Real estate investment trusts are enjoying a surge in popularity among healthcare companies seeking to boost liquidity.
By selling certain facilities and leasing them back, healthcare companies can convert low-return assets into cash and reinvest those dollars in more profitable ventures.
But what's a chief executive officer to do if existing REITs don't meet the company's needs? If you're Richard M. Scrushy, co-founder and CEO of the nation's largest rehabilitation chain, you start your own REIT.
Currently, 13 publicly traded REITs invest exclusively in healthcare properties, but none appealed to the 41-year-old CEO of HealthSouth Rehabilitation Corp.
While most healthcare REITs invest primarily in long-term-care facilities or acute-care hospitals, Mr. Scrushy wanted a REIT that would buy ancillary hospital facilities. He also found most REITs' leasing terms "unacceptable." In addition to rent, many REITs take "a big cut" of the facilities' revenues, he said. An attorney from the National Association of Real Estate Investment Trusts said there is no industry standard on revenue sharing; the percentages are negotiated from deal to deal.
Mr. Scrushy's Capstone Capital Corp., based in Birmingham, Ala., is set up to invest primarily in ancillary facilities adjacent or physically attached to acute-care hospitals. The REIT's portfolio includes outpatient diagnostic, surgery and rehabilitation centers, as well as long-term-care and subacute-care facilities.
Although Capstone doesn't take a cut of facilities' revenues, it does require lessees to pay annual rent increases based on the consumer price index.
Getting the money.Capstone went public June 23, raising $104 million from the sale of 5.8 million shares at $18 apiece. The deal netted $97.8 million after underwriting expenses.
Proceeds, plus borrowings under the REIT's $60 million line of credit, were used to buy 20 properties for $115.4 million. Mr. Scrushy's industry connections and those of Capstone's senior management team helped to nab other high-profile tenants such as OrNda HealthCorp, Integrated Health Services, Quorum Health Group and Surgical Health Corp.
HealthSouth sold 10 properties for $50.9 million, which it is investing in new operations. The return on those investments will be about twice what HealthSouth had generated through its ownership of the facilities, Mr. Scrushy said.
Since the initial public offering, Capstone has closed on a $6 million acquisition of a medical office building operated by MedPartners, a private company that acquires and manages physician practices. The REIT also provided an $8 million mortgage secured by Chapman General Hospital in Orange, Calif., an OrNda-operated facility.
The players.Mr. Scrushy, chairman of Capstone's board, recruited his banker, John W. McRoberts, to serve as Capstone's president and CEO. Mr. McRoberts had been head of corporate banking and healthcare lending at Birmingham, Ala.-based AmSouth Bank. William C. Harlan, senior officer and head of healthcare lending at SouthTrust Bank, another Birmingham lender, signed on as the REIT's senior vice president and head of acquisitions.
In addition to Mr. Scrushy, Capstone's nine-member board includes Michael Martin, HealthSouth's senior vice president and treasurer; Robert N. Elkins, chairman and CEO of Integrated Health Services and founder of Community Care of America, a Naples, Fla.-based nursing home and retirement center chain; and William B. Luttrell, president and CEO of Surgical Health Corp.
Their involvement represents a potential conflict between the interests of the REIT and those of the board members' companies. But Capstone officials say they aren't worried.
"When we were on the road show, that issue came up all the time," Mr. McRoberts said. The founders intentionally drew top industry players to the board for "a competitive advantage in the marketplace," he said. Capstone's bylaws prevent directors from voting on transactions that involve their companies, he added.
The REIT has "enough outside directors to make good, solid business decisions (when there's a potential conflict)," Mr. Scrushy said. The other four directors come from companies that do not have leases with Capstone.
Mr. Scrushy owns 1.38% of Capstone, Mr. Martin owns 0.13% and HealthSouth holds 1.19%. In addition, all directors receive annual compensation of $5,000 for serving on the board and $1,000 for every meeting attended. Under a stock incentive plan, the board may grant stock or stock options to its members.
While the potential for conflict is there, "it's very important to Richard Scrushy to make this work," said Andrew L. May, a healthcare analyst at J.C. Bradford & Co. in Nashville, Tenn. "As an analyst, you have to watch it closely."
Meeting a need.Mr. McRoberts sees a great need for REIT financing, especially for ancillary facilities. "With the healthcare industry going through such change right now, and consolidation, it requires an awful lot of capital," he said.
Typically, medical office buildings provide a 10% to 12% return on investment, he said. Freeing up that capital enables healthcare companies to invest in facilities and equipment that provide a higher yield, while REIT investors can benefit from yields predicted to be about 9.8%, he explained.
"That's what's driving this thing."
In addition to sale-lease-back deals, Capstone will provide mortgage financing and also may become involved in funding construction projects as a joint venture partner with a qualified developer, Mr. McRoberts said.
Analysts are recommending the REIT because of its "quality" tenants, experienced management and competitive yield. Forecasting a 5% growth rate for 1995, Smith Barney analysts Geoffrey E. Harris and Vivek Khanna said significant opportunities exist for the REIT to increase its earnings, cash flow and dividends.
But to grow, Capstone will need more capital. It has $38 million outstanding on its $60 million line of credit, and current commitments to provide financing will consume the balance. For the time being, the REIT is negotiating an increase in its line of credit. But for longer-term financing, it will have to return to the stock market with a secondary offering. Capstone can't realistically do that until it pays stockholders a dividend.
"They want to see that we're for real," Mr. McRoberts said. He expects the REIT to pay its first dividend in November.
"We have a good problem, and the problem is that there are more good properties out there than we can finance at this time," he said.