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Expert Q&A: NKF’s Hogan Debates Health Systems Unlocking Capital Through Disposition of Real Estate

Connect Healthcare is coming up October 2 and 3, 2019 at The Resort at Pelican Hill in Newport Coast, and we’re giving you a sneak preview of some of the insights and knowledge our expert speakers will provide. We spoke with Garth Hogan, executive managing director of NKF’s Healthcare West team, about strategies that health systems employ to monetize their real estate assets.

A year ago, Providence St. Joseph’s Health (PSJH) chose Hogan and his team as a strategic partner for the disposition of approximately 60 assets that were determined to be non-strategic and non-core to the health system’s business model. The assets included medical office, office, mixed-use, warehouse, and land. The goal for PSJH was to create capital for reinvestment into core business initiatives. The first round of properties taken to market in Phase I will close out by the end of 2019, and should raise approximately $100 million. The second round in 2020 should raise an additional $150 million, which paves the way for the system’s ultimate goal of $1 billion in the next 36 months.

Read on to find out what Hogan thinks about health systems and the way they view real estate.

CONNECT HEALTHCARE: What has changed in the way the health systems view real estate?
HOGAN: For the first time in decades, hospital CFOs are looking at their existing real estate portfolios and asking the question, “What business are we in? Healthcare or real estate?” Roughly 70% of U.S. healthcare assets are still owned by health systems and providers, while at the same time demand and availability of capital chasing these assets is at an all-time high.

CONNECT HEALTHCARE: How do health systems determine whether a real estate asset is core, non-core and non-strategic?
HOGAN: Core is inpatient facilities, cancer centers, on-campus out-patient surgery centers, and diagnostic imaging. Non-core includes multi-tenant MOBs, off-campus ASCs, MOBs, urgent-care clinics and free-standing EDs. Non-strategic assets are administrative offices, call centers, warehouse, storage, and vacant buildings. One of the first PSJH assets sold, in April 2019, was a 218,000-square-foot office tower in Spokane, WA, for $24 million to an owner occupier.

[Pictured above: PSJH’s office tower in Spokane, WA]

<strong>CONNECT HEALTHCARE: How do health systems end up with so much real estate?
HOGAN: There are a number of reasons. Traditionally, health systems preferred to own and control all of their real estate. Much of that “old school” mentality still exists. Now, when you consider the aggressive consolidations that we’ve seen in the last five years, you have a lot of real estate redundancy.

CONNECT HEALTHCARE: How do health systems determine what real estate should be monetized?
HOGAN: Typically, all non-core and non-strategic assets should be considered capital creating opportunities and evaluated as such. As consolidation between health systems increases, redundancy in assets exists, which then creates opportunities to harvest capital for reinvestment

CONNECT HEALTHCARE: When systems redeem the capital from a sale, what is it used for?
HOGAN: Ideally, the capital would be used to reinvest into core business and strategic expansion projects. Some assets become a drain on liability and capital. Monetization eliminates that exposure, while improving a health system’s balance sheet and positively impacting their credit rating.

CONNECT HEALTHCARE: What about physician groups? Should they own their real estate?
HOGAN: Physician ownership is a great vehicle for creating equity while practicing medicine. After the first five to seven years of ownership, much of the initial value has been achieved. When REITs and private equity groups are willing to pay record prices, prior to a forecast of increased interest rates, I would typically recommend a sale. Recently, we’ve seen a positive change in the way healthcare real estate buyers are structuring their offers. They’re valuing physician group-owned assets with yields similar to the investment grade credit rating that the health systems have, and creating vehicles for reinvestment of sale proceeds for tax benefits and continued growth in equity. This structure is ideal for younger physicians who have recently joined the practice.

CONNECT HEALTHCARE: Should health systems own or lease real estate?
HOGAN: That’s a good question. They can typically borrow money 100 bps less than the most competitive debt structures in the commercial lending market. However, many hospital CFOs are reluctant to use their lending power to own or acquire non-core real estate assets. Instead, they’d rather use those dollars for investment into their core business. As a rule of thumb, I always say hospitals should own if the space they utilize is 60% or greater than the gross building size, and the asset is core to their business. Nearly every other asset should be leased, which would include multi-tenant, out-patient, community based out-reach ambulatory care, administrative offices, call centers, storage, and warehouse. This formula has been used by corporate America for a number of years, yet healthcare has been slow to adapt. We sold a 9,000-square-foot clinic in Hamilton, MT that the health system was planning to vacate. A local affiliated hospital acquired the building to relocate and consolidate a large group of physicians.

[Pictured above: PSJH’s clinic in Hamilton, MT]

Connect Healthcare is coming up October 2 and 3, 2019 at The Resort at Pelican Hill in Newport Coast. More information about the event and registration details can be found here.

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