Health Care Real Estate Advisor

Leveraging Opportunity Zones and Other Health Care Financing Tools with Jerimi Ullom and Joel Swider (Webinar)

September 21, 2019 Joel Swider Health Care Real Estate Advisor 29:37 Comments Off on Leveraging Opportunity Zones and Other Health Care Financing Tools with Jerimi Ullom and Joel Swider (Webinar)

Leveraging Opportunity Zones and Other Health Care Financing Tools with Jerimi Ullom and Joel Swider (Webinar)

Do you have a hospital development project that you would love to get done but just can’t seem to find the money? Wondering if your health system can benefit from the Opportunity Zones program? Join a health care finance attorney and a health care real estate attorney to hear about some unique and innovative ways to get your project funded.

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Podcast Participants

Joel Swider

Attorney with Hall Render

Jerimi Ullom

Attorney with Hall Render

Joel Swider: Welcome to the Health Care Real Estate Advisor Podcast. I’m Joel Swider, a healthcare real estate attorney with Hall Render, and for today’s episode we’re going to listen in on a webinar put on by my colleague Jerimi Ullom and I, which aired in September 2019, on Opportunity Zones and other healthcare financing tools.

Jerimi Ullom:   Thanks Joel, we want to first of all today thank the Indiana, Michigan and Ohio Hospital Associations for having us, and we look forward to talking with everyone.

Joel Swider:     So there’s been a lot of buzz about so-called qualified Opportunity Zones, but many of the hospitals that we work with haven’t focused a lot of attention on how they can benefit from this program, at least not to date. So in today’s webinar we’re going to answer at a high level three questions that frequently arise in the healthcare context when it comes to Opportunity Zones and the financing of hospital projects more generally.

Joel Swider:     First we’ll look at what are opportunities zones, how do they work, and how can a both for-profit and nonprofit providers benefit? Second I think we’re going to find that the Opportunity Zone program has a relatively narrow fact set where it can be best utilized as a financing tool. So we’re also going to look at what other tools and incentives are available to hospitals to fund new development projects and to drive complimentary development within their markets.

Joel Swider:     Finally, we’ll look at some concrete action items surrounding the next steps for hospitals who are looking at how to get their projects off the ground. Today’s session is designed as kind of a lunch and learn. We should go about 30 minutes, but feel free to type in any questions in the chat box or email us offline we’re happy to make ourselves available to answer any more in the leads questions that you may have.

Joel Swider:     So what are Opportunity Zones? Opportunity Zones were conceived by the Tax Cuts and Jobs Act of 2017 the TCJA. They were designed as a way to spur investment in distressed communities by providing tax incentives for taxpayers who invest capital gains in certain geographic regions. As authorized under the TCJA, state governors were the ones who originally designated these zones, over 8,700 of them and the IRS then later approved those. They’re in all 50 states, the District of Columbia as well as five US territories, and this slide shows just an overview of where the Opportunity Zones can be found.

Joel Swider:     At least this is a view of the continental US and there is an official government map, which we have a link to that on our website where you can zoom in, there’s third party maps as well. You can zoom in and find the area where your hospital or health system is located. And you can tell just from looking at this map at a high level that there are a lot of zones located in and around large cities, but they’re also in a lot of rural areas, especially if you look out West. So because it’s up to state governors to designate these zones, the state had some latitude as to where they’re located. So you might be interested to find whether you’re in one or near one.

Joel Swider:     So how do Opportunity Zones work? So I’m going to go through this slide and the next at kind of a high level, and I’ve used some numbers in here just as an example, the dates as well, just as an example, so that you can see how this might work in practice. But I’ll go through this just briefly so that you can see whether or not you have a situation that might actually fit into the Opportunity Zone program or not.

Joel Swider:     So to start with, you’ll have the sale of tangible property and a gain that’s been realized from that sale. So that’s work I’m calling that investment number one because that’s from some old investment. Now some hospitals buy and sell property more frequently than others. And we’ll get into how you might partner with a developer or other capital partner who might have more gains that they can deploy. So yeah, these dates here other than the timeframes are just for example purposes. But one date that’s important is within 180 days of the sale of that initial property, you must invest that gain into a qualified Opportunity Fund. So that could be all or a portion of that original gain. And I’m calling that investment number two.

Joel Swider:     So that’s a separate investment and you’ll see in a minute that it’s treated slightly differently. Within two and a half years of that initial investment, investment number two, the Opportunity Fund has to purchase Opportunity Zone property and that includes real estate businesses, business assets, etc. And they must improve it by at least the value of the purchase price. So this fund is essentially a vehicle, an investment vehicle, it could be a partnership, a multi-member LLC tax as a partnership or it could be a corporation. But importantly it has to invest at least 90% of its holdings in one or more Opportunity Zones.

Joel Swider:     So now we’ve got the gains from the sale of our initial property, invested it into the Opportunity Fund, we’ve put that money to work and then after five years in the fund, you will get a 10% increase in basis on the initial gain. So going back to that initial amount that you invested from the first gain, you will get a basis step up of 10% essentially that amount is the amount the taxable gain goes down by 10%. Then if you hold that investment for another two years, in year seven you will get an additional 5% increase in basis or another step up on that gain from the initial investment, investment number one.

Joel Swider:     Again, there’s no gain recognized either in year five or year seven, you’re still continuing to defer those gains. Then in 12.31.2026 that is a hard date. There is a mandatory deferred gain recognition on that original capital gain from investment number one. So that and so because of the timeframes here, I’ll mention, if you want to get the full 15% basis step up on that deferred gain, you need to really invest by 12.31.2019. Now you can still invest later and qualify for the 10% basis step up if you hold it for five years. But obviously you could no longer hold it for seven years because that 12.31.2026 drop dead date.

Joel Swider:     Then as to investment two, so going back to our Opportunity Zone investment, if you hold that investment for 10 years total, then any gain from that sale of a second investment is completely erased. You get a basis step up to fair market value. So as you’ll see, I think if you can fit into it, it’s a great program, and as I kind of talked about on the previous slides you can get temporary deferral of gains, you get a step up in basis as to those gains, and you can get a permanent exclusion on taxable gains on the second investment. So it can be a good program if you qualify.

Joel Swider:     Now what happens if you’re tax exempt, you say, “Look, I, don’t have any taxable gains. I am charitable, I’m nonprofit and tax exempt.” Well how can this work for you? And so I think there’s still are some ways that you could leverage the Opportunity Zone program, one of which is, especially for hospitals that are located in the Opportunity Zone or near the border. And there’s some specific rules that the IRS put out earlier this year with respect to those types of properties that span, that are partially in the zone, partially not, which we can again talk about kind of offline if you have questions about that.

Joel Swider:     But if you’re on or near the zone, you could partner with a capital or a development partner who is able to take advantage of the tax benefits and that could result in a lower cost of capital to you as a provider for the real estate or for other development projects.

Joel Swider:     Another way that we’ve seen this work is that hospitals can attract for-profit investors to improve social determinants of health in the community. So we’ve seen a lot of focus in recent years with our clients and other hospitals where they’re looking at non traditional healthcare investments it’s really within their charitable purpose, but what they’re doing is they’re investing in affordable housing, they’re putting grocery stores into sort of a food desert area, and they’re making nontraditional healthcare investments that really help improve the population health in the community as a whole. And by so doing achieve their mission. So this is another way, and we’ll get to an example of this in just a second of how you might partner with a for-profit to provide some of those services.

Joel Swider:     Another thing to think about when it comes to a tax exempt provider is that a rising tide floats all boats. So what kinds of investments could you make that are within your charitable purpose within that community where the longterm value might actually end up not as a direct result but indirectly helping others who would be willing to invest in that community. So for example, a hospital could pledge community improvements in order to attract for-profit investors to the community, thereby improving social determinants and population health more broadly.

Joel Swider:     So just we have three quick examples here kind of straightening what this can look like and I’ve got links to the … If you want to find out more about each of these, I’ve not used the provider’s names but you can look them up. There’s an academic medical center on the East Coast, which collaborated with a for-profit pharmacy operator to open a new pharmacy and wellness store near the hospital’s campus.

Joel Swider:     The store offers a variety of health services, daily living products and health food options, and it also provides a health clinic that’s staffed by nurse practitioners. So this is again in coordination with the hospital. And so this actually came out a couple of years before the Opportunity Zone program, but when we were looking at this we thought, wow, could we recreate this today and take advantage of the Opportunity Zone program? I think you certainly could.

Joel Swider:     And so for this example the for-profit pharmacy operator could defer, reduce their capital gains by investing in the zone and the academic medical center could attract additional capital and development partners, which they have that are able to utilize the program. So again, kind of a win-win for both parties.

Joel Swider:     Another example here, this is in the Midwest, a large nonprofit Midwest health system partnered with a community development financial institution to help mobilize loan and grant funding to revitalize under invested communities this was in greater [inaudible 00:11:53] area. The goals of that partnership included supporting and trusting social determinants of health, job training opportunities, employment skills, education and food security. And I’ve got a picture here of a grocery store that they have built in a food desert area.

Joel Swider:     The amount of this investment was about $45 million. And again here we see partnering with investors and asset managers that are looking who have capital gains exposure, they’re looking for social impact investment opportunities and both the investors in the health system can benefit in these types of arrangements.

Joel Swider:     So one other example that we’re aware of is a large healthcare organization with a national footprint it’s a nonprofit integrated health system, which created an investment fund that committed up to $200 million to target housing stability, homelessness, and other community needs. So they’re approaching it again from a little bit different angle with the goal of preventing displacement of homelessness or homelessness of low to middle income households in developing communities.

Joel Swider:     They’re also using it to promote access to supportive housing and helping to make homes more affordable, they’re looking at environmental impact as well. And the tax savings here again presents opportunities for those for-profit investors and it also improves the quality of housing and improves the overall population health in the community, which is important to the hospital.

Joel Swider:     So I guess as we’ve seen in this first portion of the presentation, there really can be substantial savings and investing in Opportunity Zones if you’re either a tax payer like a for-profit health system, but what about if you don’t have, you can’t partner, the timing is wrong, what other options exist out there particularly for nonprofit providers to take advantage of those, Jerimi?

Jerimi Ullom:   Sure. Thanks Joel. Appreciate it. Yeah, so beyond Opportunity Zones, I mean we’ve dealt for years with various economic development incentives and various models to get projects completed and get projects financed. So we thought it appropriate to maybe look at a few of those, this is not an exhaustive survey, but we’ll highlight a few things that we see in the marketplace, some of which had been around a long time and some of which are relatively new models.

Jerimi Ullom:   And the first thought is that there’s really been a change, I think in the last decade when folks think of healthcare as economic development, the conventional wisdom, and I think if you go back, you can find white papers and journal articles and the like was that healthcare development would simply follow population. And so unlike manufacturing or technology or these other industries, there really was no reason to incentivize healthcare development in a given community. The healthcare providers would simply follow behind the rooftops and want to locate near them.

Jerimi Ullom:   I think we’ve seen a change in that because what we’ve seen is that healthcare can be a catalyst to an entire community. It can almost function like an anchor tenant does for a retail area, if you will. Oftentimes healthcare providers are the first development in a new area. We’ve also seen an increase in kind of competition for healthcare facilities for decades and decades, if a new manufacturing plant was being built, you would have multiple states vying for it to come to their state. And healthcare was seen as not really in the same vein. We weren’t exactly competing Wisconsin versus Alabama to see where we build our new hospital.

Jerimi Ullom:   But at the micro level location is a bit fungible whether we are in suburb A or suburb B when they buddy each other can have a big impact on the project as a whole so we’ll look at that. And then obviously I think one thing that folks have always agreed on is that having quality providers in your community is important in attracting other economic development. Much like having quality education in a community. You want to make your city, your town a place where folks want to live.

Jerimi Ullom:   And before we leave this slide, I think one other objection that has been proffered throughout the years particularly with respect to nonprofit providers is well these guys don’t pay property tax. Why would we ever want to provide any incentives or whatnot to attract them to our community? Part of that came out of this notion that property taxes were generally the tool available to local governments to provide economic development incentives. And part of it came from this notion of viewing it, I think a little too narrowly, so we’ll get to that.

Jerimi Ullom:   But if we look first if we have a situation where maybe a healthcare development is really the catalyst in an area or an anchor tenant, if you will this slide, this is a live project, it’s under construction right now, but we’ve been through several variations of a very similar project. And in this instance what happened is the health system acquired roughly 70 acres, right? They were going to develop 10 or 12 of the acres represented by the blue circle, but they were going to put in the infrastructure and the utilities and the other things necessary for that entire area to develop. They wanted to play a role on the development of the full 70 acres. They wanted to control maybe how it was developed and what those ancillary uses were.

Jerimi Ullom:   So the healthcare system was kind of the initial catalyst, they were often responsible for putting in a lot of the infrastructure but that would lead to additional development. And what we’ve been able to successfully do in many of these instances is negotiate incentives with the local county, local city, whereby the TIF revenue, the tax increment revenue, which I’ll explain shortly generated by these future additional uses, would help offset those initial investments by the healthcare system.

Jerimi Ullom:   At a micro level location is fungible. This is a map I pulled up of the St. Louis, Missouri metropolitan area, not because we have a particular project here, but because I knew St. Louis is comprised of a gazillion municipalities. And if you look at this map, you see all of these small cities and towns that make up the metro area, if you’re a healthcare system looking to locate in a metropolitan area like this whether you locate in one hamlet or village or suburb or the other might not be that critical. We’ve had lots of projects where our clients have looked at multiple sites all within a very close proximity, but all potentially within a different jurisdiction, some might be in an unincorporated area of the county, others might be in the incorporated limits of the city or the next suburb or city over.

Jerimi Ullom:   So oftentimes without being overly harsh or playing hardball with all these communities, but you may well find a location or a community that is much more welcoming and willing to provide a lot more in the way of incentives because they want your project, they want it to be the catalyst in their community. Healthcare projects often come with a number of high wage jobs as states and communities around the country I think there’s a general shift from property tax reliance to income tax. I think that the location of the jobs rather than being on the tax rolls becomes much, much more important.

Joel Swider:     And Jerimi, before you go on, I think one thing I’d add there too, I think I mentioned with respect to Opportunity Zones that a lot of times a hospital is looking to expand its existing footprint, but especially if you’re going into new markets, like you said-

Jerimi Ullom:   sure.

Joel Swider:     It may not matter if it’s a couple blocks away from this side or the other and one may be in a zone one not.

Jerimi Ullom:   And we’ve had systems we’re going to build an orthopedic hospital, we’re going to build an ancillary center, or an ambulatory surgery center, and it needs to be on the Northwest side of the city, right? That could be in any one of two or three jurisdictions. So I mentioned TIF before, real briefly we’ll overview because this is one particularly around the Midwest that’s used very, very frequently. TIF stands for Tax Increment Financing, and it is as it sounds, a structure where we capture the incremental taxes generated by a development or a project and we can capture those funds and use them to help support that project or that development.

Jerimi Ullom:   Oftentimes the current property tax value is kind of locked in as the base assessed value and any amounts beyond that become increment. It’s a little easier to think about when you view it in graphically here, if we go from left to right along the time continuum and then from South to North is the appraised value. You can see when we create the TIF area, we set the baseline of property values. The taxes associated with that baseline continue to flow where they were flowing before to the schools, to the libraries, to the city, to the county, to all of the taxing districts.

Jerimi Ullom:   But the lighter blue triangle over time, that’s the tax increment, because what we’ve done at creation is we have built a new project, or we’ve attracted additional investment to the area that’s driven up the assessed value and therefore is generating more property taxes. That increment is captured and that increment can be used to finance or to pay for portions of the development in the first instance.

Jerimi Ullom:   So if we go back to couple slides that go to the map where the hospital is the anchor tenant that hospital is investing in the infrastructure in the area, but they intend to recoup that investment from future tax increment over time. So if they spend $5 million putting in roads and drainage and utilities, the arrangement with the town will provide that the future tax increment generated in the area will come back to the hospital as a way to recoup that investment.

Jerimi Ullom:   And then of course to the far right once that TIF area ends, determined by state law, but typically 20, 25 years in most states, then obviously all of that increased value is just in the general tax base. So the big win for the city is this is increment we wouldn’t otherwise have, so we’re not giving up any of our base and at some point in time we’re going to have the value of all of it after this TIF area has run its course.

Jerimi Ullom:   Again graphically kind of how it works in practice, you could see where the new development if you will in the graphic generates revenue that can be spent in the area. Most state laws restrict how that money can be spent, it has to be spent either in or connected to or in some states on projects that benefit the area, the city can’t simply capture TIF revenue and go off and do something wholly unrelated with it.

Jerimi Ullom:   This map just gives you a sense for how widespread the use of TIF financing and tax increment as an incentive is. If you look particularly we’ve got Indiana, Ohio, and Michigan associations on the line, and you guys are squarely in the upper echelon of TIF usage. We’re resident in Indianapolis I know there are literally thousands of TIF districts in the state of Indiana, and you can see kind of around the Midwest is a home to it. California, Texas also show up as being pretty significant users.

Jerimi Ullom:  And the overview here is that there’s been a shift over the last decade of healthcare from just something that follows population to really being an economic driver. And if you think about the modern healthcare campus, you can see that readily, all the ancillary for-profit development, all the hotels, longterm care, medical office buildings, et cetera, that are on the tax rolls that generate additional jobs that bring additional people to the area. That economic development story is usually a pretty easy one to put together.

Jerimi Ullom:  Two more thoughts here. Another phrase you might hear a lot about when you’re looking at projects and project finance and economic development is P3, public private partnerships. I say here, it could be P3, it could be four, five, six, seven. There’s no magic to P3. Okay? I hate to burst all the consultants bubble, but there’s no magic around this phrase.

Jerimi Ullom:  All a P3 project is, is multiple parties coming together to get something done. And typically those come from the public space in terms of government, you might have private for-profit, nonprofit, you might have all the above. And each of them often have different tools they can bring. They have different access to capital, you might have a city that owned some land that they want to contribute to a project. And so, a P3 project is really nothing more than bringing together a group and seeing what each of them can offer to the project, what risks they’re willing to take in the project to collaborate and get the thing done. I wish it were sexier than that, but that is really what we’re talking about in that arena.

Jerimi Ullom:  This is an example of one that we’ve worked on that is still in the planning stages. Lots of boxes, lots of lines. This project was out in the western United States, it involved a healthcare system. It involved a new nonprofit that was being created. It involved the local community college. It involved the local city. And it also involved a private developer, and then subsequently a private manager. And so all of them were coming together. The health system would brand the project, it would be built on its campus. The new nonprofit was going to serve as the owner of the project. They could finance that project with tax exempt debt. They would likely get a property tax exemption as a nonprofit owner. The private developer was obviously going to build it and then they were going to manage the property on an ongoing basis. The host city was going to use the project in part particularly for their first responders, their police and firefighters, and then the local community college, this was a wellness center, they wanted it to be available to their students.

Jerimi Ullom:  So we’re able to cobble together all of these parties in a P5, not a P3 project, to try to pull together a structure that worked and a credit that worked and an underlying cashflow that worked.

Joel Swider:    So Jerimi, when somebody talks about a P3 or P5, you’re saying that they could take really any number of forms in terms of-

Jerimi Ullom:  Yeah. And in fairness, the three refers to the three P words, not the number of parties. I just like to say that because oftentimes these projects involve many, many parties. If you think about them as multi ventures rather than joint ventures. My point is there’s nothing particularly sacred about P3, and I think people often hear that phrase and think there’s some magic to it and it’s really just about bringing the parties together and what can each add.

