NEW YORK - Strong demand and limited supply created a window of opportunity for health systems to monetize their medical office buildings during the pandemic, with the largest buyer pool for single-tenant medical office buildings that the market has ever seen (1). However, another real estate trend is also emerging among health systems: the move toward buying back the facilities they currently lease.

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As lease agreements for medical office buildings and other facilities come to the end of their term, some organizations are evaluating whether to take advantage of the repurchase option in their agreements.

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“In many instances, these are buildings that the organization chose to monetize 10, 15, or even 20 years ago,” says P.J. Camp, Managing Director, H2C Securities Inc. (“H2C”). “Back then, it made sense to monetize these assets: The tenants in these buildings were overwhelmingly third-party physician groups, and the landlord was the hospital. There might also have been space leased by the hospital itself, whether for a diagnostic center or café or additional office space.”

Now, with nearly half of physician practices owned by hospitals or corporate entities (2), “The nature of the tenancy in these buildings has changed,” Camp says. “No longer are the majority of these tenants third-party physician practices; now, they are often physician practices that are owned by the hospital. As these facilities become eligible for repurchasing, there’s a desire by hospitals to ‘own their home’ rather than rent.”

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Matthew Tarpley, Vice President, H2C, believes organizations also may find economic advantages in owning versus renting medical office buildings and other healthcare facilities, including:

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• Property tax advantages. Not-for-profit healthcare organizations generally do not pay taxes on the real estate they own due to their tax-exempt status. Organizations that lease pay for this expense in some way.

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• Ability to avoid bottom-line implications of lease accounting standards. Healthcare organizations must report all leases longer than 12 months on their balance sheets under a lease accounting standard that took effect in 2019. Formerly, only capital leases were recorded as assets and liabilities on the balance sheet, whereas operating leases impacted only the income statement.

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• Desire to take cash off the balance sheet. Thanks to CARES Act funding, some hospitals weathered the Covid-19 pandemic in a better financial position than anticipated (3). Some even recorded a profit through 2020. For not-for-profit hospitals that find themselves in this scenario, the question becomes, “How do we put this cash to work in service of our communities?” Buying back leased real estate—a tactic that may help mitigate expenses over the long term—is one approach leaders are exploring.

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Evaluating Your Options​

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Is now the right time for your organization to repurchase real estate assets that are nearing the end of their lease? The answer depends on a variety of factors. Here are five key questions healthcare leaders should consider.

 

No. 1: Has the organization developed a cogent real estate strategy? Such a strategy will help you fully understand your organization’s options in light of its goals and objectives. It will also enable you to carefully assess the ramifications of a particular transaction before proceeding.

 

No. 2: Is your organization able to buy real estate back from the current owner? If your lease includes a purchase option at the end of a specified period, you may wish to consider:

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• How motivated is the owner to sell the property?

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• Does your organization have the capital to buy it back?

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No. 3: What percentage of real estate does your organization own versus lease? While there is a trend toward systems owning more real estate than they lease, there is no “one size fits all” approach to determining the right portfolio mix. Instead, the answer will depend on the organization’s location, its goals and objectives, and its overall strategy. “In some instances, a hospital or health system may have no choice but to lease the facility, such as when the facility is located in a desirable retail location,” Tarpley says. “In instances where a leased building is fully occupied by the hospital or health system—such as when a physician practice is now employed by a health system— the system may wish to own that facility and avoid the property taxes it pays when leasing that space.”

 

No. 4: What is the value of the real estate you may wish to acquire? The answer will help you determine whether your organization can afford to repurchase the facility. It’s also important to view the purchase within the context ofthe system’s comprehensive real estate strategy. For instance, if your organization can package the offering of a new development project with a buyback in the market, “You may get a better deal,” Tarpley says.

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No. 5: Who are the key players in your market—and where is the market headed? With this information in hand, you can outline the opportunities in your market that have the potential to strengthen your organization’s competitive position. Such an analysis also will help your team gauge the types of real estate investments that will best meet the needs of the communities you serve.

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Making the Right Decision

 

At H2C Securities Inc. (“H2C”), our proprietary Real Estate Transaction Alternatives Study (RETAS) helps healthcare providers navigate a dynamic environment by:

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• Understanding their long-term goals and objectives in relation to their property, portfolio, or development project

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• Determining the value of their real estate—from owned real estate to leased and to-be-developed assets

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• Identifying cost-saving and income-enhancing strategies

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• Outlining and describing the transaction options available in the marketplace

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• Identifying the properties that are most suitable for a transaction, if appropriate

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• Recommending transaction options that will most effectively achieve the organization’s goals and objectives

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• Assessing the potential impact of the transaction on the organization’s financial statements and key financial ratios

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• Developing a plan to execute the transaction(s) in the market, if appropriate, as a next step

 

Care to continue the conversation? H2C can help you better understand your organization’s options for repurchasing real estate assets. Contact us.

 

Footnotes:

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1. Based on H2C’s findings through its sales processes.

2. Liss, Samantha, “Nearly Half of Physician Practices Owned by Hospitals, Corporate Entities, Report Finds,” Healthcare Dive, June 29, 2021, https://www.healthcaredive.com/news/nearly-half-of-physician-practices- owned-by-hospitals-corporate-entities/602540/.

3. Ochieng, N., et al., “Funding for Health Care Providers During the Pandemic: An Update,” Kaiser Family Foundation, Aug. 20, 2021, https://www.kff.org/policy-watch/funding-for-health-care-providers-during-the- pandemic-an-update/.

About H2C Securities Inc.

H2C is a strategic advisory and investment banking firm committed to providing superior advice to healthcare organizations and related companies throughout the United States. H2C’s professionals have a long track record of success in healthcare mergers and acquisitions, capital markets, real estate, and restructuring transactions, acting as lead advisors on hundreds of transactions representing billions of dollars in value. 

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Securities and services offered through H2C Securities Inc., member FINRA/SIPC, a registered broker-dealer and an indirect subsidiary of Fifth Third Bank, National Association. All rights reserved. Securities and services offered through H2C Securities Inc.: Are Not FDIC Insured; Offer No Bank Guarantee; May Lose Value; Are Not Insured by any Federal Government Agency; Are Not a Deposit. 

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For more information, visit h2c.com. 

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Real Estate Banking Practice

For more than 20 years, the real estate investment banking professionals at H2C have successfully served as advisors on real estate transactions in excess of $12.5 billion nationwide. For more information on our real estate advisory group, please contact one of the following H2C professionals or visit our website at h2c.com.