Andrew Dick: Hello, and welcome to the Healthcare Real Estate Advisor podcast. I’m Andrew Dick, an attorney with Hall Render, the largest healthcare-focused law firm in the country. Today, we’ll be speaking with James Winchester, the Lead Financial Analyst for CMAC Partners, a firm that works with physicians to maximize the value of their real estate investments.

Andrew Dick: James has been with CMAC Partners for a number of years. Prior to joining CMAC Partners, he worked for a number of companies, including Siemens. We are going to talk about his role at CMAC, some of the issues faced by physicians that own real estate associated with their medical practice and a couple of other items. James, thanks for joining me.

James Winchester: Thanks for having me Andrew.

Andrew Dick: James, before we talk about your role at CMAC, let’s talk about your background, tell us where you’re from, where you went to college and what you aspired to be?

James Winchester: Great. Well, I’m actually from the UK. I often get confused for being Australian, which I think is probably because I’m starting to pick up some of the Orlando Twine, and I’m becoming this strange little hybrid. But I am actually from London, originally. I did my undergrad education in the UK.

James Winchester: I was actually trained to be a mechanical engineer and decided that that was not for me. Or perhaps it was the other way round, engineering decided that I wasn’t for it. And then I decided that I would make a transition. And I came over to the U.S for grad school, and went to a school down in Florida called Rollins College. And I decided I couldn’t leave the palm trees, and I’m still here today.

Andrew Dick: Terrific. So how did you ultimately end up at CMAC Partners? And then tell us about CMAC in general and what its mission is?

James Winchester: I was actually introduced to CMAC by one of my school connections and I was kind of intrigued by them. They work in a very unique space. And I’d spent some time working at some larger organizations previously and decided I really wanted to work for a smaller organization where I could really be impactful to the bottom line. I was also interested in the fact that they serve clients the whole way through the U.S even though they’re based in Winter Park, Florida.

James Winchester: CMAC is an organization that was started around 16 or 17 years ago now. And really had the mission of assisting physician groups with their real estate financing. And it started off with helping them with bond financing. And there was kind of a unique instrument that groups were able to capitalize on. And when the financial crisis hit in 2008, those bonds became a liquid, and CMAC really had to pivot a little bit. And they were able to really create the same value for their clients, but more using conventional financing with banks and credit unions.

James Winchester: I think that the business has become even more interesting for me. And one of the reasons why I was attracted to it in recent years, is because it’s changed and it’s evolved ever so slightly where we realized that that physician groups, a lot of them are struggling with the same issues across the country. And we’ve created a bunch of solutions that use the financing. And that financing can facilitate some structural changes within the way they operate the real estate. And it’s really become a value-add when we’re going through our process. So we’re not only saving them money, but helping them structure it in a little bit more of a thoughtful way.

Andrew Dick: I like it. Very narrow-niche. Which tells me that you and your colleagues can probably serve the physician clients very well because you’re seeing some of the same issues over and over.

James Winchester: For sure. And we are really specialists in our space. We really only work with one type of group, and that is Independent Physician Practices that have, or are thinking about real estate ownership.

Andrew Dick: Okay, got it. As a financial analyst, tell us what you’re doing on a day to day basis for some of these physician groups?

James Winchester: My role has really evolved into being quite client-facing. I have the opportunity to travel around the country when it’s safe to do so. It’s been a little bit prohibited recently. I really see myself as somebody that really tries to find out the objectives of the practice in the real estate, what are they trying to achieve and what issues may they be encountering at the moment.

James Winchester: And kind of as a by-product, we assist those groups with the real estate financing and save them money in doing so. But really, the primary driver, a lot of the conversations that I have with groups are the issues that are inherent with the way that they’ve been set up historically.

Andrew Dick: So for example, the docs may have set up a partnership or a limited liability company and most practices evolve over time, physicians are buying in and out, and sometimes the way it may have been set up initially may not have been optimized for really what they’re trying to accomplish today. Is that, in a nutshell, what you’re working through with the docs?

James Winchester: Absolutely. We’ve owner-occupied medical real estate. It’s a little bit different from a traditional real estate investment. And there are some ways in which groups can really capitalize on their returns and reduce their risks simply by the way that they structure their real estate. Because the real risk is determined by the credit quality of the operating entity that is occupying the building.