Jerimi Ullom:  Another model that we see gaining some traction is a nonprofit foundation, nonprofit real estate foundation models. Some of you may have seen this, may have heard about it recently. This is a model that’s been around for a while in higher education. We’ve seen it with student housing projects, with research facilities and the like, and we see that migrating to healthcare. We’re working on our first two projects with this model, both of them in the southern United States, and it’s really just an alternative to for-profit or developer or REIT ownership of a facility. So if you have facilities that maybe the health system doesn’t want to own, so they’re looking to maybe have a developer or a REIT or a for-profit entity own those projects and lease them back to the health system, this would be one potential alternative to that. You can almost view these entities as alternative landlords that are in the nonprofit space and maybe a little more aligned with the nonprofit mission of the healthcare providers.

Jerimi Ullom:  Very flexible, by and large willing to structure and finance and put the project together in any way the health system would like because of their nonprofit mission to try to serve the health system rather than a for-profit mission to try to enrich themselves. So this is one to keep an eye on. I’m sure we’ll be getting some more information out there. If you have interest in this model, my colleague Andrew Dick did a podcast with one of the players in this model recently and you can, I’m sure, find that by searching Hall Render Podcast, Hall Render Real Estate Podcast. And if all else fails, contact us and we’ll make sure you get it.

Jerimi Ullom:  And then, because I can’t resist boxes and lines, this was what one of those nonprofit real estate foundation deals look like. So, not simple, but can be a very, very good alternative to some of the for-profit players in the real estate development industry.

Jerimi Ullom:  And with that, Joel, we’ll see if we have any questions that have come in. I don’t believe we’ve seen any in the chat room, but if you have any beyond this, feel free to contact myself or Joel or really anyone at Hall Render.

Joel Swider:    Yeah. And special thanks again to the Indiana Hospital Association, Michigan Health and Hospital Association, and the Ohio Hospital Association for inviting us. And we hope to talk with you soon.

Joel Swider:    Remember that the views expressed on this podcast are those of the participants only and do not constitute legal advice.

 

Challenges and Opportunities in Health System Property Management with Lorie Damon

August 1, 2019 Joel Swider Health Care Real Estate Advisor 20:23 Comments Off on Challenges and Opportunities in Health System Property Management with Lorie Damon

Challenges and Opportunities in Health System Property Management with Lorie Damon

An interview with Lorie Damon that was recorded in Scottsdale, Arizona at the Health Care Real Estate Legal Summit sponsored by Hall Render. In this episode, Joel Swider interviews Lorie Damon, the Managing Director of Cushman & Wakefield’s Healthcare Advisory Practice. The Cushman & Wakefield Healthcare Advisory Practice provides healthcare organizations with strategic and transformational real estate services that directly affect positive business outcomes.

Podcast Participants

Joel Swider

Attorney with Hall Render

Lorie Damon

Managing Director, Cushman & Wakefield

Joel Swider: Hello and welcome to the Health Care Real Estate Advisor Podcast. I’m Joel Swider, an attorney with Hall Render, which is the largest healthcare-focused law firm in the country. Please remember that the views expressed in this podcast are those of the participants only and do not constitute legal advice. We’re in Scottsdale, Arizona today at Hall Render’s Health Care Real Estate Legal Summit, and I’m pleased to have with me Lorie Damon, the Managing Director of Cushman & Wakefield’s Healthcare Advisory Practice. We’re going to be talking today about trends in property management and some of the challenges and opportunities facing health providers in managing their real estate. Lorie, thanks for joining me.

Lorie Damon: Thank you. I’m pleased to be here.

Joel Swider: Lorie, before we dive into the property management, I wanted to get to know you a little bit and start with your background, who you are and how you came to be such an expert in the area of healthcare real estate services. You earned your bachelor’s degree from Hood College in English Literature, your PhD from Purdue, and you also taught a course at Harvard. How did you get into healthcare real estate?

Lorie Damon: Purely by accident. I am classically trained. I was trained to be an English professor, and I spent a number of years teaching. I ultimately decided that that was really not the career for me, and I came back to Washington D.C., which was my college home, and I found a job working in a trade association as the editor of their magazine. One of my colleagues there left shortly about a year after I had joined the firm, and she went to work at BOMA International, and a year later, she called me and said, “Hey, we have this job as our Director of Education.” “Would you be interested? You should interview.” We’re doing a lot of online learning, which I had done. I had piloted some online learning programs at Purdue, so I interviewed at BOMA, and I took the job, and I didn’t know a thing about real estate or healthcare real estate, except that I went to doctors in medical office buildings, but I had a really great … I had the best luck in that BOMA had a small Medical Office Buildings Conference that they asked me to be in charge of, and I am curious, so I had the good fortune of learning from some of the industry leaders by virtue of asking them to speak and contribute content to BOMA’s conference. I learned a lot from John Winer, who was then at Ernst & Young, and now is at Seavest, Todd Lillibridge was one of the first investors in medical office, and I used to talk with him every week to get a primmer on why somebody would buy a medical office, Gordon Soderlund, Danny Prosky, I mean, some of the luminaries in the industry and some of those who are really early, early to commit to this sector were, taught me the business. Then, out of that, in order to create our strategy for growing the conference, we really wanted to have the perspective of health systems, so I was always the person calling somebody and saying, “Oh, I’m sorry. I can’t pay you an honorarium, but would you be willing to come and speak at my conference?”, and so I really established good relationships and listened to those health systems and to real estate companies, trying to navigate their portfolios, right? I always say that one of the most important lessons that I learned is that the real estate industry wasn’t really built for healthcare, and has always, I think struggled in some ways to accommodate healthcare because healthcare doesn’t fit easily into some of our sort of standard boxes to classify their real estate or classify the occupants or classify the owners.

Joel Swider: That’s interesting to think of BOMA MOB Conference as a small conference, right? I mean, there’s what, thousands of people now, and you guys have really grown it?

Lorie Damon: There are 1,500 people there, but in my first BOMA Conference, there were about 100, and I was one of two women.

Joel Swider: Yeah, okay. Wow. Okay. Wow.

Lorie Damon: It was a great experience to watch that conference grow. Some of that was just the luck of market timing because the sector was starting to take off, and there was more interest in it, but I think it was also just very good fortune and having the right set of volunteers who were industry leaders and who were good at recognizing that the industry itself needed to come together and create a venue where we could talk about some of the more complicated matters of working in this sector, and where we could create a forum for health systems, and investor owners, and developers, and property management companies to sort of collaborate and establish a track record of best practices and common procedures, if you will. A lot of that was, really did not exist, and in its essence, that is the obligation of BOMA as the industry’s leading trade association, so it made sense. It gave us the perfect venue in which to do that. Then, one volunteer, we were so fortunate because one volunteer would recruit another. I can’t even tell you how many hours of time all of those folks that I mentioned not only spent teaching me, but just contributing to the industry so that we could have a body of knowledge about this particular sector.
Joel Swider: Sure. How long have you been with Cushman now?

Lorie Damon: I’m in my sixth year.

Joel Swider: Okay.

Lorie Damon: I will finish my sixth year in December.

Joel Swider: Okay. In my mind, I think about BOMA as, as you mentioned, it’s a trade association. You’re sharing best practices. For someone that wasn’t involved maybe on the operational side before you, before your role, and maybe I’m overgeneralizing, but how did you transition then from BOMA? You had a lot of knowledge and expertise to where you are now, where you’re really applying that for clients.

Lorie Damon: Yeah. I think one of the things that was very advantageous about my role at BOMA was that I really had a bird’s-eye view on the whole industry, right? I wasn’t in it. BOMA sits outside of it, but can see all of the things, all of the major real estate firms, regional firms, smaller firms. All of those folks are BOMA members, and there’s a cross-section of owners, and management companies, and brokerage houses who come together to comprise the membership at BOMA, and my job, I was just fortunate because my job was education and research, so I was at the crux of understanding, “What does the industry need, and then how should we teach them?” Well, in order to teach them, I had to learn it, and then I had to determine from all of the variety of sources of information about, well, for instance, “How do you create a compliant timeshare lease?” Well, it would be my job to distill seven different opinions into what looked like the most common set of practices, and then work with, in those days, I would call Bob Hicks and say, “Could you take a look at this, and make sure that we’re not communicating something that’s inappropriate or inaccurate?” All of that activity really helped me to understand how the industry worked, and like I said, how some of the methodologies for serving healthcare could be adapted to better suit the needs of that particular client base. Coming to Cushman, coming into the industry, I did have some reticence about that because I knew all of the firms, and I sort of knew, as they would say where all the bodies are buried, but I really felt like there was a great opportunity there too, to bring a body of knowledge that none of them would have by themselves to bear on a sector that was growing, and demanding, and evolving very quickly, and so I wanted to road test that theory.

Joel Swider: Sure. How has it gone?

Lorie Damon: Well, it’s been a great ride. Well, certainly, Cushman itself has undergone a number of changes. When I joined the firm, I joined one of the legacy firms, so we came together now as an entity. Cushman & Wakefield was a merger of Legacy Cushman & Wakefield, and then DTZ, and prior to that, Cassidy Turley, so we are about 10 times bigger than the company that I joined. We’re international now. We’re a publicly traded company, so we’ve seen a lot of changes on our side, but through the auspices of that, we now have an extraordinary array of services and capabilities that are really only possible with our size firm, and so that has been great because so much of that, as healthcare systems are looking at retail opportunities. I have colleagues who are retail experts. I can pick up the phone and call one of them. I have a colleague who’s an opportunity zone expert, and I can top that base of knowledge. I have a counterpart in London who we have some mutual investor clients. We also have a couple of health system operating clients in common, and so we can regularly compare notes across the pond and start to forge a truly global perspective on healthcare, which is exciting.

Joel Swider: Sounds like a powerful platform and a value add.

Lorie Damon: It is a powerful platform, for sure.

Joel Swider: Yeah. What are, I guess some of the benefits to people listening, benefits of outsourcing their property management through a platform like Cushman’s?

Lorie Damon: There are many benefits to outsourcing, but I always remind my teams and our clients that the best solution is the one that works best for you, and in health care, I just don’t believe that one size fits all. I think in any exercise where you’re looking for a partner, it’s really important to understand how you want, first of all, “What do you mean by property management? What needs to be managed? Let’s look at what those activities are. Which ones do you really want to do yourself for whatever reason?” You can do it better. You can do it more cost-effectively. For internal relationship purposes, you just need to retain that or to risk manage. You just need to retain it. “What do you want to do, and then what do you need a partner to do?”, and so I think one of the best arguments for working with an outsource service provider is that we house real estate expertise. We hire it, we train it, we groom it, we promote it. All we do is think about it, and we can invest in and deploy a variety of tools that might be prohibitively expensive, right? Lease administration is a very expensive technology, and we can work with a variety of platforms, so if that’s not a capability that you have, and you want it, and you can’t afford it, then that’s a good opportunity to look at having a service provider. If you don’t have a big enough facility management team to service a growing outpatient portfolio, if it’s just physically dispersed, and your FMs are based on your hospital campuses, it is not necessarily efficient to run those maintenance talks in a car from the campus out to a surgery center. In cases like that, I think it’s really important to be very transparent and collaborative upfront to understand, “What are the goals?” “What are we trying to accomplish, and then what are you able to accomplish? What do you want to accomplish yourself, and then what do you need help with?”, and then find, if we’re not the right partner, find a partner who’s equipped to address those needs and to do it in a manner that’s consistent with the health system’s philosophy for servicing its assets.

Joel Swider: What are some of the biggest challenges right now facing health systems in terms of managing their real estate? We’ll get to opportunities as well in a second, but what are some of those challenges?

Lorie Damon: Right. Well, I think one of the biggest challenges that I see and that I know a number of my panelists talked about today is just that their portfolios are growing, and they’re growing really rapidly, but their staffs are not necessarily keeping pace. The technologies that they use to manage those portfolios may not also be keeping pace, and so I think that’s really a challenge because in some cases, those portfolios have doubled or quadrupled in size, and it’s a lot. That can mean that you went from having 100 leases to 400 leases, and that’s difficult if you don’t have additional people to manage them. Healthcare leases get touched a lot, and so there’s sort of a constant administrative burden that comes with that growth. I think one of the other challenges in healthcare in general, but at this particular historical moment is just that there’s regulatory uncertainty and there’s also just an evolving set of regulations. I don’t mean just start getting a kickback, which has, in some ways, it feels like it’s always been with us, but I’m thinking about things like site-neutral payments, which dramatically impact how you pro forma a new site, and how you think about where to locate a new site. I think the push toward consumer-driven healthcare really changes the dynamics of site selection, and that’s a different set of skills and a different set of tools than what many health systems have historically used to figure out where they want their real estate. I think there’s just a lot of evolution in the sector now to adapt to a new regulatory environment and just a new consumer that requires a different set of real estate tools and skills than what we maybe had even 15 years ago when I started at BOMA and realized that that medical office was an asset class, and that people invested money in it.

Joel Swider: Yeah. What then are some of the opportunities on the flip side of that?

Lorie Damon: I think that some of the biggest opportunities are to really embrace the data. Embrace data is sort of my mantra. There’s a lot of data available that health systems have themselves about their patients and about future demand that doesn’t always make its way into real estate decision-making, but should and could create a much more foolproof strategy around where to put particular services or particular facilities. I think there’s also a lot of … We could all do a better job of managing the data around how our assets perform as assets, and really understanding the way any investor would want to know, right? “What are we generating and operating in common rent in this particular facility? How much of it is occupied and how much of it is vacant? Are there opportunities to lease out what we already have? Are we paying rent on vacant spaces?” I mean, really, really, really mining the data that’s available to us to create a much more optimal portfolio, I think is a great opportunity and can drive some pretty significant expense savings.

Joel Swider: Lorie, I want to switch gears a little bit. The Health Care Real Estate Legal Summit has just concluded, and you had a panel discussion on property management trends, and specifically for healthcare facilities. Could you give us maybe a little bit of a recap, or what did you view as kind of some of the nuggets of information that you kind of took away from that or that our listeners might take away from that?

Lorie Damon: Sure. I think one of the most important observations from our panel is just that there are no two systems operate that activity the same, so Nancy and Laura from Mercy Health, they manage all of their real estate internally with internal teams, including internal legal teams. Ashley, our other panelist from Atrium Health has a combination of internal teams, including an internal legal team and then external resources, including our property management partner and external counsel. I think that’s always good to know that there are just different models that evolve for that various needs. I think a couple of the other things that we heard is that there’s a real … Both of them echo that understanding control, having both control but flexibility and their portfolio, and structuring that into leases or purchase and sale agreements, or options for buybacks has become absolutely critical, and there are many reasons for that. First of all, there’s a lot of new owners, new investors who are seeking opportunities in this space, and there’s also just a lot of dynamism around what the health system might want to do and when they might want to do it, so one of their goals is to try and optimize that footprint and their control over it so that as their care delivery evolves, their portfolio can quickly adapt to those new changes. Then, of course, we close by talking a lot about retail strategies and how they’re approaching that. Mercy has a pretty significant urgent care strategy that they’ve launched in St. Louis. It’s very fast. In nine weeks, they can have them open and they have literally kind of [led 00:17:01] star city with options on every corner, which is great and very convenient for patients, but they’ve partnered to do that because they recognize that they didn’t have the internal expertise to execute as quickly as they needed to. I think we got a pretty good cross-section of some trends that other health systems everywhere else are grappling with.

Joel Swider: Yeah, and I guess that’s … Maybe I’ll close with that question. We heard from a couple of of well-respected health systems. I know you have the opportunity to work nationwide with a vast number of others. Is what we saw today representative or are there other trends or other approaches that you’ve seen that are kind of on the rise?

Lorie Damon: I think what we saw today is fairly representative. I think most health systems are really, are in some sort of growth mode, at least for their outpatient services. They are looking hard at taking care closer to the patients. I think that’s a fairly common refrain and a common strategy. What varies is the manner and form of that execution. On a lot of how you execute your outpatient strategy depends on who you are and where you are, and who your competition is. We’ve seen in some markets, urgent care is really popular sort of to the point of saturation, and other markets, we’re seeing experimentation with all new sorts of facilities like micro-hospitals, for instance are evolving, and we’re starting to see that. There are only 50 now. In two years, will there be 250? I don’t think we know. Freestanding EDs have come, and in some markets, they seem to be here to stay, and other markets, they seem to be really challenged. I think we’re definitely seeing an evolution of the types of outpatient facilities, and in the strategy for how you create an outpatient strategy to capture market share and to serve as a patient base. I think the other interesting evolution is this focus on the patient, and patient-centered care, and how that translates into the real estate footprint. I mean, Laura made a great point about how much effort Mercy is investing in creating branded facilities that look alike, so that the minute a patient steps into them, they know they’re in a Mercy facility. I definitely see that in all the markets that I visit. There is a much greater focus on making sure that hospitals have clear signage, that patients know where they’re receiving care and from whom.

Joel Swider: Well, Lorie Damon, thank you so much for being with us. It’s been a pleasure talking with you.

Lorie Damon: It’s a pleasure to be here. Thanks, Joel.

Joel Swider: Thanks. If you like what you heard on this podcast, please subscribe on iTunes, and if you’re interested in additional content from Hall Render, you can send me an email at jswider@hallrender.com subscribe to our monthly newsletter. Thanks again.

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Creating a Brokerage Firm Exclusively for Health Care Providers with Colin Carr

July 8, 2019 Andrew Dick Health Care Real Estate Advisor 29:20 Comments Off on Creating a Brokerage Firm Exclusively for Health Care Providers with Colin Carr

Creating a Brokerage Firm Exclusively for Health Care Providers with Colin Carr

An interview with Colin Carr from the Carr Healthcare Realty: In this episode, Andrew Dick interviews Colin Carr, the founder and CEO of Carr Healthcare Realty. Carr Healthcare Realty provides real estate brokerage services to health care providers.

Podcast Participants

Andrew Dick

Andrew Dick is a Shareholder with Hall Render in the Indianapolis office. His practice focuses on real estate transactions and environmental law. He advises hospitals and health care systems around the country on the planning, construction and development of new hospitals, medical office buildings, surgery centers and skilled nursing facilities.

Colin Carr

Colin Carr is the founder and Chief Executive Officer of CARR, and invests his time and expertise into the professional lives of his staff and agents, systems and processes, and ultimately the representation of the thousands of clients that CARR has the privilege to represent on an annual basis. Colin has been involved in commercial real estate since 2000 and has personally completed over 1,000 transactions. He is a licensed real estate broker in ten states. 

Andrew Dick: Hello and welcome to the Health Care Real Estate Advisor podcast. I’m Andrew Dick, an attorney with Hall Render, the largest healthcare focused law firm in the country. Please remember the views expressed in this podcast are those of the participants only, and do not constitute legal advice. Today, we will be talking with Colin Carr. He is the CEO and Founder of Carr Healthcare Realty. Carr Healthcare Realty is one of the largest brokerage firms dedicated to representing healthcare providers when leasing space or buying buildings for their business. Colin, before we jump into your business, talk a bit about yourself, where you’re from, and how you ended up where you’re at today?

