How Will Healthcare Facilities Evolve?

Posted on May 22, 2012 by MREA

A healthcare facility can embody a large selection of property, from simple medical condominiums and clinics to large, more complex, time-consuming and costly teaching and research centers. Large hospitals tend to have all of the diverse health care types that are often found in free-standing facilities. So, it is important for smaller facilities to send the proper message to its visitors, vendors, patients and staff. It is commonly overlooked, but the appearance of a medical facility provides insight about the organization, as well as the level of care that is administered. Evidence about the level of care begins at the entrance of the facility, the unloading zone, parking areas and direction signs. In most situations, the message sent is one of compassion towards the people who enter. This, and most tend to forget, is also for the employees who service the patients as attitude and behavior will cater respect and goodwill. As for particulars, to name just a few, the finish, signage, entrance and hallway adornments should be coordinated and security features, visible yet not intimidating. Collective, thoughtful design from third-party may help to ensure the proper first impression is created and sustained.

The design of health care facilities is governed by several regulations and special requirements. It is also affected by lesser publicized circumstances and pressures. The most common of these are workforce shortages, reimbursements, malpractice insurance, physician-hospital relations, capacity, care for the uninsured, patient safety, advances in technology, and patient satisfaction.

Currently, the entire health care system is under enormous pressure to reduce costs AND become more responsive to its patients. The aging population consumes the greatest use of health care services, and, it is well documented that the percentage of the aging population is increasing significantly. At the same time, rapid technological advances, often involving very sophisticated electronic platforms and equipment, make more diagnostic and treatment procedures available to the public, more rapidly than in the not-so-distant past. From a layman’s perspective, information alone should assist to decrease health care costs, yet it is not. Thus, medical facility designers are under pressure to reduce both construction costs and the costs of their design services, while compressing construction schedules AND still meet the highest quality standards. Not an easy job by any stretch of the imagination.

As cost pressures continue, health care facilities will find themselves in increasing competition for both patients and staff primarily due to a leaner budget. Yet, and it is widely recognized, the facility is one of the top requirements when attracting and retaining the best doctors and nurses, the most successful HMOs and insurance plans, and the most patients. Consumer buying decisions are based on cost, accessibility, quality of service, and, in terms of healthcare, quality of care provided. An aesthetically pleasing facility is a key aspect of the perceived quality of care.

Health care is a labor-intensive industry, and much of its labor is highly skilled and highly paid. Since 60 to 75% of a hospital’s expenses are from labor costs, a design that increases operational productivity or efficiency and reduces staffing needs can have a major impact on the bottom line.

Now, more than ever, the flexibility within a facility is key to keeping it from functional obsolescence in the face of changing needs and technologies. Healthcare facility needs are evolving rapidly, and the direction is difficult to forecast with any certainty. New equipment technologies, new treatment methodologies, changes in diseases, and changes in the patient population base all impact the facilities that house them. Inpatient care is steadily being reduced while outpatient services are growing. There is increasing emphasis on specialize care units and smaller satellite facilities rather than large, centralized facilities.

In the past, communicable diseases were the major health problem, and sanitation or cleanliness was the main characteristic of a healing or therapeutic environment. Cleanliness remains extremely important, but there is increasing recognition of the value of a pleasant, easily-understood, and non-threatening environment for patient recovery. Good design in the health care setting starts by recognizing the basic functional needs, but does not end there—it must also meet the emotional needs of those who use such facilities at times of uncertainty, dependency, and stress.

The HIPAA regulations address security and privacy of “protected health information” (PHI). These regulations put emphasis on acoustic and visual privacy. While HIPAA does not regulate facilities design, its implications for healthcare facilities may affect location and layout of workstations that handle medical records and other patient information, paper and electronic, as well as patient accommodations. As of April 2012, a cardiology practice agreed to a settlement of $100,000 for HIPAA violation for posting patient scheduling on a public internet calendar (more info here).

As the movement continues from hospital-based acute care to outpatient care that embodies more holistic, preventative, and continuous care items for health and wellness, MREA is uniquely positioned to offer professional, experienced guidance for healthcare providers and lend its vast network of working relationships and real estate opportunities for administrative and investment interest.

