Tag Archives: accounting

Hospitals Employing Physicians: Is It Different This Time?

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Around 15 years ago, physician practices were purchased by hospitals at compellingly high prices. Unfortunately for these hospital systems, within a matter of just a few years, the physicians were re-injected back into the community, largely because the hospital systems had not realized a return on investment. Fast forward to 2012, we hear similar stories about physicians becoming incorporated into a hospital’s network.
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The reasons for hospital systems obtaining physician groups may be many. But, most conversations boil down to either a specialty or geographic play, whereby hospitals seek entrance or command of certain designated fields or locales. Also, with the establishment of healthcare reform, and impetus from both hospital and physicians for greater reimbursements, as well as a movement to adopt a more streamlined, technologically advanced care distribution model — we think this time may be different.
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Based on casual conversations, the motivations to join a hospital from a physician perspective is appearing much greater today than it was in the mid-90′s. A weakened economy, high employment or practice costs, entry barriers, a more savvy-consumer, and the potential for declining reimbursements, are among the top justifications that we hear from physician groups.
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There seems to be a greater number of differences in how the hospital systems are purchasing medical practices today, though, when compared to that of years past. Mainly, hospital systems are not offering to pay exorbitant prices, likely as a result of previous miscalculations. As for those that we speak with, many are not seeking to purchase practices outright (staff, equipment, management, real estate, in some cases). Instead, the hospital is offering employment compensation, with greater emphasis on incentives for productivity, to a select group of physicians for a number of years. Also, because reform will include greater regulatory oversight of physician purchases, this may be an incentive for hospitals to complete acquisitions prior to 2014, when the majority of reform’s initiatives take effect.
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The most common way that a physician practice group is absorbed by a hospital is through a method where physician owners and practice administrators keep an ongoing operation in place, essentially subjecting to less guidelines and oversight, but to assume some naming rights, some jurisdiction, as well as partnership for likely for potential future transaction.

As for the outright sale of a practice to a hospital, it may be achieved in several different ways. A hospital may purchase a practice’s tangible assets with physicians and staff as employees of the practice, whereby the unit is obtained as a separate entity. In another instance, the hospital may acquire the assets, physicians and staff to become employees of the hospital, in which the practice discontinues. As for unique circumstances, the staff becomes employees of the hospital, but the physicians remain separate.

A certain consideration should be made by physician groups as to the value of their practice to the hospital system. Because anti-kickback laws exist, the hospital cannot pay a physician group more than ‘fair value’ for their practice. Any payment that is beyond a certain amount could be considered a ‘kickback’ for services provided to the hospital. Also, keep in mind, the revenue generated by physicians for referrals outside of the practice itself are not considered in the valuation.

Another issue that comes from a practice purchase is that physicians are not relieved of their responsibilities. This is because the acquisition is commonly considered a separate operating division or profit center of the hospital. Consequently, the physicians compensation is still tied to the profitability of their previous medical practice. This provides troublesome if physicians are nearing retirement.

One last reminder, and a stark reminder of how this time may be different, is how the practice’s patients now can easily become part of hospital’s affiliated practice, especially with the advent of electronic medical records. In essence, the hospital now owns and operates all patient lists and records that have been accumulated by the practice group.

While I will leave you with the determination of whether it is better to sell, partner or lease with a hospital, MREA has established healthcare real estate professionals, accountants and attorneys to whom you have access. Contact us for our wide range of client responsibilities that incorporate business strategies with extensive real estate capabilities.

Valuing Medical Real Estate on Cap Rates…Fuggedaboutit!

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Physician and investor ownership of medical income property still sits as a relative newcomer on the expansive list of commercial real estate investments, which includes office, retail, industrial, among several others.  All-in-all, there may be over 100 specialty and categorical types of commercial real estate investments if broken down by industry and tenancy (single, multiple).

Commercial real estate brokers typically will arrange all investments alike, utilizing a simple formula known as cap rate pricing so as not to confuse or curtail into any real estate investment type.  But, every commercial property user (from Fortune 500 company to auto repair franchise) and investment (fully-leased hospital medical office building to empty warehouse) is uniquely, comparatively different.  So, to achieve proper valuation the asset needs to be compared directly to those of competitive properties with a percentage emphasis on who transacted, why and how, as well as economic conditions within the submarket, city and national economy.  It is our experience that most buyers and sellers will place a greater weight on certain factors when transacting, especially when motivated by a needs or capital availability basis.  This is botched recipe that has led to the relative uncertainty for our sector as a whole.

So, it takes a skilled eye and real-time comprehension of certain functionality of business and investment types, as well as a wide array of financial and economic data points to properly price and transact in the commercial real estate marketplace.   Unfortunately, just a handful of brokerage platforms adhere to a heightened sense of knowledge and disclosure when advising their clients, primarily due to inefficient formulas for pricing commercial property.  While this is certainly not a testament against commercial real estate brokerage platforms, it is a testament about a vast investment class that in some conversations remains broken based on inefficient pricing mechanisms, one of which includes cap rate pricing.