James Winchester: And because that really is in control of the owners of the building of the physicians that own it, they can really, if they have good alignment between the real estate and the practice, they can really maximize their risk adjusted return. And really, a lot of the conversations that we have is helping groups that have gone and entered into good real estate investments at the time. But those real estate investments have really strayed from the objectives of the practice, and suddenly, they become a little bit more risky and the returns are not necessarily as good as what they could be if they looked at it from a holistic lens.

Andrew Dick: Let’s just back up before we do a deep dive into how some of these partnerships and LLCs are set up. Talk about the value of a physician group actually owning their real estate. It sounds like you come in and oftentimes they own their medical office building, for example. But do you also work with groups when they’re thinking about either building a new building or maybe investing in a new medical office building for their practice?

James Winchester: We do. And a lot of the conversations that we have are really helping groups understand what the risks are of them going into a new investment, how to mitigate those risks and what kind of return they’re going to be expecting to receive. And we’re really big advocates of groups investing in the real estate from which they operate for a number of reasons. I think they’re both economic, simply it’s a really good risk-adjusted return. Most of the groups that we work with, if the deal is structured correctly, they’re able to earn cash-on-cash returns of the low to mid teens.

James Winchester: And really, we see it as very advantageous for the groups to be paying rent for themselves and building up their value over time rather than paying it to a third-party. I think even more important than that though, is the non-economic factors, as we like to call them. And one of those is recruitment, for example. One thing that independent physician groups can really offer that a lot of their competitors can’t is some of the ancillary services such as the real estate that are very attractive to the new partners if they can enter affordably.

James Winchester: I think that, for a lot of groups, it can create glue within the partners that are involved in the real estate and something that really binds them together as a group. Probably the last thing is the ability to control the group’s destiny. And a lot of the times, having ownership within the building that the group practice allows them to make expansions, if they decide that that’s strategically important for the practice, or have the ability to control the lease that they’re operating out of to, maybe, reduce their expenses or…. There are a number of different things that I think groups can take advantage of with real estate ownership that they don’t have the opportunity to without it.

Andrew Dick: I think you hit on the two points that I’ve seen over my career. Which has really… You mentioned the glue that can keep a group together, which I think is right. And also the recruitment benefits of bringing in younger or newer physicians, I should say, into the practice. It’s a nice bonus for those docs to be able to buy into the real estate as well.

Andrew Dick: That’s something that many of the health systems can’t offer when you’re competing for newer physicians because the health systems typically don’t allow physicians to invest in real estate opportunities that the health system is undertaking. So I think you’re exactly right. It can be also a powerful wealth-building tool for the physicians.

Andrew Dick: So when we talk about setting up a real estate company or a partnership, what are the things you and your colleagues think about, James, when putting the deal together, if you could start from scratch?

James Winchester: We think that… Firstly, probably, as I mentioned before, the alignment of the ownership of the practice and the real estate entity can be really important. We work with a lot of groups that when they first go into exploring whether they’re going to invest in their real estate, they may have 50% of the physicians interested in participating. We think that that is not necessarily desirable. And if we can increase that number and you may be in a situation where you can’t get everybody involved, that if you can get a solid amount of the practice involved in the real estate, it can reduce some of the problems that are inherent along the way.

James Winchester: There are often conflicts of interest as you see the diversion of those two ownership groups. Because it is an economic asset. And oftentimes, it can be contentious if rents are set at certain levels or leases are negotiated in certain ways that are going to impact individuals within the group disproportionately because of that disparate ownership.

James Winchester: So I’ll say first and foremost, we’re really looking to try and create that alignment. I think a lot of that becomes really an education process. And if the transaction is put through and structured in the correct way, a lot of the times, it can be very desirable. And that’s not necessarily understood from the onset. So if we can really explain that, make it transparent, I think most of the groups that we work with feel pretty comfortable that they can get the vast majority of physicians on board.

James Winchester: I think alongside that, especially for new groups that are new to real estate, they may not be aware of some of the issues that come along the way of having a dynamic ownership group. Which is very different from what we see from a traditional real estate investment where you have new partners coming in and you need to be able to buy existing partners out. So we really look for structures and help groups through structures that make sense and are sustainable for as long as possible.

