Through REITs or private investors, hospitals can access capital currently tied up in real estate to fund other risks.

When hospitals or health systems take on the management of patient populations—for example, under bundled payment structures—they are essentially entering the insurance business. Not all hospitals are formally launching insurance arms. But all will take on insurance risk when they accept a flat price to provide complete care to a patient population (e.g., total joint patients from admission through 30 days post-discharge). Spend less than the set price and make a profit. Spend more, and the hospital must absorb the financial loss.

This is a dramatic transition from the fee-for-service model that guarantees payment for every service. Suddenly, hospitals need to have a greater financial cushion to cover insurance losses and guard against insolvency. How big of a reserve is needed? As a general rule, we recommend having liquid assets equivalent to 10-15 percent of a hospital’s annual claims. This is on top of any additional capital needed to build population health management capabilities, such as advanced IT systems.

While funding such a sizable reserve can be challenging, hospitals have options. Many healthcare finance leaders automatically think about issuing bonds or seeking bank loans. A more advantageous cash source may be found in the monetization of buildings and land the hospital owns.

Exploring Real Estate Options

There are various options to be considered when seeking to monetize real estate assets:

Private investors. Some health systems partner with private investors through joint ventures or other types of participation and investments. Physicians or other providers in a hospital’s network might make good investors, assuming the deal is structured to comply with Stark and anti-kickback statutes. Real estate developers are also looking to take advantage of the growing demand for on- and off-campus medical space in some areas of the country.

Pension funds, both public and private, are another option. Investment pension funds are limited in the types of investments they can make, but buying hospital property and leasing it back may be permitted with proper structuring and focus on the tax rules for tax-exempt entities. These arrangements can be public-private partnerships (e.g., with a state pension fund) that help create access to care and jobs.

Healthcare real estate investment trusts (REITs). A hospital can sell its buildings and land to a REIT and lease them back. REITs are companies or trusts that own and, in some cases, manage portfolios of real estate holdings and mortgages. Healthcare REITs have been on a buying spree in recent years, accounting for approximately 59 percent of healthcare real estate transactions in 2014 and 2015, according to Revista.

Sidebar: Beware the Parking Lot Speed Bump

Who Is Buying Medical Real Estate?
Who Is Buying Medical Real Estate?

Although a lot of healthcare REIT activity is in the senior housing and medical office space, more hospitals are selling to REITs. For example, one Texas health system recently completed a successful REIT deal, selling a hospital and parking building. Before the transaction, the organization was operating in the red. Now, the system has enough liquid assets to take on insurance risk without a fear of insolvency.

One advantage of REITs is that they tend to be processed rapidly, in as little as 90 days in some cases, so they can be good options when quick capital is needed.

Finding the Right Landlord

Healthcare finance leaders need to approach sale-leaseback transactions carefully to avoid potential pitfalls. These four steps can help guide the process:

Determine what real estate to sell—and when. Seeking an independent valuation of possible properties to sell may be helpful. Hospitals that sell real estate can retain control of the facility from an operating standpoint, but lose out on future appreciation in the property value. Hospital leaders need to understand the following.

  • Which properties will be the easiest or hardest to sell now?
  • Which properties are the most desirable and would garner the highest price?
  • How much have the properties appreciated in value?
  • Which ones show the most or least potential in terms of future value?
  • What are the local real estate trends, and how might the property’s 
desirability/value increase/decrease over the next five years?

Insights into the value of certain properties need to be weighed against organizations’ strategic plans. For example, how might the real estate portfolio be affected by anticipated mergers and acquisitions? Or how is a health system planning on using a particular property? An acute care facility might be operating at 50 percent capacity because of declining inpatient volumes, and leaders may be tempted to sell. But could the hospital repurpose that building into an outpatient facility to absorb increasing outpatient volumes?

There are also numerous legal and regulatory issues to consider. For example, not-for-profit hospitals must be careful about selling certain assets, such as parking lots, that can jeopardize their tax-exempt status (see the sidebar on page 5). In addition, health systems in certificate-of-need states may have a harder time selling certain buildings with specialized uses, such as acute care hospitals, which can lose their certificate of need if vacated. These assets can turn into a bureaucratic conundrum for landlords if the operating tenant (i.e., the hospital) decides to vacate.

Act from a multidisciplinary perspective. Numerous stakeholders and agendas can be affected when a building is sold. Hospital finance leaders should seek input from physicians, board members, the legal department, and others. When applicable, the philanthropy department should also be consulted. For instance, selling a building donated by a donor might cause offense.

Implement a competitive bid process. Hospitals should get bids from multiple parties that include anticipated costs (e.g., expected annual rent, rental increase frequency) as well as the expected timeline for completing the property sale and transfer.

The biggest worry of any landlord is that the tenant won’t pay the rent. Thus, with high-risk hospitals—such as those that are primarily Medicaid dependent—landlords might insist on greater security in the form of escrow funds.

It is vital to uncover all the potential strings hidden in a lease contract. For example, will the health system be required to pay for building maintenance (e.g., replacing boilers or roofs)? This is a fairly common requirement. Sometimes landlords ask hospitals to fully fund select maintenance projects up front (from the proceeds from the sale) even though the projects won’t be needed for years. Landlords also tend to require tenants to pay for any physical improvements to the plant, such as redesigning a surgical suite.

In the end, each lease contract is unique. There are an infinite number of games landlords try to play. For example, if a landlord is part of a bank, it might insist that the hospital deposit funds in the bank. Or a landlord might demand a percentage of a hospital’s operating growth. Successfully negotiating these diverse contract clauses requires knowledge of the related legal, financial, regulatory, and clinical issues.

Get references. Before signing a contract to sell and/or lease real estate, it’s wise for hospital finance leaders to seek references from other hospitals that have been involved in sale-leaseback transactions with that buyer. How easy is the landlord to work with? What are the hospital’s costs associated with the deal?

Seeking a Higher Return

As hospitals take on insurance risk, they are going to have to devote more time, energy, and resources to building population health capabilities. Strategically selling real estate frees up capital to invest in the future, while also freeing hospitals from a relatively low-performing investment.

David Friend, MD, MBA, is managing director and chief transformation officer, The BDO Center for Healthcare Excellence & Innovation, BDO USA, LLP, New York City, and a member of HFMA’s Metropolitan New York Chapter.

Stuart Eisenberg, CPA, is assurance partner, BDO USA, LLP, New York City.

Publication Date: Friday, June 10, 2016