Example.

A cardiovascular care facility has a Net Operating Income of $100,000, and the sales price for the property is $1,000,000, therefore the cap rate is 10%.  Most property investors, and now physician investors, are becoming more comfortable with this simple strategy of valuing a property for the purposes of an exit basis.

But, what does a cap rate of 10% tell you?  Let’s first discuss what it does not tell you.

A cap rate does not tell you what your return will be if the property requires financing.  With an overwhelming majority of property requiring financing and terms changing daily, what are the costs of capital? Nor, does it appropriately account for tax and interest calculations either. It cannot pit an apples to apples comparison of unique property characteristics.  It does not tell you who, what, why, how or where.  Prior to contracting on a needs or investment basis, it is very important to know the competition in the market and how, why they can transact at certain levels.  Simply doing some quick math to obtain a cap rate does not accomplish this.

If not healthcare real estate, we will be happy to direct you to advisors with a keen eye on the rolling ball.  If your physician, user or investment group needs to determine the price of which to contract in the today’s commercial real estate market, please contact us for a proven transactional formula that may lead to a higher or lower price dependent on a variety of factors.  

What Is Wrong With Commercial Real Estate? Part 2

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As most are familiar by now, the banks have not dared foreclose commercial real estate simply because it would devastate their balance sheets.  The way the value of real estate is determined plays a significant part in the calculus of whether a bank will or will not foreclose. For instance, when foreclosing a residential property, the bank has an abundance of comparable sales of which to utilize, thus, they foreclose on a property with the simple understanding that one bad apple will not spoil the whole bunch.  In commercial real estate market, there are far fewer sales and considerably less volume, so there is a lack of ability to obtain a price point.

Or, to put it another way, commercial real estate is a relatively illiquid asset, and if banks foreclose in any volume, their worst fear is that “fire sale” prices will be set and will determine how other assets are “marked to market” (that is, using an asset’s actual market value on the bank’s balance sheet), which would devastate all banks balance sheets.

Sound familiar? You may recall when the banks worked so diligently to eliminate “mark to market” accounting for the various collateralized debt obligations, mortgage backed securities and other “complex illiquid assets” on their books. And just as with those assets, regulators accommodated the banks on commercial real estate accounting, making it easier to implement this “extend and pretend” policy.

Speaking with our banking contacts, they are readying our group, and others, for a substantial list of foreclosures. The greater question now is how will they be distributed? Will they go into the coffers of the big brokerage houses, never to be seen by the majority of the public, or will they be evenly distributed throughout the cooperating brokerage world, essentially creating another commercial real estate market for brokers and investors to play.

One thing is for certain, many of the larger banks will not just dump foreclosures onto the market because of the potential balance-sheet damage. In commercial real estate, banks can write down loan losses in smaller pieces over a longer period of time.

Seeking the Lowest Rental Rate

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Tenants often determine the success of a lease transaction by the price difference between the initial landlord’s advertised rental rate and the executed, contractually negotiated, rental rate. However, by focusing exclusively on the rental rate, a tenant actually stands to lose much more than this negotiated difference.

Among the 40-50 pages that make up a typical lease document, there are at least 100 negotiable items that can lead to significant monies for, or extracted from, a leasing tenant. These range from modest ones such as monthly parking fees and rooftop-access rights to more material matters such as sublease rights and termination options. To maximize savings, tenants must negotiate all facets related to their specific circumstances. Below we have provided just a few items, other than rent, that will affect your bottom line:

  1. Accuracy of space needs assessment. Is the assessment of your space needs accurate? For instance, are you sure that you need 5,000 square feet over the five-year term, or could your space be restacked more efficiently to utilize only 4,500 or even 4,000 feet? What about the potential for expansion or contraction over the lease term?
  2. Base-building conditions. Have you identified the deficiencies of base-building conditions when comparing alternatives? If the owner is not held responsible, what is the tenant’s cost to upgrade mechanical, electrical, or fire/life safety systems? A seemingly fair comparison of two buildings with the same quoted rent is not truly comparable if one requires additional expense for base-building upgrades.
  3. Tenant improvements. How much of a tenant improvement allowance will you need to build out the space to fit your needs, accounting for all non-construction related costs? Knowing this is essential to accurately negotiating tenant improvement dollars. Is the tenant improvement allowance offered on usable or rentable square feet? If based on rentable square feet, you will have approximately 12-18% more funds at your disposal. If you are using project management services, you can also negotiate the building owner’s project administration fees.
  4. Realistic occupancy date. When can you take occupancy? This estimate must account for all factors, including scheduling of design, permitting, construction, furniture delivery, technology installation and all other relevant vendors’ work.