Evaluating Real Estate Options When Adding a Physician

Posted on May 10, 2012 by MREA

Most physicians who are given the opportunity to join a private practice expect to eventually become partners. Typically, after a few years as an employee, physicians are provided partnership role by way of purchase opportunity. The purchase would be based upon the value of the equipment, furnishings, accounts receivable and goodwill. Most practices tend to lease their medical office space, so no value is attributable to bricks and mortar. However, some practices own the real estate and issues arise as to whether incoming physicians will be provided ownership in the real estate.

The majority of medical practices are still structured as professional corporations. Typically, if the real estate is not leased, it will not be owned by the practice corporation itself for both liability and tax reasons. Rather, the facility or condominium will be owned by a separate entity. This entity is commonly structured as either a partnership or limited liability company, or if a single doctor is involved, the real estate could be owned jointly with the doctor’s spouse. Thus, a physician may become a partner of the medical practice entity without becoming a partner of the real estate entity.

In the past, most physicians showed little interest in becoming a partner in the real estate entity, not having a true understanding of commercial real estate as an investment. Additionally, they may not have been able to produce the financial requirement for buy-in to the entity or felt the location was not suitable. Whatever the reason, it was more likely than not that an incoming physician did not consider the investment. Today, with greater access to information and investment opportunities, physicians are very interested in real estate.

Prior to being added to a practice group, it is important to know the culture and seek like strategies for ancillary or investment opportunities. As per example, most senior physicians within the practice group may not share access to real estate ownership. Because real estate development, purchase and management is a significant investment of money (and time), it is understandable that incoming physicians would not be allowed access. Because of this, the senior physicians maintain that they will hold on to it as an investment for, or throughout, retirement. We are seeing some leeway here, though.

As an incoming physician, it would be important to take a good look at the real estate piece, no matter the situation of lease or purchase. If it is a lease, there will exist a written lease between two entities. The lease should not be above fair market value rental rate and in place for a reasonable period of time, both to be discussed further. If the rent is too high, perhaps to provide tax benefits to the owners of the real estate, there will be less capital to improve the practice. If the term is too short, you will face renegotiation of the rent too often, which will tends to create more advantage for owners that lease space. If the term is too long, the rent will likely step up each year to become a larger proportionate share of liabilities for the practice group.

In the situation of ownership, if the real estate is owned by one or more senior physicians, the practice will likely seek to relocate if they decide to sell the real estate. In order to avoid this situation, in addition to a long-term lease or a short-term lease with options to renew, the real estate owner(s) could give the non-owner practice partners an option to buy the real estate at an appraised value upon retirement or death, or a right of first refusal.
Now let’s assume that all parties wish to have an incoming physician buy in to the real estate entity. This may either occur at the time as the purchase into the practice entity or at the point the doctor has completed his or her buy-in. If the latter option is pursued, presumably, they will be more able to afford the buy-in to the real estate. In any event, the main issues will become the buy-in price and manner of payment.

The price can be determined in a few ways. One is simply by mutual agreement of all parties. Another method is simply using the original cost of the real estate if it was recently purchased, or the original cost plus annual CPI (Consumer Price Index) increases. The most common method, however, is by means of an an appraiser or broker opinion of value through appraisal or our brokerage entity. The fees could be as low as $500.

Once the price is determined, the manner of payment needs to be approached. One option is to simply pay each owner his or her share up front. If that is not possible, a promissory note could exist in favor of each real estate partner with payments made over time with interest.

A common method exists for partners to refinance the mortgage to as close to 100 percent financing as possible. The new partner would simply sign the new mortgage and be equally responsible for the debt without having to pay any out-of-pocket buy-in. The existing partners are able to pull out the cash equity at that time to realize a return on their investment. When interest rates are declining, refinancing is more likely to occur. A caveat is, if interest rates increase, the existing partners may not be willing to choose the method of refinancing due to larger interest payments, and, presumably, lesser real estate value.