Colin Carr: Absolutely. First of all, I appreciate having the chance to talk with you and excited to share. I grew up in northern Michigan, upper Lower Peninsula, a little resort town called Charlevoix. It’s in the Traverse City area. Lived there until I was 18. Moved to East Lansing when I was 18, and I jumped into the workforce right away. I was considering going to Michigan State or another university, and I got fascinated with business. Specifically, I got fascinated with real estate and I jumped right in. I started managing apartment complexes when I was 19 years old, and met a gentleman that owned about 13 different complexes in the Greater Lansing area. I started working for him, just apprenticing with him, and was fascinated with real estate. I worked for him for just under two years, and moved to Colorado when I was 20. Picked up managing apartments again in Colorado. I met another individual investor that I started doing a bunch of work for. Did that for several years, and then I got my broker’s license when I was 23. That’s what got me into actually brokering commercial transactions.

Andrew Dick: So, were you out on your own or were you at a national firm at that point?

Colin Carr: I started at a boutique firm when I first got my license. The firm that I worked with was just basically two other people. Their focus was exclusively retail. It was for large national retailers. Wendy’s, Walmart, Blockbuster, large, notable retail tenants. Worked for him for a couple of years, got a great experience, great opportunity to understand the market, but I had a desire soon into commercial real estate to also work on office and industrial transactions. I made a switch at that point to a large, national firm that had an office and industrial focus.

Andrew Dick: Okay. You work at the national firm for a while. What type of transaction are you working on there? Office, industrial, representing landlords and tenants?

Colin Carr: Yeah. At the first shop, it was almost exclusively retail, landlord and tenant side. During that time, I also started just getting really proactive with cold calling. As a young broker, you can wait for the business to come in, you can put your sign in front of a building and wait for the phone to ring, or you can go out there and try to find deals. I got proactive early on and I literally started cold calling every day. I got excited about doing office and industrial transactions, and so when I switched to the large firm, I had a focus on industrial primarily. That expanded into office, it eventually expanded into medical office as well. I got a taste of some land, some investment realty as well. Within a couple years, i had pretty good exposure within a fairly broad segment of real estate.

Andrew Dick: When we talked before, Colin, you told me a scenario where, when you were at the larger firm, you’re working with landlords and negotiating, for example, with I think it was a plastic surgeon. You quickly learned that when tenants aren’t represented, specifically physicians or other healthcare providers, they tend to get taken advantage of. Talk a bit about that scenario?

Colin Carr: Absolutely. When you first get involved in commercial real estate, at least for me, if a deal moved I would chase it. I would go after anything I possibly could. I was going after any aspect of commercial real estate. After about five or six years, I settled in to where I was more focused on my business model, and I got more focused on healthcare. At the time, I was doing a lot of landlord work for owners of medical office buildings, and also several as well, that own medical office buildings. I was also doing a lot of tenant-buyer work, as well. I found myself in a considerable number of transactions where I was working for the landlord, and the tenant did not have any representation, and I found out real quickly how exposed those tenants were. I also had times where I was the agent of the tenant and they wanted to go look at properties where I also represented the landlord, and I found myself involved in a conflict of interest in a number of transactions.

Colin Carr: To your point, I had one transaction specifically where I was working for, it was one of the largest medical REITs in the country. They had two really nice office buildings in one of Denver’s top suburbs. We were approaching a renewal for a plastic surgeon. The last couple deals we had done in the building were around the $24 per square foot range, and the asset manager out of Scottsdale asked me if the plastic surgeon had a broker. My response was no. He asked me if he knew the market. My response was no. Then he asked me, “Do you think the tenant’s willing to move?” My response was no. His response was, “Let’s go back to him at $29 a square foot.”  My thought was that seems like a pretty steep increase. I get the idea of making the most of every opportunity, but my thoughts were that was a little over the top. My next questions were, are we going to give him any free rent? “Did he ask for any?” No. “Then, the answer is no.” Are we going give him a tenant allowance? “Did he ask for it?” No. “Okay, the answer is no.” So, I was looking at the transaction we had done a few weeks ago with an ENT who was represented at $24 a square foot, with a $40 per square foot tenant improvement allowance, with several months of free rent. Then, I looked at this transaction where the plastic surgeon had no representation, and it was a proposed lease for $29 a square foot, with no TI, no free rent. There was other concepts there, as far as not, and other aspects where the deal was going to be extremely unfavorable for that tenant. When I pushed back against the asset manager a bit … Again, I was working for him, but it just still felt a little egregious, his response was, “Get it done.” He just hung up the phone. I just had a wake up moment there where I realized, look, it’s great to make as much money as you possibly can on a transaction, but it would be a lot more fair if that tenant had representation that could protect them. It would hopefully, at that point, be a more fairly negotiated opportunity for both sides.

Colin Carr: I had a couple transactions similar to that where I realized that the tenants were substantially exposed and they were very intelligent people, they were good clinically, they were good medically. I think that most of them, their intentions were good, but they were outmatched very quickly going up against large, sophisticated landlords and listing brokers that knew what they were doing, and they didn’t have a clue what they were doing. Yeah, long story short, over a couple month period of time I watched a handful of tenants get taken advantage of, in my personal opinion, or … let me say this. Negotiate very unfavorable terms, or just get stuck with the terms because they didn’t know how to negotiate. I made a decision at that time to create a business model that was focused exclusively on representing tenants and buyers in the healthcare space. We launched that in February 2009.

Andrew Dick: Which is pretty unique. That model is, unlike some of the other national firms that are chasing the landlords, the REITs. You recognize that, one, you wanted to only be on the tenant side, or the buyer side, and focus on healthcare. There’s also something else you and I have talked about, which is the fact that your team is willing to work really hard for physicians, and dentists, and veterinarians who maybe aren’t going to lease 10 thousand square feet, they’re going to do smaller deals. That’s really in your sweet spot, right Colin?

Colin Carr:It is, yeah. Again, a lot of commercial brokers want to chase big listings, or if they are on the tenant or buyer side, they want the larger deals. That’s just a focus and specific style of doing business. Our model was, if it’s healthcare, we want to do it. The vast majority of healthcare transactions that happen are in the several thousand square foot range. We’ll go down to 1500 square foot chiropractors or endodontists, but our sweet spot is the two to five thousand square foot range. Out of that comes a lot of additional transactions, and we’re doing large deals. We do 20, 40, 50 thousand square foot deals on a regular basis now, but we treat the 2000 square foot tenant the same way that most brokers would treat a 40 thousand square foot tenant. Because of that, that’s opened up a lot of opportunities for us.

Andrew Dick: So, at what point did you decide to go out on your own? When was that, when did you form Carr Healthcare Realty?

Colin Carr: So, over a handful of months I realized that the tenants and buyers in healthcare were not getting the focus and attention they deserved. Again, there was a large focus on the landlord side of healthcare, there was a large focus on the large institutional or large group practices, but there was virtually no focus whatsoever on the smaller, individual users. Over about a six month period of time I put together a business model. I approached the group that I was working with at the time, laid out what I believed was a viable business model, and their response was they didn’t think it had the same merit that I did. They recommended that I go start my own company. So, I did just that. That was February 2009. Within a couple months, we added our first person, within a couple months after that we added our next person. We grew to a handful of brokers in Colorado. We did that for the first five years. Handful of brokers in Colorado. We did that for the first five years, just kept just building our platform, getting more comfortable with the transactions, getting more experience, figuring out better ways to help our clients. And then after about five years of doing hundreds of transactions throughout Colorado, we decided to expand outside of Colorado and go national.

Andrew Dick: And so today, about how many brokers or agents do you have, and how many offices?

Colin Carr: So we are licensed in just under 40 states now, and we have a agents and brokers in about 35 of them. And so we have just under 100 people total right now, coast to coast.

Andrew Dick: And what type of clients are you working with? So we’ve talked about physicians, dentist … But there’s a long list of health care providers, right, that you’re working with?

Colin Carr: Absolutely. So we do dental, medical, veterinary, optometry, vision, physical therapy, chiropractic … We also do a lot of senior housing as well, and so really anything that’s healthcare-related. We’ll do fitness facilities. We’ll do health and wellness centers, med spas, but our bread and butter are the medical, dental, veterinary, vision concepts. And if it’s health or wellness related, though, we’re happy to help, and like having those opportunities.

Andrew Dick: So, Collin, when we’ve talked before, you said, “Look, we’re typically representing buyers and tenants.” What happens if one of your clients says, “I’ve got a building, Collin. I want to sell. Will you list the property?”

Colin Carr: Absolutely. It happens a lot because we specialize in finding facilities that meet our clients’ needs. And sometimes those are individual buildings. Other times those are multi-tenant or investment properties that our clients purchase. So we help our clients buy buildings. Often times we’ll help them … We’ll bring other tenants to the building as well too. But we don’t do any landlord or seller work. So if a client has a vacant space and they want it leased, we’ll refer a listing broker to them. If they have a building, they want it sold, we’ll refer a broker to sell the property. And the idea there is, yes, we’re passing on some fees, but the importance is that we’re staying focused and staying true to our core values, which are no conflicts of interest. So we refer a listing broker who comes in and sells the property or sells the asset, or finds a tenant for the space.

Andrew Dick: Talk about, for maybe health care providers that aren’t in the real estate world like we are, who’s typically going to pay your fee?

Colin Carr: So commercial real estate is very similar to residential real estate, in that the landlord or seller is paying the commission. Landlords and sellers set aside a portion of the commission, both for their agent on the listing side, but also on the tenant or buyer side to attract quality tenants. And so just like if you’re buying a house, the seller of the house typically has a commission set aside for the buyer’s agent. It’s the same in commercial real estate.

Andrew Dick: Okay. Talk a little bit about the growth of the company. How do you explain it? It’s pretty remarkable within a short period of time that you have offices across the country. You have nearly 100 employees. What do you think has been the secret sauce there?

Colin Carr: There’s a couple things. One, just our business model. Our business model is predicated upon we help people that help people. Our focus is trying to help healthcare providers and physicians to find the best locations, and negotiate terms and economics that are equitable and fair to them. We’re not interested in trying to take out landlords. It’s not adversarial against landlords. It’s just trying to protect the doctors. Unfortunately, commercial real estate, it’s a market lease rate’s the most that someone’s willing to pay. And so when it comes to a healthcare provider that’s not educated in the commercial real estate market, that’s probably not prone to, or would not welcome, the conflict and confrontation that’s inherent in a high dollar negotiation, they typically get taken advantage of and get folded in a negotiation very easily. And so our business model is predicated on protecting them, helping them find the best locations, helping them understand the market, helping them understand how the process works, and then ultimately saving them a substantial amount of time and money, and then also providing them a very tangible peace of mind, knowing they didn’t get taken advantage of, knowing they didn’t miss a good opportunity in the market, and that their location is where they’re supposed to be. And so that model or that idea resonates with a lot of people that have joined us, feeling that they’re actually having an impact and an influence on the clients that they’re working with. So I would say just the overall model, our overall business plan of helping healthcare providers maximize their profitability through real estate, that’s exciting. But I think most importantly, as far as how we’ve had the growth, is from our culture: how we treat our staff and our employees, how we treat our brokers, what our focus is. We’ve created an environment and a culture that is very, very healthy. It’s counterintuitive rom how a lot of companies run, and it’s a breath of fresh air for the majority of the people that are here.

Andrew Dick: Talk about that briefly. You said that your brokers and agents only work certain hours, and you try to preserve the time with family and friends. Talk just a little bit about that.

Colin Carr: Absolutely. So we have a set of core values that are very important to us that we don’t stray from whatsoever. And it starts with just an atmosphere of integrity, and just creating an atmosphere in our culture where people know who people are. You don’t have a work person, and then a family person, and then a friend person. It’s the same people everywhere you go. So people operate with integrity. People operate with a spirit of excellence. We’re not trying to push people to get out of balance with lifestyle, with family. We’re all about working hard, but we have a very specific life/work balance. And we encourage our team and our staff, “Don’t work the evenings. Don’t work the weekends. Work it hard during the day, but you’ve got to preserve that time with your family.” And so certainly there’s times when you get pushed to go back and do some extra hours here and there. But overall, we encourage our team to rest, to take vacations, to enjoy the time. And we work really hard, but just like a professional athlete, they work really hard when they work, but you have to rest. You can’t lift weights seven days a week. You can’t play a season that lasts the entire year. You’ve got to work hard when you work hard, and then you’ve got to rest intentionally. And the more rested you are, the harder you come back and work. And so we protect our team’s time. We don’t have a lot of bureaucracy and red tape like a lot of large companies do. And there’s a spirit of integrity, and there’s a culture where people trust the people that are here. They trust the people that are making decisions that they’re trying to build a company in an environment that’s as healthy as possible. And we’re also not building something because we have to pay out shareholders, or we have to meet Wall Street demands. And we’re also not building something so we can sell it real quickly. And there’s a lot of companies right now that have a good idea, or they have a good product or service, but in the spirit of trying to build something quickly to sell it, or trying to satisfy outside investors or Wall Street, they don’t put their people first. They put the profits first. And so we run a company that’s very intentional and with a very intentional culture. And it’s certainly not going to be a fit for everyone, but it’s been attractive to a lot of people that are with us.

Andrew Dick: Well, talk a little bit about the typical agent or broker profile. When we’ve talked before, it’s not as if some of these folks are bouncing from a national brokerage firm to Carr. That may happen, but these folks are often … This is their first foray into real estate. Talk about that.

Colin Carr: Absolutely. So our model’s unique. I’d never seen anyone doing what we’re doing right now. We’re the only commercial real estate firm that has a national presence that has a focus of tenants and buyers only in the healthcare space. So with that unique idea also came a unique approach to how we would build a team. And there’s great brokers at a lot of different firms. We decided to take a different route, which was not trying to find brokers and convince them to leave one firm and come to our firm. Our model instead was, “Let’s find people that have been very successful in other areas of business or other areas of life, and then let’s teach them a very specific way of doing commercial real estate. And then let’s show them how to be focused in healthcare. And so we have intentionally … We have a handful of people that used to be with commercial real estate firms, that you probably could count them all on one hand, but 95% of the people that are here have been successful in other areas. We have former CPAs, former teachers, former attorneys. We have people that have been in other sales roles, other advisor or service roles. We have a handful of people that have owned companies, and we’ve had people that have owned technology companies, healthcare related companies, construction companies.

Colin Carr: We’ve found people that have been successful in other areas of life that are good people, that have a tremendous work ethic, that are very intelligent, that are very savvy and street smart. And then we’ve given them the platform of how to be really good at commercial real estate and how to be really good at healthcare. And then we’ve built a platform where we have several people on staff that all they do is train, and support, and advise. And that’s incredibly unique. I don’t know of any commercial real estate firm in the country that has several people on staff full-time that all they do is answer questions. And so even if we open a new market, no matter what market we’re in or how long that person has been with us, they’re partnering with a senior broker or a managing broker that’s overseeing every transaction that’s involved in every aspect of the deal, who’s been involved in hundreds and hundreds of healthcare transactions. In every aspect of the deal who’s been involved in hundreds and hundreds of healthcare transactions. And so we have a platform and a training system that’s unprecedented that I’ve never seen in any form of commercial real estate.

Andrew Dick: So it’s interesting when we’ve talked before, you said one of the reasons you like starting with someone who hasn’t worked in the commercial real estate industry is because it’s a clean slate.

Colin Carr: Absolutely.

Andrew Dick: You can train them with your values and with your best practices. Talk just a little bit about that.

Colin Carr: Absolutely. Well, as in any industry, there’s really good, and there’s bad examples. There’s great attorneys and there’s bad attorneys. There’s really good real estate brokers and there’s really bad real estate brokers. Real estate’s no exception to that. So we had a desire not to have to undo habits, whether they’re good habits or bad habits. But the reality is the vast majority of commercial real estate brokers are landlord or seller focused. I’ve seen stats that are as low as less than 1% of commercial real estate brokers only do the tenant or buyer side exclusively. I mean that’s extremely niche. So and then to go inside that even further and say, I’m only going to be on the healthcare side of that as well. So only tenant buyers is already a niche. And then getting inside just the healthcare, I mean that’s pretty rare. So we just had the desire to start from scratch and not have to undo the landlord approach or the seller approach. And again, I mean we respect landlords, we respect sellers, but we’re not looking for the next listing. We’re not using the tenants as a chance to set up a lunch with the landlord as soon as that deal is done and ask them if they’re happy with their broker, if they have any other assets that we could list or that we could manage or that we could sell. So our focus is helping our clients get the best terms possible, protecting them. And there’s some conflict that’s inherent with the high dollar negotiation. If your focus as a broker is, I want the landlord to like me so that in the future I have a shot at listing their property or their portfolio, you’re probably not going to get your tenant the best terms possible, you’re probably going to go a little softer or you’re going to compromise a negotiation. And so our model is built on respect. It’s built on trust, it’s built on being an expert. But our focus is helping our clients and protecting them. So not having to retrain that with the broker or have them fall back on getting listings, we just wanted a clean slate to paint from, and it’s worked really well for us.

Andrew Dick: So Collin, now that you’re the CEO of a pretty large operation, how has your role changed? I mean not too long ago you were out chasing deals yourself. You may still do that from time to time, but how has your role changed? What are you doing with your time?

Colin Carr: So first of all, people ask me all the time, are you glad not to be doing deals? And my answer’s no. I love doing deals. I’ve done over a thousand transactions personally, closed transactions, which means I’ve been involved in literally several thousand negotiations. I love doing deals. I love working for clients. I never got tired of it. And I think that’s a testament to why we’ve been successful as well, as us going national or us or me personally having a shift in my day to day wasn’t because we were burned out or because we were looking for the next thing. It was because we loved what we did and we love what we do. So I still help with transactions. I might talk to, I talk to brokers all the time. I’m touching dozens of deals all the time with our team. But the majority of my time is spent training our brokers and training our team, and in growing our brand. I’ve worked with a lot of large groups on a national basis. I do a lot of marketing, I do a lot of brand identification and that I’ve gotten a very healthy education in all the aspects of the company that you would expect if you’re growing national.

Andrew Dick: So looking forward, what type of service lines or industries are you looking at to grow or exploring right now?

Colin Carr: First and foremost, we’re going to stay true to the healthcare tenant buyer only. We’re now in, we’ve got brokers in 35 states. We’re just in our infancy, believe it or not. I mean we can take that wider and deeper and continue to keep on getting better and more proficient in that area. So healthcare tenant buyer rep is going to remain our focus and we are going to keep growing that the best we possibly can. We are doing a lot of senior housing work right now and so we’re going to create a separate division that is just dedicated to the senior housing vertical. There’s a lot of specialization inside that as well with memory care, with skilled nursing facilities. And there’s a lot of things in there that are very specific that go beyond the type of transactions that we do for a physician or for a dentist.

Colin Carr: And so that’s going to be a separate division for us. And then we also are creating another division that is going to be similar to the tenant buyer in healthcare, but it’ll be tenant buyer in commercial. So it’ll be the same focus of, a lot of smaller spaces. 2,000, 5,000, 8,000 square foot spaces for corporations, for commercial professionals. CPAs, attorneys, financial advisors, architects, engineers. And we’re already doing a lot of those transactions. We go and we represent a dentist and she’ll say, “My husband owns an engineering firm, would you help him with his office?” Or we go and do a veterinarian deal and they say, “My wife’s an architect, can you help her with her office?” And so we’re doing a lot of those transactions right now for the same reason, which is, people appreciate the idea of having someone protect their interest beyond their side. And they realize there’s a lot on the line with a commercial real estate negotiation. And when they recognize that someone’s out there that would specialize just on their side of the transaction and help protect them, that’s very desirable for them.

