some instances where a single vendor is not practical for Adventist. For example, there is not a single vendor who can service all four states for linen services. Yet by regionalizing linen services, a 13 percent savings has been achieved.

Healthcare finance leaders should consider the following questions regarding their real estate cost control:

Can you document what your system spends on occupancy costs?Occupancy cost—or the total of all space expenses associated with operating and maintaining owned and leased properties—is rarely well tracked because these costs are dispersed across multiple cost centers and buried in other operating costs.

Are we managing our portfolio in a consistent fashion across all locations?Too often, especially in the wake of expansion through mergers and acquisitions, real estate management is inconsistent. Managing a portfolio in a centralized manner with established best practices can reduce waste and variability. These best practices include:

  • A culture of ongoing innovation
  • Functional operational risk management programs
  • Consistent procedures throughout the provider’s system and at each facility location
  • Empowered employee work groups to drive service delivery improvements
  • Annual operations audits of safety performance

Are we partnering with facility/project management organizations for services outside our core competency? Looking beyond common vendors, such as food service and cleaning, to experts who can drive value in facility management, lease administration, transaction services, and project management can bring state-of-the-art technologies, processes, systems, and personnel to the organization.

Capital Allocation Challenges

The past decade has seen fierce competition for available healthcare capital. Potential uses all are compelling: investing in medical equipment technology, acquiring leading edge electronic health record systems, updating or replacing aging hospital infrastructure, and others. Compounding the problem, some investor analysts have assigned the healthcare sector a negative outlook since 2008. This makes it even tougher for hospital leaders to acquire capital at the best rates.

With negative outlooks from the traditional bond market analysts, many hospital executives have been limiting real estate investment to critical infrastructure maintenance and improvement programs. This has resulted in a steady increase in the average age of plant. From 2011 to 2014, the median age of hospitals increased from 10.5 to 11.3 years, according to data reported in the February 2015 hfm magazine. Any level at or above the 10-year mark is a concern to rating agencies.

Even if a system offers the latest medical technology and treatments, patients will take notice if the buildings housing them are aging and not well maintained. Health care is becoming much more retail focused. The front door matters.

Some alternative financing options are available, such as credit-tenant leases and sales of real estate assets. Developing relationships with healthcare real estate investors can pay off.

  • Healthcare real estate investors appreciate the stable income-producing qualities of healthcare real estate.
  • Healthcare real estate offers higher investor returns relative to other traditional property types (i.e., office, industrial, retail). For example, on a particular day earlier this month, public healthcare REIT dividend yield was 5.49 percent versus office/industrial REIT dividend yield at 4.72 percent, according to a recent update from
  • Continued low interest rates help fuel increased pricing.

Healthcare finance leaders should ask the following questions related to capital allocation:

Have we done a thorough risk assessment of our capital assets?What is their serviceable life expectancy? What is the risk of equipment failure?

Is the look of our facilities consistent with the level of our services?Does it convey the message we desire to patients?

Are our environments comfortable and inviting for both patients and staff?A clean, safe, pleasant working environment adds to patient and employee satisfaction and can have an impact on HCAHPS patient satisfaction scores.

Have we considered real estate financing options to increase capital availability? Some alternatives include owning with mortgage debt, owning with tax-exempt debt, tax-exempt synthetic leasing, long-term sale leaseback, joint venture, and build to suit to own or to lease. Considerations will include cash proceeds, the cost of capital, ease of completion, control, and flexibility.

Consumer Choice

Consumers are exerting more influence on healthcare purchasing decisions due to changes in the reimbursement model. Convenience of location and facility appearance will play a role in these decisions.

Like other consumer services, healthcare systems will be measured on the basis of overall value as a combination of quality, price, and location. The “look and feel” of a hospital—which often takes a back seat to the focus on medical attention—will drive consumer decisions. Hospitals and health systems are evaluating their appearance to be perceived as leading edge, accessible, and easily identified by patients.

For example, Reliant Medical Group in central Massachusetts used a strategic real estate assessment to develop a real estate plan for the group’s primary care operations. The plan included the following objectives:

  • Evaluating the performance of facilities and identifying opportunities to better use capacity
  • Measuring the system’s readiness to handle an increase in patient visits
  • Determining if the current locations were optimal for serving the current patient base and identifying future locations needed to serve targeted growth areas

The analysis revealed variances in performance across the group, as well as opportunities for growth within the existing facilities. Reliant developed a three-pronged strategy to address future growth:

  • Leverage the current network, filling it to capacity before adding new space.
  • Secure new markets in selected additional sites and expand into growth markets to the greatest extent possible, while remaining on REIT leases at some present locations for several years.
  • Consolidate current locations into optimal site configurations as leases expire or—worst case—renegotiate.

Healthcare finance leaders might ask the following questions related to improve patient satisfaction:

Where do we realistically stand in terms of quality, price, and convenience versus our competitors? A thorough inventory of your current locations relative to your competitors and population demographics is a starting point. Location intelligence services offered by healthcare real estate firms can provide data and analysis.

How does this align with where we want to be? In essence, what is our system’s brand, and what do we want to be in the minds of consumers?

How convenient are our access points to our target market? For example, for patients with chronic illnesses, are physical locations close enough to the community served so patients with chronic illnesses don’t have to travel long distances?

Targeted Attention

Your organization’s real estate deserves close scrutiny because it is a major factor in supporting your operations and mission. Asking the questions above will help tighten the focus on this important area.

Sydney Scarboroughis managing director, JLL, Chicago, and is a member of HFMA’s First Illinois Chapter.

Publication Date: Tuesday, July 07, 2015