Should a partner leave or retire from the medical practice, will they become obligated to sell his or her interest in the real estate and should the remaining partners be obligated to purchase his or her interest? If so, at what price? Thus, it is important to have the document treated carefully or via retainership of legal counsel.

Often times the inclusion of a physician to a practice group involves several items, including real estate, that should be addressed with business intelligence. MREA is capable of assisting in your next physician addition, partner acquisition or real estate transition. Contact your local representative for assistance.

Ambulatory Surgery Center: From Concept to Reality

Posted on May 1, 2012 by MREA

In our continued expansion throughout the State of Texas, we are regularly posed questions pertaining to financial feasibility and cultivation of an ambulatory surgery center. We would like to respond by providing a few feasibility studies, to include financial summaries, in a later post. This post will be dedicated towards setting up the ASC entity, determining consultants, bidding to preparation for construction.

1. Once you have determined that it is feasible to build an ASC, you must first consider its legal structure. Will you consider owning the ASC with partners outside of your medical practice? Many physicians adopt others when building an ASC. But, prior to making this decision, it is important to determine the legal risks associated with joint ownership of an ASC. Many are familiar that Stark Law has limited scope for operations within a surgery center, yet several other legal issues such as non-compliant physicians, indirect referrals, and billing matters may arise and should be considered and should be explained to avoid contagion within an ASC.

If the ASC is going to be built on existing land investment, it is important to determine how the land should be owned. Should it be in its own legal entity or part of the ASC entity? Will all of the owners of the ASC own the real estate? Owning the real estate in a separate entity may make the cost of the ASC more affordable for others. Separate ownership of the real estate may also provide an income stream for years to come. If your ASC is owned in a separate entity, you should consider the tax implications with receiving income from more than one employer.

Your legal counsel should review with you the issues surrounding the building of an ASC. They include, at a minimum, HIPAA, Anti-Kickback Statute issues, fraud and abuse issues, and antitrust considerations.

Once you have evaluated the legal considerations and determined the structure of the organization, your legal counsel should prepare a number of organizational documents. Within this packet, you should have an Operating Agreement which details how the business of the ASC will be run. The Operating Agreement will clearly define the initial and supplemental capital contributions of each member of the ASC as well as how contributions will be required. The Operating Agreement may also contain a non-compete provision prohibiting investors in the ASC from owning an investment interest in a competing ASC within a specific geographic area. You should consult with your attorney regarding the enforceability of non-competition covenants. The Operating Agreement will also determine how new partners are admitted, and the buy-out of existing partners. A valuation formula for the Member’s ownership interest should be included in the Operating Agreement. The Operating Agreement should also contain a conflicts of interest provision which requires members of the ASC to disclose potential conflicts or business opportunities to the ASC.

2. Moving forward, now that a viable project exists, it is time to turn the attention towards the next step, which is to contact the state where the facility will be constructed to determine the steps necessary to complete the project and comply with the necessary state and federal requirements. Texas will send you a packet of information detailing this process and advising you of the significant building requirements.

In conjunction with this, it would be advisable to interview architects. In the process of interviewing candidates, be sure to qualify each one based on their experience designing ASCs within Texas. ASCs can be complex structures with significant engineering involved. Do not proceed without a qualified architect and engineer who commit to providing you with a fully engineered plan. As a caveat, if the architect advises you to proceed on a “design build basis” where the contractor and his subcontractors provide the engineering, you may be inviting delays in getting the center built.

The basic decision of what is to be built is largely based on what procedures will be performed at the ASC. If a constructing a single specialty ASC, it is common for physician to assist in direction for the layout of the ASC. Certain spaces are required inside the ASC to support the surgical procedures you intend to provide. The list of all of this space is called the program. Once a program has been developed, the floor plan layout can be done.

For purposes of certification, Texas requires floor plan review prior to proceeding with formal construction planning. Once the floor plan has been approved, your architect can proceed with the construction drawings. A significant period of time for this should be alotted, as most projects sit in idle during this phase.

Most owners want control of bidding for their projects. However, because the industry is seeing a greater number of projects moving forward, some are being performed within a construction management agreement. The advantage to construction management is that if you have advisory through experienced general contractor, or knowledgeable advisory, the process can ultimately save money within in the design process. The contractor can provide a valuable engineering function by recommending less expensive ways to construct the building or less expensive materials for the project.