Andrew Dick: So last question. Looking forward, where do you see the company in five years? Are you going to be 200 agents and brokers? 300? I know I’m putting you on the spot.

Colin Carr: Yeah, I think, I mean we’re almost north of 100 right now and will be very soon. We’re very intentional with how we’re growing it. We’re not just trying to add people. If we want to add people, we could literally be at 500 right now. I mean, we’re trying to manage the growth. We’re trying to find the right people. We want people that want to be here for 20 years. And so we’re very intentional with how we hire, with how we train. But yeah, the short answer is I think we’ll probably have, 250, 300 agents. I think we’ll have three or four divisions that we’re focused on. And again, just the commitment and desire to help protect our clients, help them maximize every transaction, help save them dozens of hours of their valuable time. We’re not growing just to grow. I’ve said this for a long time. People say, “Are you growing this to sell it? What’s the next step?” I’m doing this because I love what I’m doing and I believe in what I’m doing. And you could put a tremendously large check in my account tomorrow and it wouldn’t change what I’m doing. It wouldn’t change the house I live in, it wouldn’t change the car I drive. It wouldn’t change the amount of vacation I take. I’ve got a very good balance in my life and I’m doing this because I believe it’s what I’m supposed to do. And I believe that I have the most impact and influence that I can possibly have in the area and the lane that I’m running in. And so you keep doing the best we possibly can to help our clients and add value. And when we do that, there’s a lot of fulfillment and satisfaction that comes from it.

Andrew Dick: Great. Collin, thanks for joining us today on the podcast. Where can folks learn more about you and your company?

Colin Carr: Absolutely. So our website is carr.us. And from there you have a chance to jump into whether it’s senior housing, healthcare, commercial, you can jump into your specific vertical, but that’s a great place to learn about us. And it’s got links to all of our social sites. We’ve got dozens of videos, we have a tremendous FAQ section, a lot of glossary stuff. So if someone’s interested in finding out more about us, they can learn from there. And then we’re big on just putting your money where your mouth is. Again, a lot of commercial real estate brokers, a lot of residential brokers. We’ll go out there and work hard to get a listing and put a sign in front and the phone then rings from there. We hang our hat on every transaction that we do. So we pride ourselves on taking tremendous care of our clients and then that’s how we grow our business. So we have hundreds of testimonials on our website from 1,000 square feet up to 50,000 square foot tenants. From individual location groups to have … from individual locations to groups that have literally a hundred locations. And we can provide hundreds or even thousands of references and testimonials from people that we’ve worked with recently. So our website’s a great place to get more information.

Andrew Dick: Great. 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 Adviser. To be added to the list, please email me at adick@hallrender.com.

Developing a World Class Medical District in Chicago with Dr. Suzet McKinney

June 10, 2019 Andrew Dick Health Care Real Estate Advisor 34:17 Comments Off on Developing a World Class Medical District in Chicago with Dr. Suzet McKinney

Developing a World Class Medical District in Chicago with Dr. Suzet McKinney

An interview with Dr. Suzet McKinney that was recorded in Scottsdale, Arizona at the Health Care Real Estate Legal Summit sponsored by Hall Render. In this interview, Andrew Dick interviews Dr. Suzet McKinney, CEO and Executive Director of the Illinois Medical District. The Illinois Medical District is a 560 acre medical and research parcel located in Chicago that is home to medical research facilities, labs, universities, a biotech business incubator and more than 40 healthcare-related facilities.

Host: Andrew Dick
Guest: Dr. Suzet McKinney

Podcast Participants

Andrew Dick

Andrew Dick is a Shareholder with Hall Render in the Indianapolis office. His practice focuses on real estate transactions and environmental law. He advises hospitals and health care systems around the country on the planning, construction and development of new hospitals, medical office buildings, surgery centers and skilled nursing facilities. 

Dr. Suzet McKinney

Dr. Suzet M. McKinney currently serves as CEO/Executive Director of the Illinois Medical District. The Illinois Medical District (IMD), a 24/7/365 environment that includes 560 acres of medical research facilities, labs, a biotech business incubator, universities, raw land development areas, 4 hospitals and more than 40 health care related facilities, is one of the largest urban medical districts in the United States. 

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 are broadcasting from The Healthcare Real Estate Legal Summit in Scottsdale, Arizona. My guest today is Dr. Suzet McKinney, the CEO and executive director of the Illinois Medical District. Dr. McKinney is one of our keynote speakers at the summit and I thought this would be a good opportunity to take some time to learn more about her career in the Illinois Medical District. Dr. McKinney, thanks for joining me today.

Suzet McKinney: Thank you for having me.

Andrew Dick: So before we jump into the conversation, I thought it might be helpful to give some basic information about the Illinois Medical District or IMD for short. The IMD is located on the West side of Chicago. It is about a 560-acre area of land that is home to medical research facilities, labs, universities, a biotech business incubator, and more than 40 healthcare related facilities. The IMD is one of the largest urban medical districts in the United States. Dr. McKinney, before we jump into what you’re doing at the IMD, tell us a little bit about your background, you have a pretty impressive resume, and how you ended up at the IMD.

Suzet McKinney: Sure. Well, once again, Andrew, thank you so much for having me today. So in terms of my background, I am a public health practitioner by training. I am both masters and doctoral level trained in public health. And my area of expertise in public health is bioterrorism and disaster emergency and response. And so I have spent the vast majority of my career working in that specific area of public health as well as teaching at the University of Illinois at Chicago School of Public Health. And I have a faculty appointment at the Harvard T.H. Chan School of Public Health. I was with the city of Chicago’s Department of Public Health for a number of years, nearly 14 years. And I served as the deputy commissioner of the Bureau of Public Health Preparedness and Emergency Response there. And I loved that role. It was quite possibly, I think my dream job. And really exhilarating and rewarding to know that my responsibility was to mobilize the team that was responsible for preparing the residents of the city of Chicago for large scale emergencies and disasters.

Suzet McKinney: But I have to say in 2014, we were responding to the Ebola response and I’m not sure if your listeners are aware of this, but during the Ebola outbreak in West Africa in 2014 and 2015, the US Department of Homeland Security and the US State Department rerouted all travel from West Africa into the United States through only five cities and Chicago was one of those cities. So that really brought the Ebola response to our front door. And I think we probably spent about a day or two just really under a lot of stress and anxiety trying to figure out our response. And after those initial days, we mobilized and I just said to myself, “This is what we’ve trained for,” even though that was a condition or a disease I should say, that we always imagined was existing in some far away location and that we didn’t have to worry about it in the United States.

Suzet McKinney: Needless to say, we launched our response. It was a successful response, although it lasted a very long time. And when that response ended, I thought to myself, Ebola was the one thing that we were always afraid of. It was the one thing that was never supposed to happen. And I thought that since I had faced the one thing that was supposed to be my greatest fear and I faced it without too difficult of a challenge, perhaps it was time to find a new challenge. And coincidentally, I received a phone call regarding this role at the Illinois Medical District and decided to explore it as a new challenge and something that would place me outside of my comfort zone. And what I would say looking back is be careful what you ask for. So that’s a little bit about how I arrived at the IMD and if your listeners are just wondering what does it mean to be the CEO at the Illinois Medical District? I would tell them that my role there as the CEO is the perfect storm of public health, healthcare, real estate, finance, big business deals, and politics all rolled into one.

Andrew Dick: It sounds fascinating. Give our audience a little bit of an overview of the IMD. I gave some quick facts when we started, but tell us about the history. How did this come to being? And it’s interesting, it seems like it’s almost like a quasi-governmental district of some kind, talk about it.

Suzet McKinney: Well, you’re right, it is a quasi-governmental district. So as you said in the beginning, the Illinois Medical District is a 560-acre special-use zoning district right in the middle of the city of Chicago. We are about 10 minutes outside of downtown Chicago. The IMD was originally established in 1941 through an Act of the Illinois state legislature. And the district was established for the sole purpose of becoming a hub within the city of Chicago that was dedicated to health care, health education, biotechnology and technology innovation with an overarching goal of fostering economic growth for the city, the county of Cook as well as the state of Illinois. So back in 1941, because we were established through an act of the state legislature, we were a component of state government. We functioned just like any other state agency. But in 2012, the state statute was changed and the Illinois Medical District was made to be its own unit of local government.

Suzet McKinney: My General Council says, we are a unit of local government body politic. So all of the lawyers in the audience will understand what that means, but we are a governmental body, but we are a very unique governmental body because I am not an elected official. I am a CEO that’s hired by our board and I serve in that CEO role. But I have many of the same authorities that many mayors and town officials have, such as zoning authority and building authority. And so we function as a very small governmental entity inside the city of Chicago, which is a home rule government and also inside the county of Cook, another home rule government and within the state of Illinois.

Andrew Dick: Wow. So talk about the board of directors. How are these individuals appointed if you’re a quasi-governmental agency, so to speak?

Suzet McKinney: So as I mentioned before, we have an overarching mission of fostering economic growth for the city, the county, and the state. And because of that, our board members are all politically appointed. We have a seven-member board, four of those members are appointed by the governor of the State of Illinois, two board members are appointed by the mayor of the city of Chicago. And then one board member is appointed by the president of the Cook County Board. So it’s a very interesting mix. But I would say that all of our board members typically are appointed because of their expertise in a particular area that’s related to our work or a long-standing history of civic engagement.

Andrew Dick: Wow. Sounds like a dynamic group. How were the boundaries established? I mean, today it’s 560 acres, give or take. Was it always that big or has it evolved?

Suzet McKinney: Sure. In the beginning, it was not that large although I cannot recall how large it was in the very beginning back in 1941. What I can tell you is that in the beginning, we only had two anchor institutions, the Rush University Medical Center, which at the time was Rush Presbyterian, St Luke’s Medical Center, and then the second one was the Cook County Hospital, John H. Stroger, Hospital of Cook County. In 2006, the medical district purchased additional land and we were able to expand our boundaries through the purchase of that additional land. So we’ve been 560 acres since 2006.

Andrew Dick: Wow, that’s impressive. And today there are multiple anchors, right? Are there four or five that you would consider anchors?

Suzet McKinney: Yes. We have four anchor institutions, all of which are world-class hospitals and healthcare centers. So now joining Rush University Medical Center and the Cook County Health and Hospital System is the Jesse Brown VA Medical Center as well as the University of Illinois Hospital and Health Sciences System. Along with those anchors, Rush and the University of Illinois bring their two medical schools, which are two of the largest and most diverse medical schools in the United States. And then the University of Illinois also has within the medical district, all of its allied health schools, dentistry, nursing, pharmacy, and public health in addition to their medical school.

Andrew Dick: So talk about your current responsibilities. You said you act in many ways like a mayor, or so to speak, over the district. What is your day to day activities? What are you doing day to day?

Suzet McKinney: Well, I would say that my activities vary from day to day, but in general, a lot of those activities include governance of the district. So one of the things that we do in terms of governance is ensuring that all of the organizations, businesses and institutions that are interested in moving into the district, that their work and their mission aligns with the mission of the medical district. So we spend a lot of time, I spend a lot of time meeting with potential new residents, if you will, whether those are new hospitals, new educational institutions or other private sector businesses that may want to establish residency in the medical district. I also do a lot with real estate transactions. One of the interesting things about the medical district is that we were recently designated as a qualified opportunity zone and that brought along with it lots of meetings with investors and real estate developers who are interested in taking advantage of some of the tax incentives associated now with qualified opportunity zones.

Suzet McKinney: I also do a lot of work with our hospitals and other healthcare system partners, really looking at community health issues and some of the things that contribute to increased healthcare disparities in vulnerable communities and lower income communities. The medical district is located on the West side of Chicago, which is historically one of the most disinvested and under-resourced communities within our city. And so we do a lot of work around community health programs and trying to improve the health status of residents on the West side of Chicago. And I could just go on and on and on, but those are some of the activities that I engage in on a day to day basis.

Andrew Dick: So when you assumed the role, Dr. McKinney, talk about some of the challenges you faced stepping into that role. I’ve read a couple of articles, but I want you in your words to talk about what you’re up against and really what you’ve done since you’ve stepped into the role.

Suzet McKinney: Sure. Well, I can tell you one of the things that I always go back to when I think about challenges, when I initially stepped into the role, and I go back to a conversation that I had with our general counsel at the time, and I asked him, “What do you think the largest challenges are that the medical district is facing?” And he said to me, “Two of our largest challenges are anonymity and funding.” And with the first one, anonymity, that challenge was just the simple fact that not a lot of people knew about the medical district. They didn’t know what we were, where we were, or what we did. And so, one of the initiatives that we’ve engaged in since I started my tenure there three and a half years ago, we engaged on an aggressive rebranding campaign and marketing campaign to really raise the profile of the medical district. That included developing or solidifying our mission and vision statements, developing a new logo and marketing campaign that aligned with the mission and the vision.

Suzet McKinney: But then also really just getting out there and being more public facing, talking about the work that we were doing, the work that we want to do and establishing greater partnerships with natural partners as well as with strategic partners. On the issue of funding, we are a government entity, however, we do not obtain government funding from any other government entity. Instead, we generate our revenue through our real estate activity. So we really had to get ourselves out into the forefront of the commercial real estate market. And in order to do that, we partnered with a very large commercial real estate firm. It’s actually the largest commercial real estate firm in the world and engaged in a strategic partnership with them as well as a contractual relationship to assist us in raising our profile in the commercial real estate market. I would also say another area that posed an extreme challenge to us was just in the area of financial stability.

Suzet McKinney: I mentioned previously that we purchased a lot of land in 2006 and expanded our borders, but when that land purchased, the goal was to also develop that land. But shortly thereafter, the real estate market crashed and that new development wasn’t possible and we had borrowed $40 million to purchase new land and expand our borders. And so we were still challenged with a heavy debt load without a revenue source to sort of balance that out. And so I’m very happy to say that we doubled down on developing a strategy for repaying the debt. It took us two years, but we are currently debt-free, which I don’t think many government entities can boast that they are completely debt free. So that was really exciting for us and it represented alleviating one of the largest challenges that the medical district has ever faced. And so I’m very proud that that was accomplished under my leadership.

Andrew Dick: Well, I read a couple articles about that and I was hoping you would talk about it because you received quite a bit of public acclaim because you, I think sold off some assets or some real estate to pay down that debt or pay it off and a number of news stories just said, “Gosh, Dr. McKinney has really turned around this organization and made it so much more prominent.” So that’s just terrific.

Suzet McKinney: Thank you.

Andrew Dick: I want to talk a little bit about generating revenue through real estate. Most of our listeners are attorneys or developers that develop hospitals or healthcare facilities. When you say the medical district generates revenue through real estate, is that through developing a building and being co-owner, ground leasing land, selling land, all the above, what does that mean?

Suzet McKinney: All of the above. So of the 560 acres that make up the medical district, the Illinois Medical District owns roughly 100 of those acres and most of our anchor institutions own the land that they occupy, but they also lease additional land or building space from us. So we engage, we being the Illinois Medical District, we engage in ground leases, both short term ground leases as well as longterm ground leases. We also lease building space to entities and organizations that are interested in moving into the medical district. And now we are engaged in an aggressive plan to develop the remainder of the over 30 acres of vacant land that we still have in the medical district. And one of the things that we’ve done now that we have a level of financial stability and quite frankly liquidity that we haven’t had in the past, we’re also able to engage in some more alternative real estate transactions. So that would include things like public-private partnerships or joint ventures. And so we are exploring a number of options with a few developers currently that would get us engaged in some of those more alternative structures.

Andrew Dick: Yeah. It sounds like a pretty dynamic role that you’re in working with the developers and different healthcare providers. What I often get asked is, well, if I’m interested in developing a project at the IMD, well, how would someone do that, Dr. McKinney? If they say, “Hey, I’ve got this vision,” is it developers coming to you or are you really seeking the resident first, some academic institution or a healthcare provider or a life sciences company, is that first the most important piece, who’s going to be the resident? Or how does it work?

Suzet McKinney: Well, it works primarily the same, whether it’s the resident or the developer. And typically what happens, let’s just take the case of the resident. The potential resident may call the office or send us an email and indicate their interest in having a development in the medical district or occupying space in the medical district. And once we receive that communication, however, it comes in, we schedule a time for the resident to come in and present their project or their idea to us. One of the things that we’re very proud of is that as a unit of local government that is not a component of another unit of government, we’re able to have a little more flexibility and a more nimble structure in terms of how we engage in procurement activity and contracting activities. And so that really helps us when we are entertaining a new project.

Suzet McKinney: So once that resident comes in and presents their project to, not just me, but my senior management team as well, we have an internal discussion regarding what we’ve seen in the proposal and we make a decision as to whether or not we feel that it’s a project that would not only benefit the medical district but would also benefit that potential resident. And if our determination is positive, then we will put that resident in front of our board and we’ll bring them back and give them the opportunity to present their project to our board. Now one of the things that my board is well aware of is that I will never put a project in front of them that I don’t believe is a viable project for the medical district. Whether the viability is programmatic, financial, or any other lens that you may examine the project through.

Suzet McKinney: And once the resident presents their project to the board, the board decides whether or not to advance them forward. And if so, there is a brief review of the financials of the project and then the board authorizes me and my team to engage in the contract negotiations. So the entire process takes about three to four months, which is very fast.

Andrew Dick: I would say it’s very fast given my experience on these type of deals. So are there any projects you’re excited about that you can actually talk about at this point?

Suzet McKinney: Yes, I am very excited, one of the things that we are endeavoring to do, we’ve done a lot of work studying other innovation districts from across the country. We take our cues from a lot of work that the Brookings Institution has done around innovation districts and we’ve really tried to hone in or what factors make these districts successful because after all we’ve achieved a level of success but we want to continue that trend in the Illinois Medical District. So the vast majority of the vacant land that we have in the district currently, I would say about 35 acres is contiguous land. And so we are endeavoring to create a life sciences innovation park within the medical district that can be home to research entities, start-up companies, expanding our biotech incubator as well as infusing some residential and some retail and amenity space in the district as well.

Suzet McKinney: And so we are currently engaged in discussions with three to four developers that have well-defined projects that they’re interested in developing in that area, and we’re being very clear about this goal for life sciences. It is an area where Chicago is really lagging behind other cities. And I will tell you, I am a true Chicago in at heart and I cannot bear to see my city lagging behind others. And so we know this is an important initiative for the city, but it’s also, it’s an important economic driver as well. And we’ve seen evidence of that across the United States and we think that we can replicate it in Chicago and have a similar level of success. And so that’s what we’re doing.

Andrew Dick: So life sciences is hot right now?

Suzet McKinney: Yes.

Andrew Dick: So is it, not only because it’s used to talk about the economic drivers, is it that it’s bringing in high paying jobs? What is it that you like about the life sciences sector right now?

