The morphing tenancy of health care real estate

Abby Waner Bartolotta
Director of marketing and leasing, Health Connect Properties

Health care mergers and acquisitions are well beyond a common discussion. While the long-term economic and patient-care impact is unveiling at a slow, complicated trickle, the influence on real estate owners is nothing short of immediate and profound.

Familiar national headlines include behemoth deals like CVS-Aetna ($69 billion), Dignity Health-Catholic Health ($29 billion) and, most recently, UnitedHealth-DaVita ($4.3 billion). Meanwhile local transactions are closing at a brisk clip as management groups scoop up independent practices – i.e., United Urology Group’s acquisitions of several local practices; or OnPoint Medical Groups multi-family practice additions. Most notably for Colorado residents are their community hospitals suddenly bearing the name of larger health care systems – Platte Valley Medical Center becoming SCL Health, Longmont United Hospital turning to Centura Health or Yampa Valley Medical Center joining UCHealth.

At one end of the employment spectrum, independents are acquiescing or bolting to absorption by larger employers. The opposite end of the spectrum reflects the dwindling solo practitioners that prefer full autonomy. And somewhere in the middle are those groups that find balance through an alliance, falling short of employment and retaining relative self-governance, but with some of the benefit of a larger umbrella.

From the lens of the providers, shrinking reimbursements and escalating costs are squeezing margins to a razor thin delta. Management groups provide consolidation and centralization translating to less overhead and an uptick in profitability. A wider referral base also is accessible to those providers, often leading to a higher patient volume.

The most practical allure to providers and independent practices is the unburdening of cumbersome back-office work. To repurpose a real estate phrase, the highest and best use of a physician is the practice of medicine – not running a small business, especially one that is painstakingly reliant on the fluctuating political landscape. At its simplest, decades of medical training can again mean providing care to those who need it most, not such a novel idea after all.

And from the larger lens of community hospitals, many simply can’t provide the capital to supply the technology required nor do they have the volume to attract specialists within their “four walls.” Partnerships with sophisticated health care systems allow for sustainable care to serve the heretofore underserved populations.

On the other side of the marriage, parent companies are waiting with open arms (and deep pockets) for those providers and hospitals ready to join their ranks. The obvious benefits are market share and economies of scale – health care systems are in a race to provide convenient and affordable care to growing populations. So where does the changing nature of medical tenants implicate real estate owners, developers and managers? The financial credibility of tenants, building and space layouts, and landlord/tenant relationships all have changes ranging from subtle to substantial.

• Personal guaranty vs. national entity. Understandably, owners often are averse to a lease assignment when they have a paying medical tenant in their space backed by the physician owner’s personal guaranties. But once through the commonly exasperating lease assignment, owners can be left with the backing of a national entity whose credibility far surpasses the personal guaranty previously supplied by an independent physician(s).

Perhaps this is splitting hairs as the default rate of heavy medical users like primary care providers, surgeons or specialists is extremely low. The threat of a landlord laying claim to personal assets is minimal the way it is. (Hello, all landlords now interested in converting to medical!) Regardless, an assignment of a private practice’s lease to a national entity may include a negotiation out of a previous personal guaranty – but with it comes the credibility of a multimillion-dollar entity on the lease. In a disposition, this has no small effect on compressing cap rates.

• Building MOBS for flex tenants. It is increasingly difficult to achieve a 75% lease-up with several 2,000- to 4,000-square-foot spaces. The more providers that roll up to a larger operator, the bigger square footage is required, which may sound like a win for the developer. But, of course, the caveat is as groups merge, there are ultimately fewer users in the market. Perhaps, an owner lands a larger user and the use from the outset is standard clinic space, but as acquisitions occur behind the scenes, the specialty may eventually shift and particular care needs to be given to the construction of those spaces.

While an owner can retroactively shift walls or install sinks, they cannot throw in different structural flooring after the fact. Whether it be load capacity or floor-rating for life safety, appropriate structural elements should be considered from the outset. Or perhaps a heavier use requires increased electrical capability, and a second-generation electrical build-out also may be cost prohibitive.

• Managing the relationships. As with any transition, a sole provider’s absorption into a larger corporation isn’t without challenges. A physician who previously called all the shots may suddenly find themselves as one employee amongst hundreds. The autonomy previously given to a physician-owner in terms of choosing clinic location, lease terms and management of a space is now centralized and spun up to the aforementioned out-of-state corporation – with very little grasp of space operations in, say, Littleton, Colorado.

A leasing agent or property manager must have the ability to finesse the dichotomy of boots-on-the-ground versus national business operations. Identifying the ultimate decision maker is key in any relationship for efficiency. But, additionally, possessing the skill set to assuage the personalities that come with the physicians providing care to patients within a given space is equally as important for a long-term successful relationship.

Featured in the July issue of Health Care Properties Quarterly

Edited by the Colorado Real Estate Journal staff.