Andrew Dick: You hit on some really important points, the conflicts of interest that can exist as a big one. You’re exactly right that if only a handful of the physicians in the practice invest in the real estate company, there can be a number of conflicts when you go to negotiate the lease terms and negotiate renewals or talk about the future of the practice. I think you’re exactly right. That alignment is huge. And to the extent that you could get all of the physician partners in the practice to also invest in the real estate, I think that would make the transaction much easier and eliminate a number of conflicts.

Andrew Dick: One of the issues you and I have talked about before is the buy-in and buy-out process for a number of these practice groups. Especially if it’s a real estate partnership or company that’s been around for a number of years and buying in can be very expensive for a newer physician that maybe doesn’t have the capital to buy in or access to capital.

Andrew Dick: Talk about that process, the buy-in and buy-out and some of the things you think about to make sure it can work. Because if you’re going to offer a new physician, for example, an opportunity to buy in, it’s got to be set up in a way that it’s truly an opportunity where that physician can afford to buy in. Maybe talk about that just a little bit, James.

James Winchester: You’re absolutely right. It generally occurs as the real estate investment matures. Most groups will look at kind of an 80% loan-to-value structure or thereabouts, maybe a little bit higher in some cases. And it therefore means that, at the inception of a project, the partners are collectively having to come up with around 20% of the equity, maybe 15% of the equity, based off of the financing that they’re able to achieve.

James Winchester: And what we see is, as the real estate matures and that debt is paid down, and most of the time we’re looking at buildings that are appreciating depending on the market that they’re in, there becomes a widening movement and a delta between the assets and liabilities that’s increasing to the point where, as you mentioned, it can become not achievable for new partners to be able to buy-in based off of the traditional way with which these buildings are valued.

James Winchester: And we’ve seen groups where those buy-ins can be above a million dollars. And you’re looking at the physicians that are typically going to be the most highly leveraged because they’re at that stage of their career where they may have student debt, they may be looking to make their first home purchases. It’s just a difficult conversation for a lot of groups as that number goes up.

James Winchester: And we certainly see, for different groups, that that number can be different. And some are happy to, and don’t see any problems if the buying is quite substantial relative to what other groups see. And they can really struggle much earlier on in the process. We certainly recognize that as an issue. What a lot of groups, I think, don’t recognize it. I think that they recognize the buy-in side much more quickly than they recognize the other side, which can be equally problematic.

James Winchester: And that’s buying out partners. Especially as we’re seeing an aging population and many of the physicians that have been working to build up their equity in these real estate investments are looking to leave the practice and therefore liquidate their shares in the real estate ownership, that there can often be a real struggle to be able to facilitate that process. Especially if that buy-out of those physicians is paid over a short period of time.

James Winchester: And if there are a number of buy-outs that are occurring at the same time without adequate buy-ins occurring at the same time, it can be a real drain on returns. And we’ve seen many groups that have gone from a nicely-yielding investment, where they’re getting reasonable returns to actually having to put money into the real estate in order to be able to buy some of their partners out. Which is not necessarily desirable.

Andrew Dick: All good points. Talk about the algorithm that you and your team has developed called True Course. I was intrigued by that when we talked before. It sounds like it’s a program that helps predict timing of buy-in and buy-out of partners in the real estate company or in the partnership. Maybe just give us an overview of how that works and what it is.

James Winchester: For sure. Really, the genesis of the True Course came from really witnessing what most groups do when they start a new real estate entity or even groups with an existing real estate entity will manufacture an operating agreement, and they will put a certain buy-in and buy-out parameter in there, and they will decide to value their building. And they have these sequence of events that occur for them to get to each of these.

James Winchester: The reality of the situation is typically, for the first three or four years, they can get through and be relatively unscathed. And these buy-ins and buy-outs in the structure that they have in place works. And at some point in time, they reach a roadblock. And one of two things happens, new partners are really turned off by the fact that they’re having to come up with this large sum of capital in order to be buying into the real estate entity or the group’s really struggling to get partners to be able to buy out.

James Winchester: And really, they go through the same process again. Where they will go and look at the operating agreement and adjust it in the best way that they can. And sometimes, groups do a great job in doing that. But we really wanted to look at a process that actually looks at the probability of issues occurring and for groups dependent on the structure that they have in place when these issues are likely to occur based off of the probability of buy-ins and buy-outs occurring and what will be the severity of the issue of these problems occurring.