3. If you decide to bid out the ASC project, we recommend you get bids from multiple contractors. Your architect and consultants should make a recommendation as to which bidder wins the contract. Ultimately, it should be the owner’s decision, although the architect and consultant’s recommendations will remain of serious consideration.

Once the contract is awarded, be sure to sign a contract for the construction of the project. Also be sure to set out expectations for payment to the contractor at the start of the project so everyone knows what is expected of them. You should expect multiple requests for payment during the project based on a percentage of the project that is completed.

The architect and consultants should provide regular onsite visits. A report should be available on a bi-weekly basis to keep the owner apprised of the progress being made. Construction meetings with the subcontractors, general contractor and the owner’s representative should be held along these same scheduled intervals.

Please look forward to subsequent posts regarding feasibility studies, equipment, or licensing of an ambulatory surgery center. Contact Robert S. “Bob” Lowery of MREA for any questions during any part of the planning or implementation process of your Texas ASC.

Joint Ventures for Outpatient Facilities

Posted on April 20, 2012 by MREA

Historically, hospitals have entertained reliable income streams from the their surgical and diagnostic imaging components. Now, because patients have greater access to physician-owned surgery centers, coupled with advancements in imaging technology, it is increasingly difficult for hospitals to have income certainty from these procedures within a hospital setting.

On the other hand, proposed and already implemented changes to the Medicare payment system suggest that physician providers face the threat of losing a greater percentage of revenue. Thus, many are seeking partners with hospital systems from a joint venture perspective.

1. The most common form of joint venture is the division of ownership between the hospital and physicians. In this agreement, the hospital and participating physicians form a new entity and each contribute funds or lender approved interest equal to their pro rata ownership in the new entity. The equity investment model has proved to be a “win-win” situation for both the hospital and the participating physicians. The hospital better secures a long-term relationship with referring physicians, builds loyalty and trust, and recaptures a lost revenue stream. The physicians are better positioned for a positive ROI and can focus on patient care rather than highly detail-oriented tasks and risks that exist in real estate ownership and management. A potential drawback under the surgery center setting is that the payment received under this form of joint venture can be significantly less than what the hospital would receive for the same procedures performed on a hospital inpatient basis.

2. The healthcare industry has seen more “under hospital arrangements” over the past decade, although many have been recently banished from hospital settings. While this model can take on many variations, several characteristics are in common. The participating physicians provide to the hospital a certain ancillary service (from the use of primary equipment to turn-key management).The hospital purchases that service on a “per-click” or “per-use” basis. The hospital is the billing entity and is paid under the hospital ambulatory payment classification codes. The primary advantage of an under arrangements model is the higher payment received by the hospital as a result of the hospital billing under the hospital payment system. Moreover, the hospital bills under its managed care contracts, which commonly provide for higher payment than what is received by freestanding outpatient facilities. A few potential drawbacks to the under arrangements model are the increasing regulatory scrutiny of hospital and physicians transactions. Also, because the hospital performs the billing of the surgical procedures, the Stark law is in effect.

3. A standard block lease is where the hospital leases ancillary equipment or management responsibilities to participating physicians in return for a fair market value lease. Each participating practice bills under its own group number. The primary advantage of a block lease arrangement is its ease to initiate and terminate. Since a participating practice does not have ownership of the equipment or facility, the hospital or physician practice can quickly terminate the relationship. One major disadvantage to block leasing arrangements is that the physicians do not feel like ownerHistorically, hospitals have entertained reliable income streams from the their surgical and diagnostic imaging components. Now, because patients have greater access to physician-owned surgery centers, coupled with advancements in imaging technology, it is increasingly difficult for hospitals to exercise income certainty from these procedures within a hospital setting.