Suzet McKinney: Well, I like that it brings in high paying jobs, but I also like that it attracts young, new talent coming out of our country’s largest universities. And it also engages researchers. And I see that our health care partners, particularly our anchor institutions, are increasing their research efforts. There is a lot of momentum around translational research, really taking the research and translating that into clinical practice as well as engagement, greater levels of engagement with the patient. And so I think that life sciences is a great fit for those types of initiatives. And our university, the University of Illinois at Chicago also has a keen interest, not only in research and biotechnology, but attracting the best and the brightest talent both in terms of students and graduates, but also professors. And so I think you’re right, life sciences is hot and those are some of the things that I think align very well with our mission, but also with the mission of our anchor institutions and some of our other partners.

Andrew Dick: So you touched on maybe bringing in some multifamily into the mix. Talk about that a little bit. So it’s not just going to be office space or healthcare clinical space or research space, but you’re going to try to infuse maybe some more mixed use. Is that what I’m hearing?

Suzet McKinney: Absolutely. Our goal is to create and foster a vibrant ecosystem, a place within the city of Chicago where people want to be. And we see a place where people can live, work, learn and play. And so in order to foster that type of environment, we have to ensure that we are doing multiuse developments. So again, the office space, the laboratory space, but also the residential, some recreational. If your listeners go to our website, under the real estate tab there’s a great video that really shows the vision and what we foresee for the medical district. So we want to bring in some entertainment as well to really make the district a place that can be a place for everyone, whether you are traveling to the district to work, to go to school, to receive your healthcare or if you’re living there. So we’re very excited about that.

Andrew Dick: Well, one of the other topics I wanted to talk about was the strategic partnership that the IMD entered into with IGNITE Cities.

Suzet McKinney: Yes.

Andrew Dick: Talk about that just a little bit and what that means for the district.

Suzet McKinney: Sure. So IGNITE Cities came to our attention several months ago. And in our discussions with the firm, we learned that they are working with mayors from all across the country to help cities develop into smart cities. And so we started thinking what would it be like if we entered into a strategic partnership with IGNITE to create or foster the medical district into a smart district? What would that look like for us? And one of the things that we knew was that place-making and way-finding were challenges within the district. We see about 80000 people a day in the medical district, that includes 30000 employees, and 50000 patients, students, and visitors. But a lot of those visitors oftentimes and patients as well, oftentimes have difficulty figuring out where they need to go within the district, how to get there. And so this strategic partnership with IGNITE will not only incorporate some infrastructure improvements in the district, things like way-finding, whether those are kiosks or large touch screen panels that are installed at street level that will aid in that way-finding. But it will also include some fiber optic infrastructure.

Suzet McKinney: We will be able to provide free public Wifi for visitors and others who are in the district for whatever reason they might be there. But it will also enable us to connect with city services in a way that we haven’t been able to do in the district and help improve safety within the district. And also transportation, helping people understand when and where they can access the transportation assets that are in the district. So we’re really excited about it. This is an initiative that we see big cities doing. And so we think that being a small district within a big city, this is our opportunity to show that this is something that can work for other campuses, whether they are innovation districts, college and university campuses, or other large healthcare and research clusters. So we’re all about being a leader but also being a model and showing what can be done in other areas by using ourselves as a pilot.

Andrew Dick: Well, it’s fascinating. I think what you’re doing at the IMD is really interesting and as we wrap up here, talk just a few minutes about where you see the IMD going over the next five years. If you could have it your way, how do you think things will unfold over time?

Suzet McKinney: Well, if I have it my way, in five years we will no longer have the abundance of vacant land that we currently have. We are really dedicated to creating this vibrant and thriving ecosystem that I spoke about. And so what I see for the medical district is a fully developed district that is full of healthcare, science, and technology-based businesses, but businesses that also have a caring heart and a sense of social responsibility. In the private sector, the term that’s always used is corporate social responsibility. But as I mentioned earlier in our discussion, we are situated on the West side of Chicago and that’s an area of the city where we see a lot of disparity in terms of healthcare outcomes, healthcare access, but also educational access and just economic opportunity.

Suzet McKinney: And so as we attract private sector businesses to the district, we are being honest and forthcoming about some of those social challenges that we see in the area of the city that we occupy. And we are asking the new residents of the district to partner with us to really help us make a difference in the lives of others. And so I see that in the district’s future, but I also see the district as a place where the businesses and the organizations that reside in the district having understanding that while we all want to be successful individually, the real key to our individual success is our collective success. And so we are endeavoring to create a district where our partners collaborate with one another and we are all improved in our work, our businesses, and even our bottom lines are improved because of this incredible collaboration that we foster in the medical district. So we’re very excited about the work. We have achieved some success. And if I can just take a moment, I’d like to give you an example of one of our partners who is relatively new to the medical district.

Suzet McKinney: It’s a company called Superior Ambulance Company, and they are the largest private EMS provider in the Midwest. They’re headquartered just outside of the city in the western suburbs, but they were interested in establishing a presence in the district and when they came to us and we started working to negotiate a building lease for them, I spoke to the CEO about some of the challenges that we’re seeing on the Westside, and I said, “I’m trying to do everything that I can to help get people into educational programs that will put them on a pathway to employment or funnel them right into the workforce. Is there anything that you can do to help me?” And he said, “Here’s what I can do.” He said, “In my first year in the medical district, I will train 100 community residents to be emergency medical technicians or medical billing and coding specialists. And for every single one who completes their training, I will hire them to work from my company.” He’s been in the district, his company has been in the district now for eight months. They have trained and hired 103 community residents.

Suzet McKinney: So that’s a huge success. Now we are under no illusion that the next company or firm will have a hundred spaces to give us, but my outlook is if they have one or two, that’s one or two more than what we had and that’s a difference in one or two additional lives. And so that’s the type of impact that we’re looking to make. And we think and we hope that we can do it.
Andrew Dick: Well, it’s exciting. I’m grateful that you were willing to do this interview, really looking forward to your speech this afternoon.

Suzet McKinney: Thank you.

Andrew Dick: Where can our listeners find more about the IMD? More about you?

Suzet McKinney: Sure. So the listeners can always go to our website, which is medicaldistrict.org spelled just the way it sounds, medicaldistrict.org, and they can also access any of our social media platforms. We are on Facebook and LinkedIn @Illinoismedicaldistrict. Our Instagram handle is @IMDmedia, and we can also be found on Twitter @IL_MED_district.

Andrew Dick: Well, thank you again, Dr. McKinney and thanks to our listeners. 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 that newsletter, please email me at A-D-I-C-K@hallrender.com.

Credit Tenant Lease (CTL) Financing with Andrew Minkus

May 16, 2019 Andrew Dick Health Care Real Estate Advisor 41:11 Comments Off on Credit Tenant Lease (CTL) Financing with Andrew Minkus

Credit Tenant Lease (“CTL”) Financing with Andrew Minkus

An interview with Andrew Minkus from Mesirow Financial: In this episode, Andrew Dick interviews Andrew Minkus, a Managing Director with Mesirow Financial. Mesirow Financial is one of the leading investment banks in the country with deep expertise placing debt for CTL transactions.

Host: Andrew Dick
Guest: Andrew Minkus

Podcast Participants

Andrew Dick

Andrew Dick is a Shareholder with Hall Render in the Indianapolis office. His practice focuses on real estate transactions and environmental law. He advises hospitals and health care systems around the country on the planning, construction and development of new hospitals, medical office buildings, surgery centers and skilled nursing facilities. 

Andrew Minkus

Andrew Minkus is a managing director in Mesirow Financial’s Credit Tenant Lease and Structured Debt Products group. He is responsible for originating and structuring senior and mezzanine debt capital primarily for clients that own commercial real estate involving strong underlying credits. Andrew also specializes in structuring public private partnership “P3” transactions along with other public sector related CTL’s.

Andrew Dick: Hello and welcome to the Healthcare Real Estate Adviser podcast. I’m Andrew Dick an attorney with Hall Render, the largest healthcare-focused law firm in the country. Please remember the views expressed in this podcast are those of the participants only and do not constitute legal advice. Today we will be talking about a unique way for healthcare providers to finance sale leaseback transactions, and build the suit facilities using credit tenant leases or CTLs for short. CTLS have been around for a while, but are becoming more popular in the healthcare industry. Typically, health care providers seeking CTL financing will hire an investment bank to assist with the structuring and placement of the CTL bonds. Mesirow financial is one of the leading investment banks in the country with deep expertise placing debt for CTL transactions. Today we will be talking with Andrew Minkus, a managing director with Mesirow financial.

Andrew, thanks for joining me.

Andrew Minkus: Yeah, thanks for having me. Glad to have the opportunity to participate.

Andrew Dick: Andrew, before we talk about CTL transactions and Mesirow financial, let’s talk a little bit about your background. You’re a Midwest guy with an undergraduate and graduate degree in finance. Early in your career, you worked for Newmark Realty Capital. Tell us a little bit about what you were doing there.

Andrew Minkus: Yeah, sure. So Newmark is, I guess we would call it a full service commercial mortgage banking firm. I spent about five years there. My primary responsibility was originating conventional commercial real estate debt associated with a wide range of commercial real estate projects, but I would say primarily four food groups, retail office, multifamily, industrial. I would say much of that debt work was placed with the company’s life insurance company correspondence. But we also originated a lot of CMBS and bank executed product as well as a little bit of hard money in bridge. So that’s what I did at Newmark.

Andrew Dick: So after Newmark you made the move to Lake Shore Management and tell us a little bit about your role there.

Andrew Minkus: Yeah, so upon relocating back to Chicago in roughly 2010 I was introduced to a local Chicago private equity shop called Lake Shore Management. Lake Shore Management is in the manufactured home community business, which is a fancy term for mobile home parks. That’s their asset of choice. They own and operate a significant portfolio of said manufactured homes. And my job there was primarily to … responsible for structuring, sourcing and doing a variety of ad hoc due diligence associated with new acquisitions. And then in addition to that, I was also responsible for a variety of just general asset management responsibilities that go along with just managing the overall performance of the portfolio.

Andrew Dick: And Andrew, after you worked at Lake Shore for awhile, you made the move to Mesirow financial where you’re currently at in Chicago. Talk a little bit about that transition and how you were introduced to Mesirow.

Andrew Minkus: So the gig at Lake Shore was actually an interim role. I was plugging a hole due to some abundance of work at the time. And I could see that role was quickly becoming a permanent role. And it was at that same time that actually the gentleman that I worked for in San Francisco at Newmark had introduced me to my current division head. They had met at a conference and we hit it off and he had just started up the group here at Mesirow. I was quickly fascinated with the opportunity. I could tell that this opportunity at Mesirow was an opportunity to just touch so many different segments of the market. This job here is really a job in real estate. It’s a job and structured finance. It’s a job in public finance. It’s a job in corporate finance. So it really has just many interesting tenants to it. Yeah, that’s why I made the leap over to Mesirow. So that was back in July of 2010.

Andrew Dick: And tell us a little bit about Mesirow, its history and the scope of services offered by the company.

Andrew Minkus: So Mesirow is a diversified financial services firm. We’re segmented into two main divisions. We’re an investment management, asset management house on one side and a capital markets investment banking on the other side. We’ve been around since 1937. We’re headquartered here in Chicago. We’ve got about 20 offices scattered across the country. A couple of international offices as well. Culturally we operate like a family office. We’re private. We’re 100% employee owned. We always have been.

Andrew Minkus: I think currently we’ve got about 16 sleeves of business, many of which are highly complementary to one another. I’ve been at Mesirow for coming up about nine years. I work in the credit tenant lease and structured debt products group. As part of the leadership team here my role is origination, structuring, debt placement, bond debt placement. We originate and structure a lot of conventional CTL debt and we also spend a lot of time with a variety of other structured products such as CTLB notes and rated bifurcated ground lease financings, and ad hoc project finance situations. We securitize special tax district work. We’ve done a little bit of asset-backed securities work. And a couple of years ago we also started a little side initiative which we generically refer to as our P3 initiative. It’s actually refer to as our infrastructure and project finance group. I’m part of the committee there. And as a result, I guess I pay a particular focus to transactions, CTL transactions and the like that have an element or touch the municipal space, the higher education space, the healthcare space and that sort of thing.

Andrew Dick: And one of the reasons we wanted to talk with you today is because of your deep expertise in CTL transactions and Mesirow’s reputation in the industry as being one of the leaders in terms of facilitating CTL transactions. Tell us a little bit about Mesirow’s CTL expertise and how many people are in the group and give us a little bit more detail on, on that.

Andrew Minkus: The CTL product has been around for probably 30 to 40 years, but I will say the business has evolved tremendously over that period of time. Back in the day we invite, we, not necessarily me, but some of the older generation, spent a lot of their time doing a lot of retail transactions. Walgreens and CVSs, and bank branches and things of that nature. It was a fairly commoditized asset class and not very unique in terms of structure and I think that’s how the business picked along for probably 20, 25 years. But over the last 10 years it’s evolved really away from retail for a lot of obvious reasons and more into dealing with government credits and project finance and corporate office facilities and facilities leased to municipalities and P3-type project.

Andrew Minkus: And the other thing that’s been interesting just from a development perspective is the asset class has largely ignored real estate. Going back 30 40 years, I would say over the last 10 years, we’ve started to ignore that fact and we’ve started to pay quite a bit of attention to real estate when and where applicable. And we started to do some really unique things and solve some really unique problems that historically nobody really had a solution for. So it’s been a fun and interesting evolution.

Andrew Minkus: But when we started the group, there were three of us originally. We’ve got about 10 now. We did a little over two billion dollars in production last year, which is a number we’re pretty proud of. I guess by way of production volume that does put us as the largest CTL group in the space. And I think I would attribute a lot of that success to the fact that we run a different business model here.

Andrew Minkus: Just being a full service investment bank we have some really unique and complimentary capabilities at Mesirow. We’re known on the street for being a bond house. Fixed income is one of the big drivers of our firm and we’ve spent a lot of time and resources to build up our distribution platform, what we would call our sales and trading force. And we’ve developed unbelievably deep relationships within the QUID marketplace. QUID was an acronym that stands for qualified institutional buyer. So we just have access to a lot more capital. We’re closer to the money than any of our competitors. And we also do a lot of regular way fixed income business that we really have our hand on the pulse of the market far more so than a lot of our competition. We’re also very creative, structurally speaking.

Andrew Minkus: We talked a little bit about the various internal resources here. We’re all so very big in public finance and there are a lot of synergies and correlations between what they do in that department and what we do in our department. And in many instances we’re melding our capabilities personnel to pursue transactions.

Andrew Minkus: And then the other thing that’s nice and unique about Mesirow is we have a balance sheet and we’ve got a lot of great support from the firm and we have access to firm capital to help support some of these CTL situation. So that’s a rather unique element just looking back at the business model.

Andrew Dick: Well Andrew, what I’ve learned over the years is that the CTL space is very … it’s a small group of of folks that work on these transactions and there isn’t a lot of information out there if you search the web. And so for our listeners, talk a little bit about what is a credit tenant lease and what makes it unique when you compare it to a traditional mortgage loan, for example,

Andrew Minkus: Unlike a traditional mortgage loan the primary underwriting consideration for a CTL is that of the underlying credit quality of the tenant or the underlying user, as opposed to with a traditional mortgage loan the primary underwriting consideration or the real estate fundamentals and the local real estate metric. CTLs, holistically, are priced and treated and structured more akin to that of an investment-grade rated corporate bond or an investment-grade rated municipal bond as opposed to, say, a mortgage investment.

Andrew Minkus: There’s a unique set of guidelines and principles that govern what we do and how we structure these bond transactions and some of those parameters are fairly unique. Again, compared with that of a traditional mortgage. So for example, some of these unique parameters would include things such as, we can underwrite down to a one-owed debt service coverage. We can underwrite up to a 100% of value. If it’s a construction project, we have no loan to cost basis constraints per se. These instruments are typically fixed-rate. They’re long-dated. I mean, we could go out 40, 50 years if we like the asset enough. So for these types of reasons, it allows us to produce some really efficient results, some really unique results compared with a traditional mortgage loan for the various transaction participants. But really the conversation centers wholly around, at least it starts and predominantly centers around underlying credit quality rather than the real estate. The real estate of the secondary consideration.

Andrew Dick: And you talked a little bit about some of the loan to value considerations that that would be involved in a mortgage loan transaction, but on a CTL there are scenarios where you could loan more than 100% of of the project costs, for example, in a new construction project. Right? I mean is is there a limit on how much these a CTL lenders will actually loan on a particular transaction?

Andrew Minkus: I would say the outside constraint is really on value much more so than loan to project costs. So the answer is really no when it comes to loan to project costs. We don’t have sensitivities about cash out financing and or how that capital is going to be applied to the operation, as opposed to a mortgage investor that’s going to probably be highly sensitive to those types of parameters. So if the economics are such that it produces a result that is equal 150% of project costs, let’s say for example, we will lend 150% of project cost so long as it meets the rest of the guidelines and principles that we have to meet.

Andrew Dick: What are some of the other benefits, Andrew, to the CTL structure? For example, is it possible to get a fixed rate lease rate for the 20 years, for example, which is almost unheard of in the traditional financing market and it seems like you can lock in a really attractive interest rate for a long period of time. Am I thinking about this correctly?

Andrew Minkus: Yeah, I couldn’t have said it any better. I think that’s one of the primary benefits to the key transaction participants. It’s really an exercise to come up with the most favorable constant, whether it’s a lease constant or a debt constant. Even if we’re backing into a rent constant that highly exceeds that of, quote unquote, market rent, given the local real estate parameters, that’s not something we’re going to be particularly sensitive to. I would say were largely ambivalent to that. I

Andrew Minkus: If it’s just a means of getting a more attractive attachment point, in other words, producing an unconventional amount of leverage, but the underlying user, then that’s what we’ll do. Or contrary to that, it can work in the opposite way where the goal might be to get the rent constant down as low as possible, and perhaps the underlying user is only looking to raise enough money to build the project, which might be far less than market value. This would be an excellent opportunity to do that. And all of the product is long-dated and it’s all fixed-rate. So really the longer the better in our universe.

Andrew Dick: And when we think of credit tenant leases I almost always think about a tenant that has an investment-grade credit rating. Talk a little bit about the underwriting requirements for a CTL. Do we have to find a tenant that has an investment-grade credit profile or can we go out and get a credit rating? How does that work?

Andrew Minkus: Yeah, a couple of comments. That’s a really good question actually. I would say that’s one common misconception in the space, but let me start by saying a common misconception in the space. But let me start by saying the typical credit profile, yes, it’s of investment-grade quality, although there are a handful of exceptions to that. So exception number one, we’ve done a handful of what we would call high yield CTLs or NEIC-3, NEIC-4 type CTL products. Now the appetite for that paper is entirely different. It speaks to a completely different audience and those deals take on a completely different shape and color, but it’s not necessarily threshold in nature if you have a slightly weaker credit.

Andrew Minkus: But even stepping aside from that, and not a lot of people realize, there’s a lot of great public and private credits out there that aren’t rated. And just because of these credits or these entities or these municipalities or healthcare systems don’t carry a credit rating, that doesn’t mean they don’t have good credit considerations.

Andrew Minkus: So in many instances, we’re able to involve a rating agency in the process and we’re able to rate the CTL transaction itself, not to be confused with the underlying credit. Yes, that’s the primary criteria for coming up with a result, but it’s the transaction itself that’s getting rated and in doing so, sometimes we can even generate a rating elevation above and beyond the underlying credit of the underlying user. Because the transaction rating takes into account two things. Number one, the credit support for the transaction as well as the real estate support, which is a naked CTL. We’re not really taking into account the real estate, at least from an NEIC perspective.

