Historically, healthcare and real estate have not mixed well. At least that's one explanation for why healthcare real estate investment trusts, or REITs, have not captivated much attention either from investors or hospital systems.
It certainly doesn't help that REITs have suffered from the meltdown in the long-term-care industry and difficulties among assisted-living operators, sectors in which most healthcare REITs are heavily invested.
But while publicly traded REITs have not made much headway in persuading hospital systems to hand over their brick-and-mortar projects, other private firms that specialize in real estate development and financing are hoping that systems will take a second look at creative ways to finance their real estate off the balance sheet.
The nation's largest hospital company, HCA-The Healthcare Co., is exploring the possibility of spinning off a major chunk of its office space into a separate company, while other hospitals and systems have already used their real estate assets to improve cash flow on a smaller scale.
Healthcare financial services companies are trying to pitch the idea that selling them real estate and leasing it back frees up a system's access to capital, which then can be used to fund healthcare projects. It also lets systems concentrate on what they do best, which is caring for patients, not being landlords. In the past, however, hospitals have been loathe to give up control over their real estate.
"Hospitals in general in the past have been reluctant to get into any sale-leaseback transactions with real estate companies because they felt they were losing control," said Alexis Hughes, a REIT analyst at Credit Suisse First Boston in New York.
One of those companies is Tenet Healthcare Corp., which does have some leaseback arrangements that it inherited through hospital purchases, but it primarily manages its own medical office buildings, said David Dennis, Tenet's chief financial officer, vice chairman and chief corporate officer.
But Hughes and others said that the increasing number of fraud-and-abuse investigations into physician relationships with hospital companies has led to a renewed interest in sale-leaseback transactions, because it puts a separate company between the hospital and the physician that controls the leasing of office space, ensuring an arm's-length transaction.
"I think the desire to engage in sale- leasebacks hasn't been overwhelming, but there certainly has been an increase in the number of hospitals willing to engage in sale-leaseback transactions," Hughes said.
Nashville-based HCA, in fact, is mulling spinning off about 116, or one-third, of its medical office buildings into a joint venture with a third party controlling daily management of the properties.
"For us it does two main things in terms of strategy," said HCA spokesman Jeff Prescott. "It relieves our CEOs and other hospital administrators from having to be in the business of managing and looking after the daily functions of office buildings; and it would give us cash."
HCA's way of dealing with the control issue is to keep an equity interest in the joint venture that manages the buildings, although the percentage of equity has not yet been decided, Prescott said.
Healthcare executives are looking into these types of arrangements more eagerly than they have in the past, said Richard Gundling, senior technical director at the Healthcare Financial Management Association.
"It had kind of fallen off the radar screen," he said, "but it's come back on again because of the prospective payment system changes and margins dropping."
The HFMA has held workshops to train healthcare executives in various recapitalization processes, Gundling said.
One of the companies looking to benefit from this renewed interest is Nashville-based Medical Properties of America. The company got its initial round of funding from one of Nashville's healthcare elite, R. Clayton McWhorter, the former chairman of HCA, who has made a second career out of helping get healthcare start-ups off the ground through his venture capital firm, Clayton Associates.
In May, MPA received a commitment of $100 million in financing from Reckson Strategic Venture Partners to buy, manage and develop healthcare real estate for leasing to providers. Reckson is an investment fund affiliated with New York-based Reckson Associates Realty Corp., a REIT.
One of MPA's tenants is HCA, which occupies part of a multitenant medical office building in El Paso, Texas.
"Most hospitals do not have any particular skill at property management," said Richard Treadway, M.D., chairman, chief executive officer and founder of MPA. "Many of the doctors we see when we acquire a building say we're the first property manager they've seen since they leased the space."
Sometimes hospitals that own medical office buildings have nobody in charge of the leases, and often a lease will not contain clauses for increasing the rent to keep up with inflation, he said.
At the end of 1999, MPA had an asset base of $25 million; by the end of the year, its founders hope it will grow to $175 million to $200 million. While Treadway would not disclose the firm's finances, he said MPA is currently profitable.
Most REITs are publicly held companies with numerous investors, and they must distribute 95% of their net income to those investors each year. Some of the private financing firms, however, are far less hampered by regulations because they have fewer investors and can be set up as limited liability corporations, said Phillip Suiter, executive vice president of MPA. And unlike REITS, which have invested heavily in nursing homes and assisted-living centers, MPA is focusing on outpatient clinics, ambulatory surgery centers, physician specialty clinics and medical office buildings, Treadway said.
"From a timing perspective, a lot of the REITs are on the sidelines right now," Suiter said. "There's a supply and demand imbalance right now, and we want to take advantage of it."