4. The shared expense model is a variation of the block lease model, except that instead of each practice leasing blocks of time, it would assume a commercially reasonable proportion of the costs of the diagnostic business and utilize the imaging equipment on a first-scheduled, first-served basis. From a regulatory perspective, the shared expense arrangement may be considered more aggressive than a block lease arrangement because it will not qualify for safe harbor protection under the Anti-Kickback Statute. However, many physician practices may still prefer this type of an arrangement due to its added flexibility of being able to schedule patients on a first-scheduled/first served basis and paying expenses in a manner that more closely reflects the actual use of the imaging equipment.

MREA is a truly comprehensive medical real estate platform that plugs the gaps from that of traditional buy-sell-lease-manage commercial real estate companies. To receive a complete package of our healthcare services, real estate offerings, consulting assignments, or merger/acquisition successes, please contact Robert S. “Bob” Lowery at 713-701-7900.

Texas Healthcare Mergers and Acquisitions

Posted on April 10, 2012 by MREA

Amid an improving economic climate, and provided that a long-term reorganization of health care insurance and delivery model remain active, mergers and acquisitions will continue to increase rather noticeably.

While the healthiest corporations and service providers from the broader industry are consolidating and shifting the majority of their investment dollars overseas, many medical providers have built stand-alone facilities that are too enormous in size and cost to simply serve their niche within a locale, larger community or city. While not all regions are alike, especially when considering that of Texas’ strong population influx, international investment and patient demand, many large physician groups and systems in the United States are weary of growing outside of physician boundaries and are awaiting coercive change to help define their future.

The reasons for staying local are many, as suggested by several insiders. One is the contention regarding regulatory influences located in municipalities, cities and states and the inability to structure same healthcare delivery models state-by-state. Another is that, commonly during stronger economic times, organizations tend to compete over the same clients, or patients for the sake of this article. As such, nearby outpatient facilities and surgery centers will continue to be a viable growth strategy. Another factor has to do with the influence of key physicians within the hospital system who would much rather drive to their practice, or investment, than fly. The last reason that a business model may remain local is due to the lack of familiarity and partnership with qualified business professionals to support and grow operations outward, rather than upward and around.

How Quality Leadership Creates Long-Term Synergies for Healthcare Mergers and Acquisitions

Mergers and acquisitions will grow and will affect healthcare providers and physicians.

During a healthcare merger or acquisition, the feelings of physicians and employees involved usually swings one of two ways. Sometimes physicians are excited about the prospect of working for a larger, stronger post-merger organization, especially if it creates opportunities for ownership, seniority or stability. More often, though, the physicians and staff see themselves at odds with new ideas, management styles or facility relocation.

Without third-party leadership, the nightmares that may occur with existing administration, especially if undersized, have the potential to create potentially undesirable circumstances that could jeopardize the transaction simply through association. Working with the conflicting interests of two cultures to form one means standardizing policies, procedures and systems. In this case, facility administrators have to reach out to coordinate with other real estate administrators, executives and physicians to determine whether to consolidate facilities with overlapping functions, and if so, how that should be done and which buildings should be divested. The exact criteria varies and the process must be handled appropriately so that all interests remain confidential, costs are minimized and physician continuity is ensured.

No matter with whom the provider chooses to work, every merger or acquisition is different, and therefore each requires a separate strategy to reduce heavy cost and reduce or eliminate potential redundancies. Our due diligence and merger planning team is responsible for looking at every aspect of business side of the transaction, from financial data and corporate philosophies to real estate holdings, and then work to construct a plan for the transition into the post-merger environment.

As cumbersome as this appears to be, it is very surprising to note how most large practice groups and healthcare providers in the past rarely sought such assistance. This expertise is very common within the corporate real estate world to eliminate conflicts of interest and provide confidentiality and goodwill among employees. Today, it is imperative for healthcare providers to seek third-party facility transition executives that are responsible to the healthcare industry, have the resources and capability to provide informative research and comprehensive reporting, maintain a quality reputation within the sector without conflicts of interest, and can intelligently advise across business, real estate and merger or acquisition activities.

A Healthcare Real Estate Success Story

Posted on April 1, 2012 by MREA

Given economic and regulatory uncertainties, a provider of healthcare services retains our firm to improve relationships with the physician practices that occupy several medical office properties around their hospital campuses. This essentially enables the provider with an opportunity to obtain positive economic outcomes such as tenant retention, property referral, good will and financial clemency.

