Behind the Columbia/HCAs, Integrated Healths and PhyCors of the world, you'll find a real estate investment trust or two.
The premier, for-profit companies are among the most recognizable names in REIT portfolios. But they're not the only users of healthcare REIT financing. A slew of smaller for-profit providers and a number of not-for-profit healthcare systems also are tapping REITs to build assisted-living facilities, develop medical office buildings and expand outpatient capacity.
"Managed care needs to be funded somehow," said Doug Korey, director of business development at Ziegler Capital Co., a West Bend, Wis.-based subsidiary of Ziegler Securities. "Healthcare REITs are the logical place to fuel that."
By finagling with the builders of healthcare continuums and organizers of healthcare delivery systems, REITs have scratched out quite a profitable niche. Last year, the nation's 12 publicly traded healthcare REITs posted a 23.9% total return, bettering the S&P 500 by nearly a percentage point (See chart). Their total market capitalization reached $9.4 billion in 1996.
"Watching healthcare REITs is like watching wallpaper dry," quipped Jeffrey Bagley, a healthcare REIT analyst with NatWest Securities, New York. The stocks have been so stable there are few surprises, he said. Most of the healthcare REITs have stable cash flows, ship-shape balance sheets and established track records, he added.
That's helped REITs reduce their own cost of capital, making them more competitive with bank financing, analysts said. REITs also have been helped along by the "spread" off of U.S. Treasuries, which are priced relatively low at the moment. The spread is the difference between the yield on Treasury notes and the interest rate paid by a REIT on money it borrows. The Federal Reserve Board recently reported the weekly average annualized interest rate on 10-year Treasury notes at 6.58%.
American Health Properties, for example, was able to lower its cost of capital with the sale last month of $220 million in notes, priced at 80 and 105 basis points over the five-year and 10-year Treasuries. The Englewood, Colo.-based REIT will use the net proceeds to retire outstanding debt under a $150 million bank facility and repay $152 million of senior notes. The new five-year and 10-year notes carry coupons of 7.05% and 7.5%, respectively, compared with an average interest rate of 10.9% on the old debt.
Nashville, Tenn.-based Healthcare Realty Trust, another benefactor of cheaper money, recently bumped up its unsecured credit facility to $100 million from $75 million, lengthened the facility's term by more than two years and reduced interest costs to 112.5 basis points over the London InterBank Offered Rate, from 125 basis points.
"What you have here is a declining cost of capital, and in the spread business that's essential," Bagley noted. REITs make money by lending money at a higher rate than they borrow it.
By lowering their interest costs, REITs can cut better deals with healthcare companies keen on keeping a lid on their capital costs. But despite added flexibility in negotiating rates, the bulk of most REITs' business remains within the for-profit healthcare sector.
"The big barrier to doing a lot of not-for-profits is tax-exempt financing," explained Helen T. O'Donnell, first vice president and healthcare research analyst at PaineWebber in New York. REITs will have a tough time making inroads with tax-exempt providers as long as cheaper capital is available to them through the sale of tax-free bonds, she said.
But you won't find many REITs chasing not-for-profit business, either. "Why would you want to do a deal with a not-for-profit?" Bagley asked. There's no profit motivation, he maintained. "I want that operator incented to make some money."
Two of the hottest money-making areas right now are assisted living and medical office buildings. That's because there's plenty of business to go around. REITs are capitalizing on the rush to add lower-cost assisted-living capacity and the boom to build medical offices by healthcare providers as part of a physician-alignment strategy.
Capstone Capital Corp., one of the newer, smaller healthcare REITs, also likes companies that integrate outpatient healthcare services. One of its current favorites is Nashville-based Arcon Healthcare, a private, venture-capital-based operator of "hospitals without beds." So far, Capstone has committed $25 million to the company, whose facilities will house physician, diagnostic, surgical, therapeutic and rehabilitative services.
Launched less than three years ago by Richard M. Scrushy, chairman and chief executive officer of HealthSouth Corp., Capstone has amassed a portfolio with names like Columbia, OrNda HealthCorp and MedPartners.
"We like hooking our wagon to leaders," said John W. McRoberts, Capstone's president and CEO.
Building relationships with larger players in the industry is one way healthcare REITs have remained competitive with banks, pension funds and life insurance companies.
"I also see (REITs) starting to vary their path in terms of how they put out their dollars," said Ziegler's Korey. It's not just traditional sale-leasebacks anymore.
Ziegler, in fact, is a partner with Birmingham, Ala.-based Capstone in providing "mezzanine," or second-mortgage, financing to long-term-care providers. So far, the companies have committed more than $22 million.
Similarly, G&L Realty Corp., a Beverly Hills, Calif.-based healthcare REIT, formed a joint venture late last year with Nomura Asset Capital Corp. The partners are poised to provide $200 million in financing to the senior-care industry.
With the continuing flurry of mergers, acquisitions, development deals and managed-care restructuring in healthcare today, REITs "are going to need a variety of products to remain competitive," Korey said.