Part III - Healthcare Facility Financing
With 2017 already underway, and the new administration and Congress beginning to tackle the repeal and/or replacement of Obamacare, we take a brief timeout to talk with Mike O’Keefe, a director in the healthcare real estate segment of Navigant’s construction practice. We asked Mike to weigh in on what’s ahead for healthcare providers and their stakeholders in the realm of healthcare facility financing, what types of projects are on the drawing board, capital availability, and the impact all the changes within the industry and Washington will have on organizations’ real estate portfolios.
Q. The landscape is shifting in healthcare, becoming more patient-centric with consumers accessing healthcare through ambulatory settings. As healthcare providers respond to this changing scenario, what will be the predominant forces of financing for their capital projects in 2017?
A. Well, for core strategic inpatient facilities, cash reserves and tax exempt debt will continue to be the first choice for not-for-profit clients. But as the demand for capital continues to increase, we are finding that many of our clients, some who would never have considered using third-party capital before, because at face value it appears to be more expensive, are changing their point of view.
As the ambulatory footprint of healthcare providers continues to grow vis-a-vis value-based medicine and population health strategies, third-party real estate capital will become an increasing way for healthcare providers to finance this growth. This includes private equity funds, REIT capital, credit tenant lease financing, public-private partnerships, and even taxable and tax-exempt structured finance solutions.
We are advising our clients to take a holistic view of their capital needs to determine what investments provide the highest return on their capital, and whether they need to own the vehicle that helps them execute their ambulatory strategies. And when decisions are evaluated in this context, many of our clients come to the conclusion that they need a real estate partner to finance and execute their burgeoning ambulatory footprint, and that third-party cost of capital is not so bad versus 15-20%+ returns providers can get from investing their capital in other strategic business ventures.
Q. Interest rates were nudged upward by the Fed by a quarter percent, and may rise three more times in 2017 making debt financing more expensive. How will increasing interest rates affect capital availability for healthcare organizations and their facility development projects?
A. Well, capital is abundant now, especially for the right projects – ones with a strong business plan, a strong market location, strong credit on the provider side. But, as interest rates continue to rise and, for example, 10-year treasuries have gone up over 50 basis points since the election alone – and rent yields and cap rates respond in kind to those increases in treasuries – it will cause those projects that are on the fringes to not pencil out from a market rent or a financial projection standpoint.
One of the key critical success factors for accessing capital will be for providers to demonstrate that they can execute. We've found lessons learned over the last several years that the money follows strong strategic plans, strong feasibility studies, and strong management teams who have demonstrated that they can carry an idea to fruition successfully.”
Managing Director and Practice Area Leader, Healthcare Real Estate
Navigant Global Construction Practice
Q. What types of projects do you see being undertaken by healthcare providers in 2017?
A. For one, micro-hospitals. They’re a very hot topic now, and becoming a hub for many of our clients’ ambulatory network strategies. Another are ambulatory care centers, either new market growth, or consolidation of existing clinic facilities.
Many healthcare systems have been rapidly acquiring physician practices, and with that comes quite a bit of real estate, perhaps not assembled in the most efficient way. So, we’re working with many clients to evaluate their current ambulatory footprint to look for opportunities to consolidate their growing physician network into full-service ambulatory care centers and optimize their real estate portfolio.
Another area that we’re seeing more activity in is the rural health market, critical access hospitals. We’re working with a number of clients now that have been operating for years in antiquated facilities that are functionally obsolete. With interest rates so low and with access to USDA-backed financing, many critical access hospitals are electing to relocate to new campuses to help reposition themselves as integrated healthcare providers i.e., running the gamut from inpatient services to ambulatory to health and wellness services combined.
Q. The financial marketplace for the healthcare industry has a myriad of lenders and investors, e.g., banks, private equity, credit tenant financing, REITs, etc. How would you advise the healthcare executives as to how to determine what type of financing mix is right for their organization’s capital projects?
A. I would suggest that they conduct an objective and unbiased evaluation of all alternative financing and ownership options compared to the baseline of financing and owning the project. That evaluation would include the impact on financial statements, on key credit ratios, on debt capacity, etc. to really determine what is the optimal financing solution for the specific project they plan to implement.
The range of alternative financing and ownership options should be evaluated and measured by how they support an organization’s strategic, financial, and operational objectives.