Andrew Dick: Andrew, talk a little bit about NEIC and what that means. So, it’s my understanding that those are guidelines used by the insurance industry. So for example, if a life insurance company wanted to make a CTL loan, they would be subject to those guidelines. Is that right?

Andrew Minkus: Yeah, it’s the risk capital charge designation that that’s referring to. So there’s a scale between one and six, one being the lowest designation, which carries the lowest risk capital charge, six being the highest designation, which carries the highest risk capital charge. The NEIC concept really only applies to US-based Life Insurance Companies, which happen to be the primary audience for this asset class. But yeah, when a US Life Insurance Company purchases a CTL asset or any fixed income asset, it does receive NEIC designation treatment. So the lower the risk capital designation, the more attractive the asset is to the investor. In other words, the more competitive the interest rate’s going to be.

Andrew Minkus: Because it dictates how much capital they either have to, or don’t have to, keep dry on the balance sheet. And the idea is to not keep dry powder on the balance sheet because that money just sits there and it doesn’t get deployed. So typically NEIC-1 and NEIC-2 are the two characterizations that refer to an investment-grade rated asset. So anything in the A category… A, double-A, Triple-A… would typically fall into the NEIC-1 bucket and anything in the triple-B category would fall into the NEIC-2 buckets.

Andrew Dick: So we’ve talked about life insurance companies making CTL loans or purchasing the loans. Talk a little bit about the other types of companies that would make a CTL loan or buy a CTL loan beyond a life insurance company.

Andrew Minkus: So in addition to LifeCo, Pension Money finds this asset class pretty attractive. We’ve sold and distributed a handful of product to various bond funds and mutual funds, alternative asset managers. There’s a good bit of religious money out there that finds these assets pretty attractive. And then some of the structured product vehicles that might be situated next to a conventional CTL or maybe underneath in a subordinate capacity, those types of instruments have broad appeal within the hedge fund community as well. So yeah, it’s not just the life insurance companies that are taking this product down and parking it in their portfolio.

Andrew Dick: And on the other side of the table, who are the typical tenants? We’ve talked about municipalities, non-profits. Most of our audience, they’re going to be healthcare providers or folks who develop healthcare facilities. Talk a little bit about who the borrower or the tenant could be in a CTL transaction.

Andrew Minkus: Yeah. In terms of the underlying users, like I was saying, this business has evolved quite a bit over the years, but I would say the lion’s share of the product that we see and that we’re involved with today, is going to involve of course healthcare systems. I would absolutely put that sector at the top of the list, just given a lot of the trends in that space right now. Any number of good corporate credits, whether it’s a tech, a Pharma, you know, we do quite a bit with the auto sector in Michigan for example. We financed a lot of headquarters assets for a couple of insurance companies, a couple of healthcare credits, Unilever, Verizon, companies like that.

Andrew Minkus: Higher education is another sector that’s picking up quite a bit of steam and starting to generate an appreciation for what we do in the financing space, whether it’s a student housing facility or a classroom or administrative facility. Non-profits are potential good candidates. Research institutions. Cultural institutions. Governmental entities, of course. Local governments, regional governments, state governments, and really anything that takes on that P3 profile. P3 meaning Public, Private, Partnership.

Andrew Dick: And talk a little bit about how a healthcare provider could use the CTL structure. When I’ve worked on these transactions, we’ve primarily use the CTL structure for build-to-suit medical office buildings, for example. A $30 million medical office building that will be a master leased to a non-profit healthcare system that has a double-A credit rating for example. But a CTL transaction could also be used for a sale lease-back. I mean, talk a little bit about the scope of transaction structures that you’re seeing in the market.

Andrew Minkus: Yeah. So there really are no limitations to your point in terms of transaction structure as well as product-type. So we’re involved in many transactions that involve the sale and lease-back of an asset. We do a lot of build-to-suit work. We finance a lot of facilities that are just getting renewed. So a straight recapitalization we would call that. Also a lot of just organic acquisition work and again, the instrument can be applied to any product-type. A headquarters, an auxiliary medical office building, a hospital, a central plant, a utility plant that’s servicing a healthcare campus, a data center. We don’t even necessarily need hard collateral per se. So for example, we finance tenant-improvement leases, with essentially no real property, for example. A licensing agreement, things of that nature. So again, the scope is fairly broad in terms of just the application of the product.

Andrew Dick: Andrew, when I think of CTLs, I think of a larger transaction, 30 million plus. Is that a misconception or when does it make sense to use a CTL? What is the smallest CTL you’ve worked on, to the largest, for example?

Andrew Minkus: Yeah, good question. I think I’d relegate that into the misconception category as well. So I mean, look, I don’t run around the country mentioning this… although maybe I do now that I’m on the podcast… but the smallest transaction we’ve ever done has been south of 2 million bucks. So I would say our sweet spot is probably in the $25 to $300 million range. The largest transaction that we’ve put together is a little bit north of $650 million. We have two 10-figure assignments that we’ve recently been mandated on. So there’s really no limitation. We try not to let our egos get in the way if it’s a nice clean piece of business. We’re happy to have it, even if it’s a small transaction. But also if it’s a substantial transaction, we certainly have the capabilities to handle that as well.

Andrew Dick: Great. And talk a little bit about how some of the CTLs are structured in terms of the amortization schedule. I’ve seen CTLs where the lease is fully amortizing, meaning that at the end of the 25-year lease-term, the asset is effectively owned by the tenant. But I know that there are ways to structure CTLs where they may not be fully amortizing. So talk about that structure in general.

Andrew Minkus: Yeah, so I touched a little bit in the beginning just about the general evolution of the space and the business. And the direct answer to the question, which we get quite often, is “Do CTL loans need to be fully amortizing?” The answer is a resounding, “No.” Now having said that, the conventional guidelines, that guide what we do and how we do it, technically require a conventional CTL to self-liquidate. Or have a balloon not to exceed an amount equal to 5% of initial par. However, there are many ways to extend the amortization now. So historically that didn’t really happen very often. There’s a synthetic insurance product called Residual Value Insurance and/or Balloon No Guaranteed Program that’s been around for some time, but never really utilized in a very meaningful way.

Andrew Minkus: But in addition to that, that’s really why we started this Structure Products Initiative about four years ago and we’ve underwritten a little over 4 billion within that initiative and the best way to think about it as a basket of solutions that allows us to provide for extended amortization. And we do this by way of structuring Pari Passu A2 notes and Zero Coupon B notes and Pick Bonds and Residual Certificates and all sorts of more esoteric, creative structuring work. They’re really hybrid securities that are supported with both good credit during the lease term as well as some real estate.

Andrew Minkus: I talked a little bit in the beginning about how the industry largely ignored real estate for many, many years. We’re no longer ignoring real estate, when and where applicable, and these types of structures can serve a variety of different benefits really. They can of course be used to produce more leverage. They can be used to produce more cash-flow. They can be used to ratchet-down a rent constant. They can be used to produce, in some cases, a more favorable tax outcome. So and/or any permutation of those potential benefits. So it’s been just a really interesting trend and development in this space. As I say, when and where applicable.

Andrew Dick: Andrew, over the years when I’ve worked on CTLs, some of the healthcare providers that I represent will insist upon a purchase option at some point during the term of the lease. Maybe it’s in year 10 or 15 if it’s a 25-year CTL. I know that sometimes those can be challenging to structure. Talk about purchase options in CTL transactions. How are those viewed in the market and how do you set those up from your perspective?

Andrew Minkus: So I think you’re right to suggest that purchase options can introduce some challenges. They’re not easy to structure around. I guess the best thing I would say is they need to be thought through carefully up-front. And there are different ways to structure around a purchase option. I think a lot of it hinges on the relationship between landlord and tenant, assuming they’re unaffiliated. That’s not always the case, right? Perfectly fine if they’re affiliated entities. That’s more of a synthetic arrangement, but I think we need to just appreciate perpetual ownership versus tenant reversion. What happens to the asset at the end of the term? Who is the beneficial user?

Andrew Minkus: I think the cleanest way to deal with purchase options, at least when you have two unaffiliated parties on each side of a lease, is if the purchase option carries an obligation by which the buyer or tenant is obligated to assume the existing debt, if they can’t come to an agreement on the purchase price economics that allowed the debt to be satisfied, paid off, albeit with [inaudible 00:12:28], then they get the right to assume the existing debt package. Which is not necessarily a bad outcome because we’re putting together some pretty efficient and pretty attractive financing, at least we would humbly think. That’s probably the easiest and cleanest way to deal with a purchase option.

Andrew Minkus: Now that introduces all sorts of privity into the loan documents. Again, that’s why you really have to appreciate the relationship up-front. How open-book is the relationship… which I realize is a topic maybe we’ll touch on a little bit later… but absent the ability to do that, what we would be forced to do is structure call optionality into the debt instrument to mirror that of the purchase optionality under the lease.

Andrew Minkus: That’s not an insurmountable hurdle. It’s a more challenging hurdle. It’s a less efficient hurdle. Call optionality can be very expensive. Which kind of ripples through the entire structure and it’s going to impact the landlord’s economics and of course it’s going to impact the tenants economics. So I think some of the considerations there are, you got to think about how we’re going to structure the call option. At what point in the structure does that call option and corresponding purchase option come into play? Is it a one-time right? Is it an ongoing right? Of course, the further down the road you introduce that purchase option, the more favorable the economics of that purchase option are going to be. If you’re looking at a 25-year term and there’s purchase option risk within five years, somewhere close to par, that’s going to be a very, very expensive endeavor.

Andrew Minkus: So economics is one consideration. There’s also a consideration of familiarity. So CTLs are primarily structured on a taxable basis. Not always. They can be structured on a taxable basis, not always. They can be structured on a tax exempt basis at times as well. It depends on where we’re distributing this debt instruments. So if we’re distributing the debt into the taxable corporate muni market, I would say generally there’s less resilience to absorb call option risk in a transaction. Whereas the tax exempt, like the classic muni market, they’re probably a little bit more resilient to call optionality at various points in the structure. So I think how the deal is structured, what the plan of finance is, where we’re planning to distribute the instrument all comes into play. It’s really just a long way of saying, “It’s absolutely not a threshold issue, but it’s a significant consideration and it can introduce some challenges.” But usually it’s just a challenge that can be overcome with economics. That makes sense?

Andrew Dick: It does. It does. That’s helpful. One of the questions I get from my clients is, let’s say it’s a larger health system with multiple hospitals, they’re working on a medical office building transaction, build to suit. One of the questions I would get is, “Well, why wouldn’t the health system just issue bonds and then take the capital and use it to build the medical office building?” It seems to me, Andrew, that that the CTL is designed so that the health system, for example in my world, wouldn’t have to go through a bond issue. It’s a simpler approach for one-off transactions, for example. Am I thinking about that the right way?

Andrew Minkus: Yeah, I would fundamentally agree with that. Potentially there are a few different reasons. At least we conduct a lot of surveys to generate this type of feedback of course. Some of the reasons that we find that the health care system, for example, that would endeavor to do something like this rather than issue with direct bond is, yeah. I mean, it’s a quicker process. So sometimes it’s just a function of speed of execution, right? To do something direct, the structure of public offering probably takes a little bit longer. It’s going to make a little bit more noise. It’s probably going to involve more transaction costs, more layers of legal costs, a little bit more diligence. Rating agency involvement is something that you probably aren’t going to avoid if you do a public offering or a direct deal. Whereas on a CTL, if the underlying credit already carries an independent rating, we can sort of lean on that. So it’s faster, it’s a little cleaner.

Andrew Minkus: Typically size of the deals is sometimes a big factor too, right? I mean, let’s say it’s only a $20 million assignment, not that there’s anything wrong with a $20 million assignment. But to go through the rigamarole of structuring a public offering, it might not be worth it. So I think for some of those reasons, sometimes there are internal accounting considerations or sensitivities that might trigger one structure over another.

Andrew Minkus: The other thing that comes up, this isn’t necessarily about direct or indirect, but more of a taxable versus tax exempt. But when you finance a CTL on a taxable basis, there are no use restrictions with respect to the asset. That’s something that comes into play on healthcare assets quite a bit, right? So if it doesn’t meet the private activity test or if you just want general flexibility with the asset, the CTL is a much friendlier format for that.

Andrew Minkus: So those would be a few reasons, at least that we hear from some of the health care clients why they decided to go with the CTL. It’s becoming really in vogue because there are all these auxiliary MOB facilities, you know, 20,000 feet here, 30,000 feet here. They’re smaller assignments, 15 million, 25 million. So it’s just a little bit cleaner. It’s just a little bit faster, probably a little bit smoother.

Andrew Dick: That’s helpful. When we think about build-to-suit transactions and using a CTL, it seems like there are a couple of approaches that I’m seeing in the market, Andrew. I want to get your thoughts. Sometimes the health system will have a new facility in mind. It will engage a developer on a fee for service basis and the health system may call you at Mesirow, and say, “Help me find the capital for the CTL transaction.” Another approach that’s becoming common is that some of the healthcare real estate developers will call upon a health system and say, “Hey, I know you have this new project in mind. Let me bring the CTL financing along and package all this up for you.”

Andrew Dick: What are you seeing in the market and what are the pros and cons there? It seems like if the health system went directly to you, that may be a more transparent process, potentially. Or if they use the developer model and the developer brings you along, I guess the health system would need to just make sure they fully understand how the CTL’s being set up. Am I thinking about this the right way?

Andrew Minkus: Yeah, I think you are. I think there’s really two general approaches to this when there’s a private sector developer involved. It really centers around whether the private sector is going to host more of an open-book process or whether they’re going to host more of a closed-book process. There’s nothing wrong with either process. Let me just start by saying that we probably do as much on an open-book basis as we are involved in transactions that are put forward in a closed-book basis. So no allegiance. I can’t say one’s better than the other. It really depends again on the commercial relationship between the landlord and the tenant, right? Between the private sector and the tenant, and I think a lot of it hinges on eventual benefit of beneficial ownership as well.

Andrew Minkus: But when you have a private sector developer that’s building a facility for a system and there’s really no plan on behalf of the private sector to own the asset beyond the lease term, this is what I would call more of just a pure structured-finance deal. The private sector developer, although they may technically be the landlord for 15 or 20 or 25 years, they’re really more of a straw landlord and acting in a fee-development capacity.

Andrew Minkus: This is probably a good scenario that would give rise to an open book process, right? Everybody kind of sitting around the table, negotiating all the docs in concert, the lease document, the loan documents, the developers really just working for a fee at that point. Because 100% of the rental income is probably being zapped into that CTL instrument anyway. So I would say it’s probably more common that we see that open book process and there’s complete clarity and transparency from all sides into the total economic arrangement. Everybody’s completely incentivized to come to the right place. Whether it’s enhancing a certain lease provision, everybody can see that it’s not just benefiting the landlord, it’s benefiting the tenant as well.

Andrew Minkus: Now we could have a scenario, we’ll call it scenario two, where the other private sector developer, there was an RFP that was disseminated and four different developers responded to the RFP, each with their own tract of land, that’s been in the family for 20 years. There happens to be one piece of land that’s highly desirable for the underlying healthcare system. It’s right next to their main hospital or whatever. This private sector developer has no interest in giving up the ownership to the underlying health care system. They want to keep it in the estate and keep it for the family.

Andrew Minkus: That’s probably more of an arm’s length, traditional closed-book type process, right? The landlord has its deal and the tenant has to negotiate its deal. Everybody is going to be focused on quote unquote market terms, both of which can be perfectly fair, but that would be a process that perhaps there would be less transparency. The developer may not feel obligated to disclose all of its economics.

Andrew Minkus: Now where that gets a little tricky is in that scenario, the developer might see how beneficial it may be to utilize CTL financing to finance this type of project and in doing so might ask the tenant for a few things to make the lease hyper efficient for purposes of fetching the most efficient financing. That’s where the tenant might say, “Well, you’re asking for a little bit of an off market provision here. What are you going to do for me?” Or, “Why do you need that?”

Andrew Minkus: I’ve been a tenant on a variety of medical office facilities. I haven’t had to sign a lease with provisions X, Y and Z. So it doesn’t produce the smoothest negotiation, but again, there’s nothing wrong with the closed-book process. We probably see half and half. Again, it really just hinges on the relationship between landlord and tenant and really what’s happening at the end of that lease term.

Andrew Dick: No, that, that was helpful. If it’s a closed-book process, maybe the tenant is comfortable with the economics and feels like it’s still getting a good deal so to speak.

Andrew Minkus: Yeah, exactly.

Andrew Dick: So Andrew, as we wrap up here, talk a little bit about the future of the CTL market. It seems like there’s been an upward trend and it’s becoming more popular. Where do you see the CTL market over the next three to five years?

Andrew Minkus: Yeah, that’s a great question. We get asked a lot what we think the size of our market is. Most of the transactions are structured on a private placement basis so nobody really has access to that data or at least the real data. I think right now, folks are led to believe that it’s a four to six billion dollar kind of market. I think it’s safe to say that if you asked us that question 15 years ago it probably would have been half of that. So I think a lot of that is due to some of the creativity and some of the evolution that we talked about in this space. I think to a large extent we might be responsible for a lot of that. So I think where there are creative minds and well-structured product, I think this is a segment of the market that’s going to continue to grow.

Andrew Minkus: Then I can tell you historically speaking, from a performance perspective, this is one of the best asset classes in history, because you’ve got great credit support, you’ve got good liquidation features, in many cases, self-liquidating features, but not always, and good real estate support and a lot of asset essentiality, too. So I think the trend lines look good. They look positive. We’re constantly coming up with innovative and imaginative new structures to implement CTLs and attach to CTLs, like a lot of these B notes that we underwrite. I mean, I can tell you a lot of the conventional CTL products wouldn’t have existed if not for some of those unique esoteric structures that we’ve put into the market.

Andrew Minkus: So I think it’s going to be an in vogue asset class for some time. In many cases, it’s the only way to finance these types of assets because a lot of these assets are what I would call non-commodity in nature. It’s really hard to finance non-commodity real estate assets. What I mean by non commodity is specialty real estate, like hospitals and data centers and central plants and funky things like that. The mortgage markets, the conventional mortgage, traditional mortgage loan markets, they really choke on product like that. So for that reason, this will always be around in my humble opinion. But I really think it’s going to continue to grow. At what clip? I’m not sure. That’s my two cents on the market.

Andrew Dick: Andrew, this has been a great conversation. Really appreciate your insights here. Where can our audience learn more about you and Mesirow Financial?

Andrew Minkus: Yeah, so you’re certainly free to visit the website. Our department has a page there, Andrew Minkus at Mesirow Financial. My email address is aminkus@mesirowfinancial.com. And of course my direct line 312-595-7922, be delighted to speak with anyone at any time. I really appreciate you having me.

Andrew Dick: Well, thanks again Andrew. And 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.

 

Real Estate Valuation Trends with Victor McConnell

April 17, 2019 Andrew Dick Health Care Real Estate Advisor 00:29:48 Comments Off on Real Estate Valuation Trends with Victor McConnell

Real Estate Valuation Trends with Victor McConnell

An interview with Victor McConnell from VMG Health. In this episode, Andrew Dick interviews Victor McConnell, a Director of Real Estate Services with VMG Health. VMG Health is a health care valuation firm.