James Winchester: And typically, we see groups that have a large real estate value, relative to each physician, are going to be the ones that are really prone to this. Because they’re going to see a bigger build up of equity more quickly. And there are some ways, there are some methods that we found by using this program, that can really help groups mitigate these issues and make them occur less frequently.

James Winchester: And I really don’t think it’s an issue that you’re going to completely avoid, but as long as groups understand the different risks that they have, and when those risks are likely to occur, they can really apply some sound financial planning to be able to deal with them and be ready to deal with them when they do occur.

Andrew Dick: So, James, what are a couple of the factors that you look at when you’re inputting the data into that program? Age of some of the owners, value of the building or…? Give me a sense of some of the factors you’re looking at?

James Winchester: Age of the owners is very important. We try and put as much information in as possible. I think there’s something along the lines of 37 different variables that we try and model for. The pace with which the debt is repaid can often be an important one because that can create a trigger event a little bit earlier. We also try and identify what market the group is in. And what that really tells us is, what are the chances of new physician partners joining that market.

James Winchester: If you’re in a growing geographic area, then I think is a little bit easier from the recruiting side. And that generally tends to mitigate some of the issues that you’re going to see on the real estate buy-in and buy-out side because you’ve got more partners coming in than you perhaps do on the way out.

James Winchester: For stagnant or more stagnant markets, it can be more of an issue. Because you may be on the other end of the scale where the size of your practice may be reducing emphasis slightly, and suddenly you’re trying to fund buy-outs when there’s no capital coming into the entity.

Andrew Dick: Interesting. It sounds like it’s a very novel approach to an issue that comes up quite a bit in real estate holding companies involving physicians. One item we’ve alluded to already is, it can be challenging for newer physicians to buy in. You talked about how much, I think roughly, capital a physician may need to bring to the table, whether that’s 20% of the value of the buy-in.

Andrew Dick: Talk about maybe some strategies that younger physicians should think about when they’re trying to buy into a real estate partnership or company. Sometimes it’s easy for them to get loans from a bank to buy in, sometimes it’s not. What are your tips you would give to a younger physician looking at an opportunity like to buy into their real estate entity?

James Winchester: Sometimes, I think younger physicians will become turned off by the value of the buy-in without understanding the true investment of that buy-in. If I enter in with a $500,000, for example, that is really there to provide me a return on investment, which I think needs to be explained first and foremost. Even that being said, I think it’s important for those younger physicians to continue having conversations with the leadership, to see whether there is a structure that really suits that particular group.

James Winchester: And we see a few different models that groups use. And I certainly don’t think it’s a one-size-fits-all. And I certainly don’t think that there’s a perfect answer when it comes to buy-ins and buy-outs. But, there are certainly different methodologies that groups used that can be desirable in certain circumstances. For example, there is a model that’s quite widely used that really bifurcates the ownership with two levels. One would be a voting share, and the other would be an investment share in a class A and class B model, for example. That can be something that is of interest for certain groups.

James Winchester: I think that the downside to that is that it doesn’t necessarily fix anything on the buy-out side. Which can be equally as problematic. Especially if you’ve got some physicians that are investing more heavily, they’re usually going to be the ones that are closer to retirement and therefore going to have a larger amount of buy-out that’s going to be required at the time that they do retire. But it certainly can help with attracting new partners to be able to get in.

James Winchester: We also see certain models that look at vesting the real estate ownership over time and they may have a very minimal requirement for the buy-in to start off with. But the investment really increases as the physician partner contributes more time with the practice paying rents and therefore their ability to be in the real estate. One thing that we certainly see a lot of groups doing is going through cyclical recoup of their investment.

James Winchester: One thing that I think a lot of the time is missed when we’re looking at these real estate investments is, although the real estate investment may have been 80% loan-to-value at the time that it started, when a new physician is buying in, their return on investment is going to likely be reduced as that time goes on, because they’re having to put more capital in for a very similar distribution that they would be receiving.

James Winchester: So a lot of the times we like to say to groups, well, if you have new partners that are coming in and they were investing in this building today and you weren’t occupying this building at the moment, would they come up with 50% of the value of the building to put into it? And the answer usually is no. They’ll probably use more of the bank’s money in order to improve their returns and essentially risk less of their own money.

