It was supposed to be the next hot financing trend.
Not-for-profit hospitals and healthcare systems would begin unloading their real estate holdings to real estate investment trusts. REITs would take ownership of medical office buildings, outpatient surgery centers and other ancillary facilities, freeing up hidden cash and enabling providers to focus on core operations. For REITs, the trend promised to uncork an untapped market.
With a few minor exceptions, REITs have made little headway persuading not-for-profits to finance bricks and mortar off the balance sheet or to relinquish control of those assets. So what happened?
First of all, few chief financial officers have focused on deploying real estate assets. Much of their time is preoccupied with the complexities of merging institutions, cutting costs and boosting revenues from operations. Dan Rode, a technical director with the Healthcare Financial Management Association's Washington office, says he hasn't heard of any CFOs moving quickly on real estate transfers.
Neither have REITs captivated CFOs as a method of financing new construction or mortgaging existing properties. At interest rates of roughly 9% to 10% and sometimes higher, REIT financing is considered pricey. Most hospitals can borrow relatively cheaply-at tax-exempt rates starting below 6%. Taxable projects get financed from available cash or through other methods, such as bank loans and taxable bonds.
Despite some diversification into medical office buildings, most publicly traded healthcare REITs still concentrate largely on the nursing home, assisted-living and retirement facility sectors. In fact, several healthcare REITs have seen their stock prices tumble amid long-term-care providers' own struggle to cope with the implementation of a Medicare prospective payment system.
Meanwhile, the hospital industry as a whole remains on firm financial footing. The median total profit margin reached 5.4% for all hospitals in 1997, according to the Center for Healthcare Industry Performance Studies in Columbus, Ohio (Dec. 21, 1998, p. 48). By and large, the industry has successfully adjusted to revenue pressures without having to sell real estate.
REITs, meanwhile, have fallen from grace with investors, squelching access and heightening the cost of raising capital for property investments. In 1998, public healthcare REITs ranked among the worst-performing REIT sectors, losing 25.7% on average for the year. Only lodging/resort REITs, with losses of 52.8%, and mortgage-backed security REITs, losing 29.3%, did worse. REITs also trailed the market as a whole, as measured by the Standard & Poor's 500 Index, which tracks larger stocks, and the Russell 2000, which measures the performance of small stocks (See chart).
REIT troubles aside, hospitals interested in selling their real estate holdings or using REITs to finance new development are finding opportunities to do so.
Ephrata (Pa.) Community Hospital, for example, recently entered an agreement with Healthcare Realty Trust, the most active publicly traded REIT in the not-for-profit hospital sector, for development of a $10 million professional office building and a $4 million cancer center. The Nashville-based REIT will develop the properties and lease them back to Ephrata. "That way we don't have any huge outlays in real estate. That's not the business we're in," says William Merritt, vice president of corporate compliance and system finance at the 124-bed hospital.
Last December, Health Care Property Investors, a Newport Beach, Calif.-based REIT, announced a major expansion into the not-for-profit hospital market through an agreement with Indianapolis-based real estate developer Bremner & Wiley. The developer wanted to cash out its real estate holdings. Together with Clarian Health Partners, also of Indianapolis, Bremner & Wiley sold 13 medical office buildings and outpatient surgery centers to the REIT for $68 million. Clarian owned six buildings and leased space in 10 of them.
Lillibridge Health Trust, a private REIT based in Chicago, soon will close deals with 10 not-for-profit hospitals and health systems in two states. Sydney Scarborough, the REIT's executive vice president, says Lillibridge has discussed possible transactions with 135 hospitals and health systems and expects to ink deals worth $300 million in the next 18 months.
The REIT initially had hoped to complete its first property acquisitions last fall (June 8, 1998, p. 37). Instead, the company found itself renegotiating financing amid Wall Street's liquidity crisis. It has since lined up $75 million in private money, but the financing snag contributed to a delay in closing its first deals, Scarborough explains.
Unlike other REITs, Lillibridge is focusing exclusively on helping not-for-profit hospitals and health systems finance new outpatient facilities and sell existing property. "I'm hearing a lot of interest," says Scarborough, although she acknowledges that many hospitals, for now, are more interested in testing the waters with a single real estate transaction than in selling an entire portfolio of properties.
There are other options, too.
"I think basically what you're going to see is not REIT financing per se but essentially private equity," says Daniel Cain, a partner and founder of Cain Brothers. The New York-based financial adviser and investment bank has scrapped its model for an "affinity REIT." The idea was to bring together a number of hospitals and health systems to form their own REIT.
Instead, Cain Brothers' merchant banking arm is using its own equity to invest selectively in healthcare properties. The firm expects to close one such deal with Saint Mary's Regional Medical Center in Reno, Nev., in about a month. Cain did not disclose how much the firm is paying to acquire a medical office adjacent to the hospital.