Additionally, the provider wants to measure its own operations through the simple method of acquiring physician input regarding service delivery, as well as report on the present adequacies when compared to other like providers so as to audit possible tenant separation.

MREA collaborates with the client to coordinate a proprietary satisfaction assessment specifically geared towards to medical tenants. This includes:

Tenant survey of satisfaction with building services, property management performance and lease renewal intentions
Action planning reports for each hospital campus, region, service provider and the national portfolio, highlighting performance trends, strengths and weaknesses
Comparative performance analysis of year-over-year results and versus report
In-depth, statistical analysis of property and tenant characteristics influencing satisfaction, retention and relationships
Recommendations for the enterprise and each service provider to improve customer service delivery, strengthen relationships and boost retention
Customized presentation of the results and recommendations to each service provider’s national account management personnel and property management teams

While we will keep our results confidential, based on assessment the client:

Targets improvement initiatives toward highly influential property management practices, such as frequency of proactive communication with tenants
Requests action plans for improvement from each hospital campus and service provider
Increases tenants’ satisfaction with management by 10% to exceed benchmarks
Improves tenants’ likelihood of renewal rate by 5%
Identifies “at-risk” tenants whose lower satisfaction level and higher likelihood of defection warrants immediate property management follow-up
Strengthen physician relationships with property management and hospitals

We are proud to offer this service as part of a growing list of healthcare real estate competencies located here.

Effect of Rising Interest Rates on Commercial Real Estate

Posted on March 22, 2012 by MREA

We admit it is dangerous territory to write about rising interest rates, especially when predicting a potential up or down movement. We have not come anywhere close to the topic over years of participation in the sector.

Around 2005, there was heightened speculation that treasury yields would rise and the undoing of commercial real estate would begin. It never happened, and 7 years later some of same properties are trading at double that of 2005 prices, an approximation that can be cited with hundreds of local examples.

So, why are we touching on this subject today, especially given the number of forecasters whose predictions have laid years of waste pouring over the topic? Well, with the stock market improving without real improvement in bond yields, due in part by the Fed buying bonds and keeping rates artificially low, one of two things will likely occur; the stock market will need to drop or treasury yields (and their direct correlation with mortgage rates) will move higher. Both should be moving in tandem, yet, they are not.

Interest Rates and Cap Rates

When talking about the potential for rising mortgage rates, we would be lax in our responsibility not to mention it impact on capitalization (cap) rates, a simple measure of return that fuels commercial real estate investment demand.

Follow me here…If you are to consider the cap rate equation from the perspective of a math or economics professor, high cap rates or high investment profitability is a result from high net operating income (NOI), usually a product of higher rents and/ low relative property values. Low cap rates and low profitability is a result from lower rents and/or high property values.

In recent years, cap rates have trended parallel to interest rates. And, with interest rates (and mortgage rates) at all time lows, cap rates have moved below where investors are comfortable for necessary returns on a commercial real estate investment. Thus, cap rates are now in limbo. So, if bond yields and mortgage rates move higher, we could see where this will not have an immediate impact on investment. Actually, it might spur ‘real’ investment back into commercial real estate.

Historically, a decline in interest rates and cap rates affected the commercial real estate market where property values improved; rents, or income, remained stable or fell. The upward climb of property values from the availability of lower rates typically had a direct correlation to a period of low to modest stock market returns and significant move into commercial real estate.

To supplement, cap rate values have remained higher than prevailing 10-year treasury bond yields. The simple reason is that if bond yields were to rise above the cap rate return of the property, any property would be difficult to sell. This is because the return is less than the bond yield. Why would you own real estate if you could just own a treasury bond. Similarly, if you buy a bond at 4% and the value of the bond goes up to 6%, not many are willing to buy your bond back at face value.

Conclusion

In a period where mortgage rates could potentially rise dramatically, owners are hoping for an increase in income (rising rents and/or rising demand for space) to offset the damage incurred by higher financing costs and, most recently, inflationary concerns.

MREA | Medical Real Estate Advisors

Precision Guidance for Healthcare Real Estate