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Unlocking Value from Healthcare Real Estate, Part 1

Health systems are facing more pressure than ever on sources of hospital revenue. Hospital cash flow, though strong the last couple of years, is expected to moderate to historical lower levels of three to four percent growth.  Health systems will need to identify alternative sources of cash to make investments to transition from fee-for-service to a value based care model.

graph of rising costsThis continuous need to analyze and scrutinize expenses is not going away and will become a higher priority if revenues are uncertain or grow at rates less than expenses.  Where can focus be placed for immediate results?  Health system’s real estate holdings, which typically comprise 40 to 50 percent of their total assets.  Health systems, both large and small, should evaluate the benefits of monetizing non-strategic assets in an effort to strengthen their balance sheet, reduce exposure to fraud and abuse laws, reduce future capital liability, and provide a clear focus on their key health care mission.

As we close out 2016 we see a number of market driving trends that will continue in 2017.

  • The investment market for healthcare real estate is fundamentally sound from both a capital markets and an investment demand perspective, creating a market where capitalization rates and transaction volumes are exceeding all historic measures for the asset class. Health systems that have capitalized on this opportunity and are realizing significant gains, accessing both proceeds and tax-deferred liquidity by entering into a transaction. There is a narrowing of the gap between cap rates for various healthcare property types. The capital markets and the lack of available properties for sale are driving this change.
  • Lease renewals are down due to functional obsolescence for medical tenants. Developers 80% renewal targets are not good assumptions. Health systems that purchased physician groups are moving the groups from functionally obsolete real estate to higher quality medical office buildings.
  • Health systems have real estate departments, primarily focused on transactional management; most require help dealing with the need for cash. Building an ambulatory care network is about being first to market and getting the best real estate location. The best locations drive traffic, the secondary locations don’t always provide the uptick in revenue required.
  • Health systems are engaging advisors that are separate from transaction businesses to identify the real estate monetization strategy as health systems develop their real estate strategy and portfolio.
  • Sale-leaseback transactions are attractive vehicles for monetizing real estate. Property, plant, and equipment occupancy costs for these assets is typically the third largest operating expense and represent almost 40 percent of a hospital’s balance sheet; so they impact finances tremendously. Reducing them not only improves flexibility, but makes the transaction more attractive and generally results in higher up-front cash for the health system that can be reinvested in clinical service line development.

Health systems should be active and continuously engaged in evaluating the strategic options related to their real estate portfolio including monetizing non-strategic assets through acquisition, disposition and debt & equity recapitalization strategies; strategic capital planning (including monetization of non-core real estate); and having a development plan for growth.  Our approach guides health care organizations through a financial evaluation to set the operating strategy which translates into a bottoms-up expectation for organizations that we work with.  This approach, coupled with establishing the right management infrastructure needed to control variation, results in a consistent and sustainable strategy for achieving performance improvements, operating efficiencies, and cost savings

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