Tag Archives: healthcare providers

Leasing Vs. Owning a Medical Facility

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While opinions widely differ among the ranks of healthcare providers, most would agree that the financial ramifications of long term commitments for medical real estate space will continue to weigh heavily on growth in people or technology. Some see real estate as a cost of doing business, yet, we attempt to dispute this notion and advise that it can be a tremendous avenue for personal wealth if performed with diligence and comprehension. The leasing vs. ownership model for a medical building still significantly benefits the providers seeking to purchase or development. That said, is the advantage of real estate ownership appropriate for you and your organization?

Providers, especially small to mid-size physician practices, need to answer several questions in order to determine if ownership is the right strategy going forward.

  • Will the provider own the building alone or should a joint venture with other practices be considered?
  • Will partnering with a hospital be considered?
  • Will a third-party developer or investment partner be considered to help guide the practice through the development process?
  • What are the front-end cash requirements?
  • What is the tolerance for debt guarantees?
  • How does ownership align with long-term practice strategies or goals?
  • What is a viable exit strategy?

The answers to these questions will help guide the physician group (and broker/developer/investor) to the right decision regarding equity participation in a medical office project. In today’s tight lending environment, the more cash invested, the better the borrowing terms available. Although borrowing for commercial real estate today has become increasing more challenging, especially compared to residential, we routinely take calls from lenders who will fund medical single and multi-tenant buildings by qualified buyers that will use the space.

How will the provider’s occupancy help to determine the cost of the building? Follow me here, as this is difficult for medical tenants to grasp. Rents are based on the cost of the entire project and cost of borrowed funds along with the return on cash investment desired, rather than the availability of space. In today’s medical real estate investment climate, the typical cash on annual return ranges from 9% to 15% per year based on a fully occupied building. As time lapses and rents improve, two favorable investment events happen: The cash return increases on an annual basis, and the market value of the property increases. Both of these events create increased value and wealth for their owners.

The inherent risk is the inability to maintain building occupancy with a practice group or medical rent-paying tenants. Empty buildings are extremely volatile and difficult to price. Prices parallel the availability of space coupled with the absorption of space in the regional and local marketplace. Rarely do vacant buildings increase in value unless the land underneath appreciates in value.

If you have a question regarding leasing, ownership, or simple investment into a medical building, please contact MREA at 713.701.7900.

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Medical Office Buildings: A Class Of Its Own

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Ninety-nine percent of real estate service platforms consider office and medical office one in the same. They are not. There are numerous differences between medical office space and standard office space. The most obvious are rental rates, expenses, tenant mix, construction costs, tenant improvement allowance, and building features such as elevators and parking. In addition, the proximity and the financial condition of an adjoining hospital should be examined. These examples do not even begin to touch upon the intricacies within the healthcare system itself, which is of unique consideration when purchasing a medical office building.

Medical office buildings (MOBs) are deemed “specialty use” real estate. From our perspective, many lenders will consider financing MOBs, but most lack the experience in transactions or simple dealings. Thus, identifying capable players within this asset class is critical. Whether traditional debt, fully amortized structures or even shorter term, higher leverage deals, the MOB is becoming a greater diversification tool for lenders and investors alike.

While government involvement has had a tremendous impact on the past, present and future of the healthcare industry, demographic changes that include an aging population and a increasingly informed and health conscious society is guaranteed to increase demand for years to come. Consolidation will remain a continuing trend for practice groups that lack association with stronger, more diverse physician networks and/or hospital systems. This will have a negative impact on buildings with small, not very well connected and/or aging physician groups.

As for funding, financial sponsorship remains essential to MOB transactions, especially off-campus assets. Here, owner-occupied doctor groups or hospitals themselves receive favorable underwriting treatment. The commitment to their investments and their businesses will be of tremendous importance. Of greater impact is sponsorship that features a commercial real estate firm or private equity company who joint ventures with tenants. Some of the most aggressive lending structures are dedicated to this type of partnership.

Lenders prefer on-campus MOBs, however locating and underwriting these investments can become complicated due to bond financing or land lease issues. Thus, finding the medical office property within the tight radius of the hospital might just be as easy to work, if not easier.

In terms of the lender’s perception of the development and ownership of real estate, a lot has changed after a strong run in the middle of the last decade. Healthcare is no longer deemed recession-proof and, without government support (loose term), it instead operates like the majority of for-profit businesses which became severely impacted by the credit crisis of 2008/09.

While this distinct type of investment is certainly not immune to the juggling act that is supply and demand in a highly levered world, as the economy rehabilitates, the medical office building is becoming one of the most aggressively sought after asset types within the healthcare real estate sector. Call 713-701-7900 to request assistance with one of our several MOB opportunities.