Host: Andrew Dick 
Guest: Victor McConnel

On-Campus Medical Office Buildings: Is a Premium Warranted? If So, When and Why?

Financial Feasibility & Speculative Medical Office Building Construction

Podcast Participants

Andrew Dick

Andrew Dick is a Shareholder with Hall Render in the Indianapolis office. His practice focuses on real estate transactions and environmental law. He advises hospitals and health care systems around the country on the planning, construction and development of new hospitals, medical office buildings, surgery centers and skilled nursing facilities.

Victor McConnell

Victor H. McConnell, MAI, ASA, CRE is a director in VMG Health’s Real Estate Services division and is based in the Denver office. He has real property valuation & consulting experience in 42 of the United States, including extensive experience with the valuation of healthcare related properties.

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. Please remember the views expressed in this podcast are those of the participants only and do not constitute legal advice. Today we’ll be talking about valuation trends in the healthcare real estate industry. Hospitals, healthcare providers, and investors are always looking at different ways to value healthcare real estate assets. Typically, a real estate appraiser with deep healthcare real estate experiences needed to competently complete a healthcare real estate valuation assignment. VMG health is one of the leading healthcare valuation firms in the country. Today we’ll be talking with Victor McConnell, a director of real estate services with VMG Health. Victor, thanks for joining me.

Victor McConnell: Thanks for having me Andrew.

Andrew Dick: Victor, before we jump in to some of your valuation work, tell us a little bit about yourself, where you’re from and your educational background.

Victor McConnell: Yeah. I grew up in a small town in Texas about an hour east of Dallas, Greenville. I went to Undergrad at Dartmouth College in New Hampshire, was a English creative writing major, the classic trajectory from Small Town Texas to Dartmouth to healthcare evaluation.

Andrew Dick: Earlier in your career you started working a night shift at a hotel and in Telluride. What was that like? How did you end up there? Tell us about that.

Victor McConnell: Again, that’s the classic… that’s a classic pathway to get into a career in healthcare real estate valuation. After college, I was bouncing around. I got into climbing a lot of rock, climbing and ice climbing and such. I was living in Telluride working odd jobs and eventually had a bad skiing accident and broke both legs in ’05 and needed a desk job. That slowly led to me getting an internship with a commercial real estate appraisal firm that happened to be doing a lot of work for CVS drug stores. Over the years I got further into commercial real estate and did more and more work in the healthcare sector and joined VMG as a consultant initially in about 2012, and then a full time as VMG was building out their real estate practice in 2013.

Andrew Dick: Victor, tell us a little bit about VMG health. I mean, I’m familiar with the company. It’s one of the leading valuation firms in the healthcare space, but talk a little bit about the scope of services offered by VMG.

Victor McConnell: We were founded in 1995 by some ex Ernst & Young partners doing healthcare business valuation and originally valuing everything from the physician practices up to entire health systems. Over the years VMG grew and added service lines, added what we call PSA, the valuation of Physician Compensation Arrangements, other contractual agreements, added capital assets in real estate in the 2000s. Now we’re one of the… if not the largest multi discipline healthcare evaluation firms, so a kind of a middle of the road transaction that engages all of the VMG service lines or core service lines as; hospitals acquiring a physician group, physicians who are going to become employees post transaction, what’s the fair market value of the business and the intangible assets, what’s fair market compensation post transaction and what’s fair market value on either lease or purchase basis for the real estate and the equipment. Then we ensure that all those pieces and the various assumptions fit together in the evaluation.

Andrew Dick: Victor, I’ve worked with you over the years and then I know you have a lot of experience in the real estate space. Tell us about VMG’s real estate practice. Who are you working for? When I worked with you, you were typically working with a hospital or healthcare system, but I know that you’re doing a lot more than working with healthcare providers.

Victor McConnell: Yup. Our core clients tend to be hospital systems but over the years we’ve grown our presence and have worked with a lot of REITs and real estate… healthcare real estate focused private equity firms, lenders, assisting them with their underwriting, trying to get their arms around risk on a particular deal. Sometimes a typical appraisal for a loan or a market rent study. Then we’ll work on litigation related assignments where there’s a dispute that involves value and then the compliance driven work for health systems or on the operational side, private equity buyers that are acquiring healthcare businesses, which is anybody in healthcare right now is very aware of that trend. There’s an increased need for quality of earnings, which has been a growing area of practice for us as a firm. That type of work is driven primarily by the activity in the PE market.

Andrew Dick: So when you’re on those type of projects Victor, you’re testing the income assumptions on the business that will be in the space.

Victor McConnell: Yeah, pressure testing the EBITDA as it were going through, and there’s varying levels of scope. On a real estate focus, we wouldn’t really call that a quality of earnings. Typically that’s more of a… maybe it kind of QOV light or where we’re benchmarking some key risk factors. A true business QOV is a pretty in depth time consuming process where you’re going line by line through a businesses projected revenue and expenses.

Andrew Dick: Victor, valuation, opinions really run the gamut in my world. Some are really light in terms of supporting information. Some have a lot of data. What I found over the years is that healthcare real estate valuation data is closely held. Typically, you can’t hire a local appraiser in a certain market who’s a generalist to value a hospital a or an LTAC or behavioral health care center, just because they don’t have access to that kind of data. That’s always been my assumption based on some of the work product I’ve gotten back from a generalist. Is that true? Talk a little bit about how just the data that VMG has is really what makes it a powerful partner for powerful resource for folks looking for valuation information.

Victor McConnell: Yeah. I’m obviously biased here, but our core compliance driven valuation work across service lines allows us to build up a pretty robust internal benchmarking data set. W annually publish a free study called the Intellimarker that’s a benchmarking study focused on the ambulatory surgery center industry that anybody can download. That study is made possible by our core valuation work. Similarly, on the real estate side, all of the work that we do in our other service lines allows us to get information about transactions and about real estate prices and rents that may not be available from subscription databases like Costar, Inner Vista or other public record sources.

Andrew Dick: Well, Victor, let’s talk about some trends in the industry. Recently you wrote an article about micro hospitals that was published by Becker’s hospital review. Tell us a little bit about your experience working with the micro hospitals, the valuation trends. What’s going on in that kind of sub sector of healthcare real estate?

Victor McConnell: We’ve seen a lot of activity there. Part of this continued move away from the large hospital campuses and the fragmented delivery system that’s a recurring theme. If you listen in on any healthcare real estate conference panel or all of your competitive podcasts, I’m sure Andrew, the… So I think micro hospitals are a manifestation of that. They’re relatively new delivery type that there’s not necessarily even a clear definition of what a micro hospital is. There’s a pretty wide range in terms of size and in terms of services being offered and the cost, the per unit cost per bed or per foot cost can be quite high. When we’ve done work on the behalf of investors who are looking at them, they really wanted to get comfortable from a due diligence perspective because the… on the real estate side, the downside, the dark value on those can be pretty significant.

Andrew Dick: Victor, talk a little bit about how investors look at the micro hospitals. Are these considered a riskier investment in terms of how they’re priced? I think recently there had been some CMS regulations that are focused on micro hospitals and length of stay and-

Victor McConnell: I know Hall Render put out a news blast about that. Do you want to give our listeners a quick overview of the length of stay?

Andrew Dick: Well, I think just briefly. I think CMS has said that you actually have to have in patients with an average length of stay of a couple of days. If you don’t that could potentially jeopardize your hospital status. But victor, how do the investors look at this?

Victor McConnell: Well, I think if you don’t have an ADC and if you don’t have a census of two at the time of the survey, then yeah, you can lose that hospital licensure. In my experience, the way that investors have looked at them is really relying on their operator partner. Given the potential riskiness of the asset, they may be do more due diligence around what the operator is projecting than they would on an asset that’s been around longer, like a surgery center. So, what does that look like? It might mean that you’re doing a deeper dive around the payer mix, and the capture rate and the various volumes that are being projected in the market position of the facility to see if what’s being projected is accurate and realistic because the rental rate that they’re going to be paying the real estate investor can be again quite high. So, they want to know… they want to have comfort that they have a healthy rent coverage ratio.

Victor McConnell: Then in addition to that, I mean, a lot of them are done with credit rated entities. In those cases, the investor is going to look at it maybe a little bit less facility specific if they’re getting a good credit rating behind the lease.

Andrew Dick: When you talk about partnerships or the credit rating of the tenant, it’s been my experience a lot of these micro hospitals are joint ventures between maybe a national for-profit, micro hospital company and a local healthcare system that agrees to brand it with their name. Is that what you’re seeing as well?

Victor McConnell: Yeah. I’ve seen that structure probably I guess most commonly. Although, I think there is some variation there. But without actually being involved in really in the weeds, it’s hard to know sometimes if you haven’t… on some of them that we didn’t work on directly, I only know what’s available in a transaction overview that’s published by some real estate publication. But I’d say my general experience is lined up with yours.

Andrew Dick: Victor, moving away from the micro hospitals, you and I wrote an article a number of years ago for the American Health Lawyers Association that was called, on-campus medical office buildings is a premium warranted. We thought the article was timely because, one, from a valuation perspective over the years, investors in the healthcare real estate space tend to distinguish between on-campus versus off-campus. We also thought it was timely because from a regulatory perspective, if stark or anti kickback applies, there’s some guidance that suggests that proximity maybe shouldn’t be taken into account in terms of setting the rental rate if two providers are entering into a lease, for example. Talk a little bit about the evolution of on-campus versus off-campus from evaluation perspective. It seems like there used to be a widespread in terms of valuation for an on-campus asset versus off-campus, but that may not be true today.

Victor McConnell: Yeah. A big part of the impetus was as you said, a reaction to I think… I think you and I had both seen other attorneys and appraisers who had said, “You can’t charge a different rate because something is on-campus, because of the language around proximity to a referral source.” When I looked into the issue, ultimately I disagreed with that contention for reasons that are laid out in detail in the article. You can observe in the data some of the differences in how the market prices on-campus versus off-campus assets historically. Then you can also walk through some of the physical differences with an on versus off-campus building that you have a amenities often with on-campus buildings, that if you build up a return on cost model would be accounted for, things like a sky bridge or parking deck or access to hospital cafeterias or common space that an off-campus building might not have. Then you have the… sometimes elevated construction costs or higher land value.

Victor McConnell: Again, that will show up if you do a return on cost analysis and then a supply constraint in a lot of cases around a hospital campuses. That now that being said, I have seen cases where the rents on a hospital campus were actually lower than the average off-campus in rates in a given. That was because it was a hospital that had an oversupply of medical office space and it was a… had poor financial performance. So physicians didn’t want to be located on that hospital campus. The larger trend over time has been that the spread and cap rates or the pricing difference between on and off-campus has shrunk over the course of the last decade or so, and more health systems have strategic off-campus assets that are larger, have a wider array of services, that had some specialty build-out or space that’s located in high visibility retail settings.
Victor McConnell: As the real estate investment community sees those trends, they say, “Well, maybe actually the risk associated with this off-campus asset is lower than the one that’s on an aging hospital campus that we’re not sure what’s going to happen too.” That’s a long rambling answer that can be followed up by a review of our HLA article.

Andrew Dick: Now that’s a good summary though Victor. I think in short from the healthcare lawyers that are listening, the bottom line is that in some cases there may be a premium that is warranted for on-campus that can be justified for legitimate reasons outside of proximity to referral sources.

Victor McConnell: Yeah. It’s not a unilateral adjustment that, okay, every on-campus buildings should be X% of an off-campus building. No, that’s not correct. But it is a case by case basis and sometimes the premium is warranted. So ultimately be the answer that I give is the classic answer of the appraiser or the analyst is, it depends.

Andrew Dick: Well, that’s an interesting discussion and if our listeners want to learn more, feel free to go to the show notes and we’ll post a link to the article. Victor, moving on to other unique characteristics of healthcare real estate, we often see ground leases involved, for example, when a hospital wants to develop a medical office building on their campus, hospital may say, “I want to retain fee title or ground lease the land to a developer or physician group who develops the MOB.” What are you seeing in terms of trends? I mean, are hospitals still… do they still like the ground lease model? I think they do. If so, what are you seeing in terms of valuation trends?

Victor McConnell: Well. Ground leases are interesting in that in a lot of cases the dollars associated with the ground lease can be relatively small compared to the total dollars in a deal when you have 50, 100 million dollar construction projects and the annual ground lease payment may be fairly small. But there’s still a significant consideration in it is a 50 to 75 year term. In a lot of cases, ground leases will cover a long list of property rights that can affect what a health system can do with a real estate asset down the road. Sometimes they have put options or purchase options or use restrictions. Those things sometimes have a value impact and sometimes they don’t. I think that health systems who choose to own their own real estate will often still pursue a ground lease structure.

Victor McConnell: I know we’ve seen credit tenant lease agreements and some health systems buying back real estate in kind of a reverse monetization. But generally speaking, I think that the ground leases is still just as prevalent as it was five or six years ago when you’re looking at new on-campus development. The way that I think about ground leases in the context of a new development is always what are the various parties, if you have physician investors, if you have a developer, if you have a hospital and they’re all contributing various things to a development. They may be contributing land or capital or site improvements for the host campus or a portion of a parking garage. You have to look at the development holistically as a valuation professional and determine that all of the various parties are getting a fair market value return on the assets that they’re contributing to the development.

Andrew Dick: Yeah, that’s a good summary. I mean, Victor, over the years when I’ve worked with appraisers that don’t do a lot of work in this space in terms of valuing ground leases, I’ve had… it seems like a wide range of opinion. Some appraisers have said, “Well, under a ground lease, you have most of the tenants. So the owner of the improvements, it’s unlikely that the ground lessee will ever default, because if they do, they could lose the improvements in some scenarios or they know the ground owner knows that the ground lessees lender might step in to ensure that there’s no loss of improvements.” As a result, some of the appraisers have said, “Well, we tend to believe that it’s such a low risk investment proposition that it should be valued differently than a traditional lease. How would you respond to that?

Victor McConnell: Well, a ground lease does have a different risk profile than a building lease. If you look at returns, ground lease rates of return are going to be below a improvement. Part of that has risk, and part of that is that improvements depreciate and land does not. So if you acquire a ground lease, it is an asset that continues into perpetuity. I would say that there is a lower risk profile but it shouldn’t be zero or it shouldn’t be a number close to zero. It should be commensurate with what we see ground leases trading for in the market. There is market data available in the ground lease sector. Actually, a year or two ago there was a wreath that was launched that focuses on ground leases as well.

Andrew Dick: I think you’re right. I was going to ask you about that. I think the ticker symbol was SAFE, S-A-F-E, and they focus on assets that… ground lease assets. I’m not sure how many health care properties they have, but-

Victor McConnell: I personally haven’t seen. I don’t know if they own any or not. I haven’t gone through their 10 k’s or… and I haven’t anecdotally run across any on-campus assets that… or anything like that they’ve acquired.

Andrew Dick: Okay. Victor, as we wrap up here, talk about the future of healthcare real estate and valuation trends. What do you predict in the future? It seems like valuations, for example, MOB assets right now seem to be at an all time high for products that have credit tenants. But what do you predict over the next few years?

Victor McConnell: Well, I’m a skeptic, personally and professionally. Humans in general are not great at predicting the future. In early 2008, I think the global survey of economists forecasted global GDP to grow 2%, and we had the worst recession in 75 years. So anything I predict, I don’t… I wouldn’t put a lot of stock in it. But I think that all of that said, with that significant caveat, I think seeing healthcare real estate continue to become a more recognized asset class, having a larger buyer pool, foreign capital that’s investing in impatient assets and large portfolios, institutional funds, sovereign wealth funds, all of these things have… that didn’t exist in healthcare real Estate 10, 15, 20 years ago are growing. They’re going to continue to grow. I think the cap rate as compared to other core property sectors to apartment, retail, office, industrial, those will continue to compress.

Victor McConnell: I think some select surveys had showed core medical office properties trading at very close to office. It depends on what segment of the market you look at. Simultaneously, healthcare will just… healthcare real estate and… will continue to get more complex, more fragmented, more different types of properties. If you think back 50 years we had a nursing home, a hospital and a doctor’s office. Now we have EL Tags, ASCs, ALFs, Sniffs, SELFs, MOBs, on-campus, off-campus,-behavioral health.

Victor McConnell: Behavioral health, cancer centers, proton centers. Even if you bring up behavioral health, which is one we get a lot of inquiries around, that alone is a very broad term, running the gamut from quasi residential houses up to full scale steel frame psychiatric hospitals. It’s all behavioral health, but very, very different real estate assets, different reimbursement models, different business models. I think that, that again speaks to the complexity of the healthcare real estate market. One of the things that makes it unique relative to some of the other property markets is the… how the business and the real estate are inextricably intertwined. If you’re an investor, you have to understand the business on some level to invest in it. Part of that business is the regulatory risk, which is a lot of what drives your work and my work. Certainly, I’m sure you saw the DOJs 2 billion in recoveries for last year for the ninth straight year. I think that’s the other trend that looking forward is not going to change, the continued regulatory scrutiny.

Andrew Dick: Victor, you recently published an article called Financial Feasibility and Speculative Medical Office Building Construction, where you talk about some trends in the industry where we’re starting to see more specs space being built. Tell us a little bit about your article and some of the work you’re doing around the speculative MOB space.

Victor McConnell: Yes. Financial Feasibility and Speculative Medical Office Building Construction, not exactly a war and peace of titles. It doesn’t really roll off the tongue there. But, yeah, I think part of the… some of the other trends we’ve talked about, the growth of the sector, growth of the buyer and investor pool has led some developers to say, “Well, maybe we can build space at a given location on a spec or speculative basis where we don’t necessarily have tenants pre committed and we’ll lease it up just like we would with office or retail.” That’s something I don’t think happened very often 10 or 15 or 20 years ago because the perceived risk was higher, TIs, the build-out cost for medical office space was higher and so people just stayed away unless you had a tenant who came to you and said they wanted a certain space.

Victor McConnell: But now, we’ve been involved in some projects that were mixed use developments or other off-campus developments where someone thought that medical space would be viable. So then you have to figure it out if it is viable or not by doing some market analysis and some feasibility analysis. That was the purpose of my article.

Andrew Dick: Victor, I mean we’re… some folks say we’re nearing the end of a real estate cycle. How much spec space is really being built? I don’t see a lot of it, but are these developers that have a lot of experience or are they folks that maybe don’t have a lot of experience that are taking a flyer on this?

Victor McConnell: I think that the medical sector is a little bit different. Well, obviously healthcare real estate is affected by the larger kind of real estate macroeconomic forces, and is certainly affected by the real estate cycle. There are also these other factors that are unique to healthcare real estate that the hospitals and patient care, that continues to grow unabated, accompanying population growth and an aging demographic. So the need for space to treat people, even if you have a real estate market that’s declining, that still exists and there’s only so much shelf space that could be converted to medical from something else. I think that the range of people building it, some are more sophisticated than others, but I think that they are responding to a real need in the market, a need for off-campus space and in areas where there’s demand for certain outpatient care.

Andrew Dick: Victor, thank you for being on our podcast today. How can folks connect with you, reach out to you?

Victor McConnell: Our website is vmghealth.com. My email is victor.McConnell@vmghealth.com. But I’m not a hard man to find. If anyone wishes to get in touch, they can find me via VMG’s website.

Andrew Dick: 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 that list, please email me at adick@hallrender.com.

