Access trapped capital through structured real estate and noncore asset deals

Since the COVID-19 pandemic took hold in the United States in March 2020, health systems have had to balance ongoing operational disruptions and their resulting cash flow strains with balance sheet strength. Now, balance sheets are facing additional new pressures as tightening monetary policy and economic and geopolitical issues bring volatility to the capital markets.

Other pressures began building before the pandemic and continue to place demands on health system resources. New opportunities for physician groups, often backed by private-equity dollars, are disrupting health systems’ traditional physician alignment strategies. New competitors are offering consumers more options for how and where they receive healthcare services. Health plans are becoming more aggressive in identifying and encouraging use of lower-cost providers for their members.

Health systems must invest in new strategies and new partnerships to maintain and ultimately look to grow their relevance in their markets, and real estate may offer a means to support it.

Identifying opportunities

Once health system leaders understand and identify their financial and operational goals, they can utilize a basic framework that balances the essentiality of a resource to the organization’s operations or strategy with the need for the organization to maintain control of that resource. This framework will help identify
capital-raising opportunities within real estate or noncore asset holdings that can support organizational goals (see the exhibit on next page).

The most obvious candidates for monetization are assets that fall in the lower left quadrant of the exhibit, which are considered nonessential to the organization and which the organization therefore does not need to control. Essential assets, over which the organization feels it must maintain control, are typically best funded through traditional financing. Assets that fall into the upper left or lower right quadrants of the framework require closer consideration.

If an asset is nonessential, is the organization’s desire to maintain control outweighed by the negative aspects, including credit implications, of carrying that asset and its related costs on the balance sheet? Or if it is an essential asset but the organization feels it could give up some control, how might the rating agencies respond to that decision? In all scenarios, the answers to these questions will be affected by both the essentiality of the asset in question and the materiality of the transaction’s impact on the organization’s financial position.

The sale of a building with retention of a ground lease, for example, may strike an appropriate balance between essentiality and control (see sidebar, previous page). Parking might be an essential service to provide to patients, family members and staff, but the organization may be willing to give up temporary control over operations through a concession arrangement and monetize the revenue generated by parking fees while maintaining ownership of the structure.

Matching deal structure to goals

Just as there are many goals that can be supported by a monetization strategy, there are many structures available to ensure that the transaction protects key organizational interests and aligns with the organization’s goals. The question of control, for example, is not an all-or-nothing proposition. The organization might wish to give up some control over an asset, as in the parking concession example, but still maintain a long-term ownership interest.

Possible deal structures include full sale of an asset, sale/leaseback transactions, joint venture ownership, ground lease structures, physician ownership structures , concessions and more.

Additional considerations

Before pursuing a monetization transaction, the health system should check with its financial advisers, auditors and legal counsel to get their view of the transaction and its impact on the organization’s financial statements. This will help ensure that the transaction structure pursued will be able to meet the system’s goals.

Health system leaders should also be aware that alternative capital sources accessed through real estate or noncore asset monetization transactions will generally come at a higher cost than traditional funding, such as tax-exempt debt. This higher cost should be a factor in determining whether a deal is worth pursuing, but the cost may be offset by the greater flexibility and control that these transactions can offer.

Health systems have been under incredible stress for the past two years and the demands on their resources will only grow. A monetization strategy that draws upon real estate and noncore assets can help meet these demands and support the organization’s core operational and strategic goals.  

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One system’s experience

A well-capitalized health system was obliged to acquire a mixed-use asset next to the system’s main campus at a formula-driven price. The integrated asset, which took up a city block, included an office building, an extended-stay hotel and a parking structure.

The asset offered services that were important, but control was not necessary. Plus, the system was reluctant to use bond financing or liquidity because of concerns about debt capacity and its credit profile.

The system decided to keep the land and sell the developed asset to a third party subject to a ground lease. After a competitive bid process, the asset sold with prepaid ground rent and capitalized closing costs, and a rent reduction of about $1 million at a below-market cost of capital.