Not-for-profit healthcare systems can't seem to get enough capital, particularly "strategic capital," to grow their businesses and expand market share.
Yet many systems are sitting on millions of dollars of unspendable capital tied up in bricks and mortar. And, more often than not, systems are just breaking even or losing money on their real estate investments.
Real estate consultant Todd Lillibridge and strategic planning specialist Sydney Scarborough recognized the dilemma and decided to do something about it. Late last year they formed a private real estate investment trust called Lillibridge Health Trust. The Chicago-based REIT is negotiating to buy not-for-profit systems' medical office buildings, clinics and other properties generally not eligible for tax-exempt financing. Healthcare systems might invest the proceeds in, say, information systems or physician practice management strategies.
"Our goal in developing Lillibridge Health Trust is to bring to bear a captive source of capital to give our clients access to the private equity markets," says Lillibridge, the REIT's chairman and chief executive officer. "We come along and take brick and mortar and monetize it."
Lillibridge and Executive Vice President Scarborough discussed their plans for the REIT exclusively with MODERN HEALTHCARE.
While other healthcare REITs focus on for-profit providers, Lillibridge Health Trust is the first to target the not-for-profit healthcare sector.
Chicago-based John Nuveen & Co., an equity investor in the REIT, is assisting in marketing the concept, prequalifying potential candidates and providing credit underwriting services. Lillibridge Health Trust wants to finance investment-grade systems that rank No. 1, 2 or 3 in their markets.
"We're not after those that need the money," Lillibridge says. The REIT is targeting systems that want to use the money they have more wisely.
Because of confidentiality agreements, Scarborough would not disclose names of clients. She says the company has entered agreements, is negotiating deals or looking at properties worth a total of $450 million. The first closing with a group of systems, expected this fall, will produce $20 million to $30 million per provider.
Currently, the REIT is privately financed by its founders and Nuveen. The company is planning a $100 million private placement of debt and equity with institutional investors this fall and hopes to go public in late 1999 or early 2000.
Lillibridge Health Trust could face some competition down the road. Cain Brothers & Co., a New York-based financial adviser and investment banking firm, is shopping around its own model, the "affinity REIT." The idea is to bring together a number of not-for-profit hospitals and health systems to form their own REIT. Providers would receive REIT stock in exchange for their asset contributions and could tap the equity markets by selling shares of the REIT to the public.
Lillibridge is familiar with the affinity REIT. He's also run across a number of Roman Catholic systems that have considered forming their own REITs. But under those models, the systems would continue to wear the hat of landlord. In his view, providers need to ask themselves, "Are we really in that business?"
The market for REIT financing is potentially huge. Lillibridge Health Trust estimates that not-for-profit hospitals and health systems have $400 billion of capital tied up in outpatient buildings alone. And that asset pool is growing by $7 billion to $8 billion per year, according to the REIT.
Providers are beginning to realize how much capital they could redeploy by ridding their balance sheets of outpatient facilities. "We've seen a lot of positive enthusiasm," Scarborough says. "It seems like the timing is really right."
For years, not-for-profit healthcare providers have shown little interest in REIT financing. For many, it's a control issue. Providers have been reluctant to cede control of a property to another owner, says Gerry Means, a senior vice president with Bedford, Texas-based financial adviser Ponder & Co.
But as healthcare delivery evolves and providers realize that healthcare doesn't revolve around the hospital anymore, system executives are becoming more open to other ownership arrangements, says Kenneth Kaufman, founder and managing director of Northfield, Ill.-based financial adviser Kaufman, Hall & Associates.
"Once you've made that philosophical change in your thinking, then control issues may not be nearly as important," he says.
Lillibridge and Scarborough say they're willing to accommodate providers' desire for more control. Rather than a sale, for example, the company will consider a joint venture. Providers also may negotiate buyback clauses enabling them to recover control of their properties at fair-market value.
Providers often pay very little attention to real estate, Scarborough has found. "We bring the ability to manage these facilities and take that responsibility off their backs." But that, too, is negotiable, she says.
If a system decides to lease back a facility, executives must weigh the cost of lease payments against its cost of capital. One reason not-for-profits haven't fallen in love with REITs is the cost of the money.
These days not-for-profit healthcare providers can issue tax-exempt bonds at 5.5%. But not-for-profits that lease back from a REIT can easily pay 1.5 to 3 percentage points more. In fact, depending on the provider's credit quality, costs could total as much as 12%, says Terry Ward, president and CEO of the Ward Group, a Houston-based medical facilities developer and manager.
Lillibridge Health Trust's cost of money, or what it needs to charge in rent, runs about 9% to 9.5%, says Tony Speranzo, vice president and manager of corporate finance in John Nuveen's Irvine, Calif., office.
REIT financing isn't for everyone, Ward says. "It can't compete with the not-for-profit bond money." But what it gives healthcare providers is flexibility, he says.
Instead of letting cash sit in unproductive real estate assets, a system can plow more money into its investment portfolio or invest the capital in ways that will boost revenues and income from operations, Ward explains.
Lillibridge Health Trust is targeting properties that are generally financed with taxable money, like medical office buildings. But finance experts say not-for-profit healthcare providers have ways of tapping less-expensive capital. It's called "back-door financing," and here's how it works:
Say a healthcare system wanted to build a $15 million medical office building for its physicians. It can't issue tax-exempt bonds because of federal prohibitions on the private use of that money. But it can scrape together $15 million worth of tax-exempt capital projects that it would have financed with cash. So it borrows $15 million at low tax-exempt rates to finance those projects and uses cash-on-hand to pay for the medical office building. In effect, the system has leveraged $15 million of tax-exempt money for a nonexempt purpose.
But Scarborough says lease costs need to be weighed against a hospital's total cost of capital-both debt and equity-which runs between 9% and 12%.
There are other benefits of selling to a REIT. Turning over property ownership and management to real estate professionals relieves healthcare systems of that burden, she says. "I really believe hospitals need to focus on their core business."
Providers also need to look at the returns they can generate and the best use of their money, says Nuveen's Speranzo. Few of them make money operating medical office buildings, he says. Most of the value is trapped in the property. The value is released by selling the asset.
As Lillibridge points out, REIT financing gives healthcare executives another balance-sheet management tool. By taking real estate assets off the balance sheet, a system can strengthen its cash position.