James Winchester: So sometimes, just framing in that narrative makes groups realize that they need to do something in order to assist these new partners so that they can make it achievable, and they can make the investment desirable.

Andrew Dick: All good points. Let’s let’s switch gears. When you and I have spoken before, we talked about the fact that the healthcare real estate market is really hot right now. A number of investment groups and developers are out there pitching physicians to build new buildings. And the developers, in some cases, will want to own a hundred percent of the ownership interest in the real estate. In some cases, these developers and investors will offer the physicians the right to buy in.

Andrew Dick: I’ve seen a lot of different opportunities being pitched right now. Sometimes, the physicians feel like they need to give the developers and ownership stake in the project. Maybe you could give us an overview of some of the pros and cons of whether or not physicians that partner with the developer. What should they consider, in other words?

James Winchester: Andrew, I think this is a great question. We see it a lot with independent physician groups. I think one of the important things to address, to start off with, is that there is often a difference between development and investment within a medical office building. And they’re often conflated when groups go out and they decide that they want to be involved in new construction. And I think that there are certainly times where it can be beneficial to provide developers a piece of the pie.

James Winchester: But it should be looked upon as really a separate issue from going out and the developer developing the building and more as an equity partner that’s going to provide something throughout the life of the lease when you’re in the building. we see that sometimes groups find it advantageous if the developer is able to share in some of the guarantee risk at the start of the project. And if they are struggling with equity capital shortfalls and they need a contributor, then they may lean upon the developer in order to provide that shortfall and assist in their capital stack.

James Winchester: I would say that more often than not, a long the real estate investment, there becomes conflicts of interest between developers and independent physician groups. Because, simply their objectives are not aligned. And I think that there are some great developers that become good partners with groups. But that’s not always the case.

James Winchester: First and foremost, I think it’s important for groups to identify who’s got control of the asset. And if you’re getting involved with a developer and losing control of that asset, and losing control of the lease that’s in place, that may seem fine at the time that you’re starting the development. But can be something that is not desirable at all, and can leave a group hamstrung once the building is up. And really the developers value diminishes. Because, the value derived from these buildings is really concentrated in that lease that’s in place, because it’s an income-generating asset.

James Winchester: I think that that really leads to a misalignment of the value and compensation as time goes on. We work with many groups that have perhaps got involved with a developer for one of these reasons where they’ve also become an equity partner. But they found that three or four years into the project, they’re looking for ways to be able to exit that developer share or buy that developer out. And they almost always are having to do so at a premium, and they are still able to get some good returns on the building by capitalizing on a hundred percent of that control.

James Winchester: But more often than not, their comment to us was, well, I wish we didn’t give so much of it away at the start. And we’re a little bit more thoughtful as to what this would look like after the construction was completed.

Andrew Dick: Okay, James, let’s let’s talk about the capital markets. That’s really one of the areas that CMAC has a lot of experience in when physicians are going to seek, whether it’s debt or equity financing for a real estate transaction. Talk about what you’re seeing in the markets right now. Is it a good time to seek out capital? Talk about what’s going on in the market.

James Winchester: For sure. My overarching comment was, it’s been a little bit choppy. But it’s starting to settle as everybody understands the implications of COVID a little bit more and banks are able to predict what the next six, 12 months is going to look like. We saw… It was kind of interesting at the onset of COVID. We were seeing, just before it, some very aggressive pricing and spreads. And most of the transactions that we complete, the bank is providing a spread over liable.

James Winchester: And what we saw as COVID here was that banks started to widen their spreads a little bit over liable between the 50 to 70 basis points mark. We were in continuous conversations with the lenders, trying to find out exactly what was going on and why. And they were really explaining to us that some of the indexes from which they were previously pricing on were no longer reflective of their cost of funds. So they were seeing that it was costing them more to be able to borrow the money to provide it for these loans than was reflected in liable, which was usually a pretty good index to be able to measure their costs for providing that capital.

James Winchester: What we’ve seen since is, those spreads have started to come down. I would say that they’re still not at the same levels that they were pre-COVID. And certainly banks have become more selective with the opportunities that they’re going after. We still have a couple of large national banks that are having real difficulty being able to bid on new transactions and some banks that are finding it difficult to bid on new construction projects.