A Healthcare Real Estate Success Story

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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:

  1. Tenant survey of satisfaction with building services, property management performance and lease renewal intentions
  2. Action planning reports for each hospital campus, region, service provider and the national portfolio, highlighting performance trends, strengths and weaknesses
  3. Comparative performance analysis of year-over-year results and versus report
  4. In-depth, statistical analysis of property and tenant characteristics influencing satisfaction, retention and relationships
  5. Recommendations for the enterprise and each service provider to improve customer service delivery, strengthen relationships and boost retention
  6. 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:

  1. Targets improvement initiatives toward highly influential property management practices, such as frequency of proactive communication with tenants
  2. Requests action plans for improvement from each hospital campus and service provider
  3. Increases tenants’ satisfaction with management by 10% to exceed benchmarks
  4. Improves tenants’ likelihood of renewal rate by 5%
  5. Identifies “at-risk” tenants whose lower satisfaction level and higher likelihood of defection warrants immediate property management follow-up
  6. 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.

Will Lease Accounting Changes Affect Healthcare Providers?

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Just when our clients were becoming comfortable with the general premise of healthcare reform and the likelihood of declining medical reimbursements for years to come, enter the August 2010 Financial Accounting Standards Board proposed accounting rules for real estate and equipment. These changes have the potential of tremendous impact on equipment and real estate via the composition, execution and implementation of leases.  In its current form, and depending on the breadth of an organization’s lease commitments, this has the effect of throwing tens of thousands to millions of dollars of lease commitments onto each balance sheet.

Speaking specifically to the healthcare industry, real estate and equipment leasing has been utilized extensively to assist with several business pressures, whether it be administrative, technological, competitive or regarding growth plans. This has been the preferred method, and a substitute to purchasing which requires significant cash outlays, among other prohibitive items.

Lease Accounting Changes

To explain where we are potentially going, we should address where we are currently. The Generally Accepted Accounting Principles (GAAP), which is code for how CPAs and businesses prepare financial statements for income and expenses, assets and liabilities, draws a line between an operating lease and a capital lease. Under the new guidelines, the difference in classification will be deserted.

It might surprise you, but, according to several sources within the accounting industry, the distinction should be abandoned. This is because the current trend has been where businesses place lease commitments off of the balance sheet, whereby financing new transactions without recording existing lease commitments as liabilities.

It has been suggested that the effect of adoption will add an estimated $1.3 Trillion onto balance sheets of businesses, significantly impacting both assets and liabilities of companies, which is to include private and non-profit organizations. Under the proposed standards, long-term real estate and equipment leases will be required to be disclosed, similar to that of a purchase.

The greatest impact would be that of dumping your equipment and real estate onto the balance sheet, but, even more complicated is that it would be necessary for lessees to calculate what is known as an ‘expected outcome analysis’. This can be defined as the present value of future lease payments. As each lease seems to differ from one other, under the rules it will be required by the lessee to determine potential financial outcomes within leases, including extensions, CPI adjustments and expense reimbursement items such as improvement amortization.

The new measures would require revisions at each reporting period. For each period, the changes stipulate that the income statement be revised to reflect the interest expense component, as well as losses to the asset.

Concerns are certainly mounting. Many are not sure how dramatic of an impact the shift will be, as well as their difficulty in determination of long-term forecasting models for relatively unpredictable financial outcomes. This uncertainty would create a deterioration of the use of lease term variables, to be explained further. Other criticisms include that of the time and costs transferred to real estate owners and businesses to implement such change.

As for impacts of leasing changes with regards to the healthcare industry, there are several as well. As was evident by medical real estate development growth that has occurred on and off the hospital campus, leasing has been a very effective tool for hospitals, now referred to as medical centers.  These systems developed facilities to provide for favorable referral situations with physician groups to provide for and offset the enormous costs associated with operating a hospital. As for equipment leasing, most of these institutions have levered improving medical and technological advances by leasing equipment, so as to not become tied to the purchase of vital items, essential in patient satisfaction, that may become extinct within a short period of time.

The potential effects on real estate could have significant impact for systems and physician practices that have used lease transactions to add assets or expand in geography, now essentially having to make room on the balance sheet for all of it. Quickly, some will find themselves flirting with the line of allowable leverage that demonstrates necessary stability for the purposes of future investment. Arrangements such as ground leases or subleases have the potential to become negative consequences, rather than the opposite. It is no doubt that many healthcare providers are in their respective war rooms developing strategies designed for lease administration changes. MREA is currently working with hospital systems, large and mid-size physician groups to educate about such changes.

As for modifications to these proposed, monumental changes to accounting principals, please contact our firm.  A new exposure draft is to be made public in the second quarter of this year.

MREA – Medical Real Estate Advisors was strategically designed to assist healthcare providers via our ‘healthcare business meets real estate’ mission statement. The firm’s owners are actively licensed CPAs, principals and real estate practitioners that, when utilized properly, have the ability to provide streamlined solutions to complicated business and real estate items that otherwise would absorb valuable time, multiple contacts and resources to remedy. Contact your representative today or go to http://mreausa.com.