Capella sale to REIT shows hospitals seek to monetize real estate

The sale of Capella Healthcare to a real estate investment trust heralds more deals to come between hospital operating companies and REITs as more providers realize it's time to cash in on their rich real estate portfolios, analysts say.

Acute-care hospitals are now just one piece of the continuum of care that health systems need to control. As the market's demands shift, providers are assessing which pieces they need to own outright and where they could monetize their real estate. Meanwhile, REITs are banking on continuing strong demand for healthcare services as more Americans gain insurance and the population ages.

“There's been an increasing amount of competition to own hospital facilities,” said Mindy Berman, healthcare practice lead in the capital markets group of JLL, an investment management firm specializing in real estate.

Capella, a privately held, Franklin, Tenn.-based chain with 11 hospitals, last week said it will be sold to a real estate investment trust in a $900 million deal. Medical Properties Trust, which focuses exclusively on acute-care facilities, will own Capella's real estate, while the hospital operations will be jointly owned and managed by MPT and Capella's senior management. Private equity firm GTCR has owned Capella since its founding in 2005.

The transaction is the second this year in which a REIT has purchased a hospital operating company and separated the real estate from its operations. In April, Ventas, a REIT, forged a $1.75 billion deal to acquire Ardent Medical Services from its private equity owner, Welsh, Carson, Anderson & Stowe. Similar to the Capella deal, Ardent's current management and other investors will own the hospital operations, with Ventas retaining a 9.9% stake.

Hospital systems, many of which operate with thin margins, have been trying to reinvent their business at a time when they also need to invest in areas such as physician recruitment and information technology. As more care moves to outpatient settings, hospitals often are operating with unused capacity in their acute-care wings.

A good portion of their assets, meanwhile, are tied up in their facilities and real estate—sprawling complexes often in attractive downtown locations. Under value-based payment models, health systems need to develop outpatient and ambulatory-care facilities—often in outlying communities, away from the main medical center.

Separating their clinical side from their real estate gives them more flexibility. “They can use their capital in other ways,” said Craig Acosta, director of the facility and capital assets practice at consulting firm Kurt Salmon.

Leasing outpatient and post-acute care space provides a lower-risk, lower-cost point of entry into those service lines. Indeed, in some cases, hospitals have chosen to partner with real estate developers on ambulatory-care centers, with the developer owning the real estate and the hospital holding the lease. “The question for them is how much do they have to own, compared to lease,” Acosta said. “The thinking is that in 10 years, healthcare will look very different.”

Michael Wiechart, Capella's CEO, said his company chose MPT “because we believe they have a differentiating strategy in acute care. REITs can access the capital markets very efficiently. As a capital partner, they do the heavy lifting for us.”

MPT, for instance, can provide the financing for further acquisitions. In addition, Capella is in the midst of a $26 million project at National Park Medical Center in Hot Springs, Ark., which will expand its cardiovascular and emergency department services. At Capital Medical Center in Olympia, Wash., Capella is investing $16 million in an operating room expansion.

In May, MPT purchased two Ascension Health hospitals in the Kansas City area, St. Joseph Medical Center and St. Mary's Medical Center, which are now being leased and managed by Prime Healthcare Services.

Until recently, REITs were unable to profit from the operations of a healthcare facility; they could only generate income by leasing the real estate.

But the federal REIT Investment Diversification and Empowerment Act passed in 2007 provided the legal mechanism for REITs to participate in the business side of healthcare.

Senior housing has been the main area for REIT healthcare participation. But larger healthcare REITs seeking to diversify their assets see hospitals as another, independent revenue stream.

While the senior housing market is driven by the larger economy—for instance, the ability of seniors to sell their former homes—hospitals' finances tend to be tied more closely to payment policies, Berman said.

REITs see hospitals as a good investment. “The health system industry has been consolidating, and the expectation is that it'll continue to consolidate,” Berman said. “In some sense, the REITs are betting on consolidation.”