James Winchester: In general, we’re say that we’re seeing most coming back to some level of normality. And because there’s been so much intervention with the fed and rates are so low right now, even though the spreads are a little bit wider than what we saw before COVID, there are still some great opportunities to really capitalize on low fixed interest rates because the underlying market and the index is from which these loans are priced upon are really low and therefore there’s really aggressive rates available.

Andrew Dick: Yeah, it sounds like maybe things are starting to smooth out a little bit, but we have ways to go in terms of the capital markets leveling out. Where do you think the healthcare real estate industry is going in the future? Do you think we’re going to continue to see growth and opportunities? It truly seems like it. But I would welcome your thoughts.

James Winchester: I think that it has, again, proved its resilience. Certainly, if you look at it and compare it against other real estate assets like retail and hospitality, it certainly stood well above those in terms of its performance over the last few months. I think that it’s really going to be based on the underlying performance of the healthcare industry in general, which most people I think expect to remain pretty strong.

James Winchester: And certainly, in terms of values of these assets, we’re seeing actually capital move towards the space. Which almost is counterintuitive considering that real estate in general has been as competitive over the last few months, but because certain investors and real estate investment trusts are moving away from what are deemed to be more risky investments and moving that capital towards the healthcare space, which is deemed as more of a safe haven, we’ve seen on the buyer and broker side some really aggressive proposals come out in recent weeks.

Andrew Dick: Good to hear. Where do you see the most opportunities for physicians interested in investing in real estate? I know that at CMAC you’re focused on physicians often investing in the real estate associated with their practice. Are there any other opportunities out there that you’re working with groups on? What advice would you have when a physicians interested in investing in real estate?

James Winchester: We see a lot of, specially groups that can create real estate investments that really compliment the underlying practice. And I think those are the ones that we like to recommend for four groups. If it’s something where they may be able to… If they’re an orthopedic group and they’re able to invest in physical therapy on-site, for example, that can be something that’s really advantageous.

James Winchester: When physicians at an investment strays into the into other areas where there is a different risk profile for the investment, I think it really comes down to understanding the balance between risk and returns. You can often get into desirable real estate investments that are going to yield a high return, maybe as high as the medical risks that you’re investing in with the practice. But it’s not likely to carry the same level of risk. And that’s an important thing for a physician investing to be aware of.

Andrew Dick: I think that’s a good point because when your practice is the tenant and a so long as you’re practicing within the space, the risk pro profile should be quite a bit lower for the real estate that your practice is using. So, good advice.

Andrew Dick: James, what would you tell someone who’s trying to get into the healthcare real estate business? What advice would you have for someone who’s new to the industry? How can they learn more and grow in the industry?

James Winchester: I would say, especially for independent physician groups, there’s a great resource called the Congress of Physician-Owned Medical Properties that was started a few years ago, and really was put into place because there are so many groups that really don’t the opportunity to discuss with each other what works and what doesn’t work when it comes to their real estate.

James Winchester: Many of these groups are sitting with assets of 40, 50 million-plus. And it can become extremely important for them to be structured in a way that increases their success in the long run. So I would say that that is certainly one resource that I would tap into if I’m a new physician partner and an executive that’s new in the space for sure.

Andrew Dick: James, as we wrap up here, where can our audience learn more about you and CMAC Partners?

James Winchester: I think, probably, the best places to visit our website, which is www.cmacpartners.com. We are pretty much always available to speak and answer questions that groups have, and we’re happy to do so. I really like to think of us as a group that wants to help the industry become stronger. And we understand that our role or our success is not going to be anywhere near as good if the industry doesn’t succeed with us.

James Winchester: So if there is any opportunity for us to put groups in touch with industry experts, like Hall Render and yourselves that really specialize in this space and can really offer some value, then I think that we love doing that. So we would be happy for anybody to reach out

Andrew Dick: Great. James, thanks for joining us today. I enjoyed the conversation. Thanks to our audience for listening to the podcast on your Apple or Android device. Please subscribe to the podcast and leave feedback for us. We also publish a newsletter called the Healthcare Real Estate Advisor. To be added to the list, please email me at adick@hallrender.com.