Capital Markets Update with Chris Bodnar

March 13, 2019 Andrew Dick Health Care Real Estate Advisor 33:14 Comments Off on Capital Markets Update with Chris Bodnar

Capital Markets Update

An interview with Chris Bodnar from CBRE. In this episode, Andrew Dick interviews Chris Bodnar, the Vice Chairman of CBRE and co-head of CBRE’s Health Care Capital Markets Group. Chris talks about his career in the health care real estate industry along with various trends in the industry. 

Podcast Participants

Andrew Dick

Attorney with Hall Render

Chris Bodnar

Vice Chairman of CBRE

Andrew Dick: Hello and welcome to the Health Care Real Estate Advisor podcast. I’m Andrew Dick, I’m an attorney with Hall Render, the largest healthcare-focused law firm in the country. Please remember the views expressed on this podcast are those of the participants only, and do not constitute legal advice. Today, we will be talking with Chris Bodnar, the vice chairman and co-head of CBRE’s Healthcare Capital Markets Group. Chris is one of the top healthcare real estate investment advisors in the industry. We will talk about his journey from college, to his most recent promotion to vice chairman of CBRE. We will also talk about the healthcare real estate industry and where Chris sees the future. Chris, thanks for joining me today.

Chris Bodnar: Thanks for having me.

Andrew Dick: Chris, before we talk about your current role at CBRE, let’s talk about your background. Tell us where you’re from, where you went to college, and what you aspired to be.

Chris Bodnar: Of course, yeah. So, I grew up in San Jose, California. Went to a large high school and was one of the few people who wanted to venture outside of California and try to find a college in a different state. Looked at a lot of colleges on the East Coast and eventually ended up touring University of Colorado in Boulder. Just fell in love with the school, and fell in love with the mountains too and picked up skiing and snowboarding when I was in college as well. Beautiful town and as you could tell, I haven’t left the state yet.

Andrew Dick: Well, tell us a little bit about your education at UC. What did you study, and what were your interests at that time?

Chris Bodnar: I went into business. I wasn’t exactly sure what I wanted to do. I ended up getting an emphasis in marketing and commercial real estate. Really, the reason I tried to get that emphasis in commercial real estate is that University of Colorado provided a program such that if you took a certain amount of classes while you were in school, you would automatically qualify to take your broker’s license exam right out of college. For me at the time, I was really only thinking about saving 3% on a commission when I bought my first house. I had no idea I would really dive into this commercial real estate sector and still be in it today.

Andrew Dick: Tell us about how you transitioned from college to working at CBRE.

Chris Bodnar: So, the University of Colorado did a really good job of bringing in industry experts to talk to the students. They would set up panel discussions after class and bring in experts from a variety of different fields. One of the panels that I attended had, I think, an appraiser, a banker, property inspector, and an investment sales professional. After listening to the panel, I really gravitated toward the investment sales broker and felt like it would fit my personality really well. For that position, you needed to have a solid base of sales skills, and I come from a family where my dad was in sales, working in Manhattan most of his career. I felt like I had a solid base of sales skills but what the investment sales broker also had was a strong base of analytical skills, which I’d also thought I brought to the table as well. So, I ended up getting an internship with, coincidentally, the gentleman that was speaking on that panel. It just so happened he was interviewing a bunch of different students at school, and I was fortunate to land that internship while I was still in college.

Andrew Dick: So, what were you doing in terms of investment sales? Were you focused on a certain product type, or was it whatever they ask you to do?

Chris Bodnar: Yeah, the first team I joined, that’s the gentleman who was on that panel who has now gone off and had a very successful career as a principal on the commercial real estate side, but when you start off you’ve got to do a little bit of everything, but the team I was on was purely investment sales, focused on the Denver market. As far as our product type goes, we had the most experience with office and industrial properties. Obviously over time I started moving into the direction of healthcare, which we could talk about later.

Andrew Dick: So, you finished the internship and you were given an offer to join CBRE full time, and at that point were you just continuing your work in the investment sales market, covering office and industrial product?

Chris Bodnar: Yeah. For the first couple years when I was on the team, it was doing office and industrial and doing a little bit of everything that they needed. Honestly, that included doing everything from graphic design work to building ARGUS models for the properties that we were selling. About two years into the job, I went to my mentor at the time, and also the team leader, and told them I’d like to go after a segment on my own. Brainstormed with him and thought about some different segments I could go after. I asked him about, potentially, trying to focus on more product in the Boulder market. He came back to me and said, “Hey, we’ve kind of got that all canvassed already. I think we’ve got that section of the market covered.” At that time we were focused on industrial, but just really didn’t have the same amount of industrial listings as we did office listings.

Chris Bodnar: So, I went to him and said, “Well, how would I focus more on that?” They steered me away from that as well since we felt like we had that covered, and my last suggestion was Colorado Springs. He said, “We don’t really have that covered, so if you want to start canvassing that market, go ahead and do that.” So, I basically started commuting to Colorado Springs every weekend to canvas that market and try to get some deals. Really, one of the first deals I came across, I stumbled across a medical office building. I think the group that owned it was a group of physicians, but I think they liked the platform that I worked within. CBRE is a big company, but they really took me underneath their wing and explained to me the difference between medical office and traditional office.

Chris Bodnar: They started to explain to me the contract that they had with the hospital. They started talking to me about the payer mix surrounding the building and why they’re located where they’re located. They started talking to me about some of the referral patterns that have been established in the building. They would get referrals from the primary care group in the building. They would refer patients into the surgery center, which they were also partners in the surgery center. They refer patients to an imaging clinic, pain management, to physical therapy, and so there was this ecosystem that was created in this building that, for lack of a better word, created this stickiness of the tenancy and a higher probability that these tenants weren’t gonna leave.

Chris Bodnar: Then as I was really understanding the product type, I discovered that there’s a buyer pool out there that really focuses on the sector as well. These groups were national in scope and really gave me the idea that perhaps there could be a case study or business plan put together to take more of a national approach to this sector, and really turn the brokerage model on its head because for the last hundreds of years, the first rule in real estate and investment is location, location, location. We took that away and said, well, how about we focus our practice on really understanding an industry, and really understanding the buyer pool and what’s the facilities? Then we can partner people with people in different markets that have that intelligence at the local level.

Andrew Dick: Chris, talk a little bit about when that was within your career. I think when we had talked before, you said you really started creating the vision for this group around 2006 or 2007. Is that right?

Chris Bodnar: Yeah, a lot of the vision happened in 2007. 2006, 2007 and it ended up, looking back, being a really good time to start building a business and start putting together a business plan. Obviously, we were at the beginning of the recession, and things started slowing down a lot which gave me time to focus on a new business plan. I ended up leaving my team in 2010 and joined a partnership with one of my current partners, Lee Asher, who’s based in our Atlanta office. It was somewhat of an arranged marriage by the company. I had a lot of experience working more on the private capital side, working with high net worth investors 1031 exchange investors, and Lee worked on an institutional team. So, he was selling hundred million dollar plus type buildings, and had really good relationships with some of that institutional capital. Our personalities melded very well together. Our strengths and weaknesses complimented each other really well, and like I said, we started that partnership in 2010.

Andrew Dick: So Chris, at what point were you committed to this concept? You told me you and your wife decided that in order to really build this business within CBRE, that you needed to move around the country, make connections in some of the major markets. Talk a little bit about that journey, because I thought it was really interesting.

Chris Bodnar: Yeah, it was a fun time. Like I said, Lee and I started our formal partnership in 2010. We had been working together before that, and in 2011, I threw out a crazy idea to my partner and said, “There’s only so many investors and capital groups that I can meet with in Colorado. I can’t take the same guy to lunch every other week.” My wife and I, we didn’t have kids at that time. Today we have two young daughter, but at that time we didn’t have kids and so I talked to Lee and I said, “Well, what do you think about me traveling the country for a year and focusing on a specific market, one market at a time, where I can dive deep and try to build some relationship with the capital groups out there, build relationships with the owners of healthcare real estate in those markets? Build relationships with the providers and the health systems in those markets, and also get to know my CBRE colleagues on those markets better, and try to form partnerships in those cities.”

Chris Bodnar: So, over the course of a year we ended up moving, and we drove this whole way. My wife and I got in the car, drove to San Francisco, stayed there for three months, drove down to Las Angeles, stayed there for three months. We moved across country to D.C., to Washington, D.C., stayed there for three months and then finished the journey in New York. It was just a phenomenal trip just to get exposure to those different cities and nuances of those markets, but more than anything, creating relationships in those cities that still exist today.

Andrew Dick: How were the local CBRE professionals? Were they receptive to this idea, or were they a little standoffish that you’re coming in, trying to make connections in their market?

Chris Bodnar: I expected a lot of pushback. Brokerage is a very territorial business, and we were taking a different approach to the space. I would say that we were welcomed in every city that we went, and I have to credit leadership at CBRE for making that happen. I’ll give you an example. When I was in New York, probably one of the most territorial places in the country to do business, the managers of the tri-state region had me come in and sit in on their managers meeting, and talk about what I was doing and what I was going after. These are 20 different managers throughout the tri-state region, and some of the top brokers in Manhattan that were at that meeting. To just have that collaboration, yeah, I’m not sure if that would happen at every other firm out there but CBRE has done a really good job of keeping the mindset that we need to put, “the best players on the field,” so to speak.

Chris Bodnar: What that really comes down to is doing the best thing for our clients and Lee, and myself, and Shane, and my other partners, we bring a level of expertise that brokers in other markets just don’t have. So, it’s a partnership that they can leverage, and I think when we take that collaborative approach, they realize that we can all do more business together if we take that mindset and try to go after some business.

Andrew Dick: Talk a little bit more about your team today, Chris. You’ve built a pretty deep bench. How many people are on your team? What are they doing? Talk a little bit about that.

Chris Bodnar: We have a great team now. Like I said before, it started out with me and Lee. Our next addition was a gentleman by the name of Ryan Lindsley. Ryan was working at CBRE at the time, but he was working on more of the outsourcing of real estate functions for providers, and not on the capital market side. His wife actually got into medical school at Georgetown, and had to leave where he was working which was Pittsburgh, and it created an opportunity for us to pick him up. Shortly after that we brought on Sabrina Solomiany. Sabrina had previously worked at another investment stales firm, HFF, and was a great fit for our team. We recently just brought on last year Shane Seitz, who is a really well respected healthcare real estate professional who’s been in the business for 20 years. The last 10 years was one of the largest publicly traded healthcare REITs. So, that was a great addition too, but we had such a great team of graphic designers and financial analysts.

Andrew Dick: Chris, one of the reasons we wanted to talk with you was because you have built one of the leading healthcare real estate capital markets groups. Talk a little bit about the type of services that you’re offering to your clients.

Chris Bodnar: We offer a range of services from acquisition, to disposition, to recapitalization strategies. We’re working with investors and healthcare providers with the strategic capital planning for really all types of healthcare product. Really everything outside of senior living, so right now we’re working on deals ranging from medical office buildings, to surgery centers, to rehabilitation facilities, to behavioral health centers. So, it really runs the gamut. We also do some advisory type work with health systems, and a lot of that has revolved around assisting these providers in selecting a developer for new projects.

Andrew Dick: Chris, when we’ve talked before, you told me that you have a broad range of clients. It’s not just hospitals and healthcare systems, but you’re also working on the investor side with publicly traded REITs and institutional investors. Tell us a little bit about the client base that you’re working with.

Chris Bodnar: We break it down into five buckets, the first being the publicly traded healthcare REITs, the second being the nontraded healthcare REITs, the third being more institutional type of investors and that can range from pension fund money, to sovereign wealth funds. The fourth bucket would be high net worth private investors or 1031 exchange investors, and the last is obviously the providers, the health systems and the physician groups that at different points in time could either be looking to acquire healthcare real estate, or looking to potentially sell it.

Andrew Dick: Chris, one of the informational pieces that your group publishes is what’s called an Investor Developer Survey, where you go out to the market and capture data from investors, and hospitals, and healthcare systems. You compile that data and it’s one of the leading reports, in my mind. Talk a little bit about the 2018 Investor Developer Survey, and then the type of information that you’ve gathered for 2019.

Chris Bodnar: Yeah, so we’ve been doing this survey for over 10 years now. We did it with the mindset that there’s so much research that’s done in our sector, but all of it is looking backwards. We felt like this survey could give us an indication of what can happen for the upcoming year. The survey asks a series of 25 questions ranging from, “What does development look like for the coming year?” To, “What do cap rates look like for the Avera Health Facility or a class A on campus building?” It’s been a great way to understand where the market might be going, but I would say two trends that we’ve seen that have been prevalent over the years, one, is the amount of capital that’s coming into the sector. We do ask a question about how much each group has allocated to the healthcare real estate sector for investment. That has continued to increase year over year substantially, and the other one is just the on campus versus off campus evaluation of real estates.

Chris Bodnar: If you were to look at our survey 10 years ago, there would have been a pretty large spread between the way investors look at pricing for an on campus facility versus off campus. That spread has continued to narrow year after year as off campus has become a product type that’s been much more accepted. I think a lot of that has to do with where health systems are looking where to place their real estate and where to plant the flag. Those are probably two of the bigger trends that we’ve seen happen, that have come back to us in the responses to the survey. We’re just sorting out the 2019 responses now and expect to get that publication out here in the next few weeks.

Andrew Dick: Chris, do investors follow some of the reimbursement trends? For example, when you and I have talked before, the on campus versus off campus distinction can be important from a reimbursement perspective. When we talk about provider based space, do the investors look at that in their analysis, for example, with medical office space if a hospital is the tenant and the hospital is treated that space as provider based space?

Chris Bodnar: Yeah. We talked about this [inaudible 00:19:30] between on campus and off campus. Obviously reimbursements and specifically section 603 of the Bipartisan Budget Act being upheld and giving the final ruling on the year that went into effect, the beginning of this year. Obviously reimbursements are different for on campus versus off campus, and for some groups, that’s very important. There are some REITs out there that are very focused on the on campus product type because they feel like it’s a higher margin business for the providers. On the other hand, there’s a lot of institutional funds out there that are basically taking the approach that they want to follow the hospital. So, if the hospital is looking to place real estate in a better growing market with a good payer mix, while the reimbursements might not be the same, they may make up for it in volume based on planting a flag in a market where there’s not much competition.

Andrew Dick: Chris, over the years we’ve seen certain transactions, some of the larger transactions being considered off market, and when I’ve talked to you before I always asked the question. Is there a trend of a number of off market transactions occurring? Is that trend increasing, decreasing, and what are the pros and cons of off market transactions?

Chris Bodnar: Well, for my benefit I hope they decrease. It is something that happens when you’re in a niche market. If you go to these conferences focused on healthcare real estate around the country, you get a pretty quick view on who are some of the active investors in the space, and some of those groups do get approached directly. We’re obviously a little biased here, but do feel that a lot of times money has been left on the table in taking that approach. We do feel that running a competitive process and taking an institutional approach in underwriting, and allow an investor to look at things differently and potentially create some more proceeds from a deal than they otherwise would. If you look back for the last year, we have been able to increase a buyer’s final price by around 5% to 7% on average over the last year. That’s purely by creating that competitive bid process where you take an offer and you try to push them further through a best and final to get to their higher price.

Chris Bodnar: Obviously, there are other things outside of price that I think are important to look at. We’re not attorneys, but we do see a lot of the points that are negotiated in contracts around the country, and we know what’s market for deals and what’s been agreed to in the past. Hopefully we’re that conduit to help bring parties together and get our clients the best possible deal. So, I think those off market deals happen but when they do happen and they fall through, they don’t have somebody right behind them to step back in. That’s the benefit of running a process and having multiple buyers at the table.

Andrew Dick: Talk a little bit about some of the larger healthcare REITs investing more in the life sciences industry. Is this a trend that will continue in the future, or is this just a step forward to try to diversify their portfolios?

Chris Bodnar: Yeah, I think it’s probably multiple things. Obviously for the REITs that have exposure to the multiple different product types, this is a way to further diversify their healthcare REIT. Life sciences is definitely a growing business. It’s very different than seniors housing and medical office, which are located in every market around the country that has a population that needs to be cared for. Life sciences is more focused on the talent pool, the education of the workforce, and the funding that’s being provided by the government and where that’s located, what companies are there that they could build off of, and that’s why you see a lot of the life science’s product located in primary core markets. The Bostons, the San Franciscos, the Seattles. We’ve even seen more product type pop up in the Los Angeles, Southern California markets, Houston. Parts of Upstate New York have created tax incentives for companies to move there.

Chris Bodnar: So, it’s a very different product type. It’s a growing segment of the market, and I think a lot of the REITs are looking at the multiples that they can achieve for each product type that they own within their REIT, whether it’s medical office, or senior housing, or life sciences. Life sciences is trading in an aggressive multiple, and I think getting more exposure to that sector helps diversify the REIT.

Andrew Dick: Chris, you’ve been in the industry for at least 15 years. What are the biggest changes that you’ve experienced during that time period?

Chris Bodnar: Yeah, for healthcare real estate, I mentioned this previously regarding just the evolution of capital, 10 years ago if you were to look at this sector, healthcare real estate was considered an alternative asset class. Whenever you hear the words alternative, a lot of investors think that they’re gonna get a higher yield. There’s more risk involved with it, and the opportunity is really proven to be true. Healthcare tenants don’t typically move that much. They’re highly invested in their space. Their patients are location sensitive, and if you look back over the last 10 years, you’ve seen the product type perform really, really well in periods of economic uncertainty. The last recession, healthcare real estate performed very, very well, and so the way investors are looking at healthcare real estate has really evolved from a, “alternative asset class,” into really more of a core asset class.

Chris Bodnar: So, we’ve seen the pricing for this product type evolve as well where it was pricing as an alternative type of deal, and now pricing more like a core product type. So, the demand for these assets has continued to increase, and the other thing we’ve noticed over the years too is that it gets talked about a lot, but there’s been significant merger and acquisition activity within the industry over the years, and if we were to look at a rent roll for a medical building 10 years ago, it was a bunch of smaller independent physician groups occupying those buildings. As time has moved on, you look at that rent roll today and you’re seeing a lot of consolidation that’s taken place. The average square footage of each tenant has gotten larger, as there’s been that consolidation, and a lot of the independent practices have been taken over by the hospital. So, for those hospitals that have good, strong balance sheets and income statements, it has acted frankly as a credit upgrade to a lot of investors in the space as well.

Andrew Dick: Chris, I always like to end these calls on a high note. Talk a little bit about some of the transactions that you’re most proud of.

Chris Bodnar: One that always sticks out in my mind is the monetization that we did for Catholic Health Initiatives, CHI, in 2016 and 2017. A couple reasons. One, it’s the largest health system monetization that has occurred on record. It was a monumental effort to get that one across the finish line. A lot of planning that took place, and it’s very rewarding to go back and look at some of the presentations that we put forth to the CHI board, showing them what type of pricing we thought we could achieve on a very large grouping of assets, and under the time period that we thought we could achieve it. Being able to execute on that was highly rewarding, but I think what was even more rewarding was the people and the relationships that were created. I was spending a lot of time in CHI’s offices and got to know them very well, and now consider a lot of those people close friends.

Chris Bodnar: The buyer for that deal was Physicians Realty Trust, and we had done a couple transactions with them previous to this, but this is the first big deal that we did with them. Again, when you’re working on a transaction of that size, you’re on the phone with these folks day in and day out and meeting with them in person. You really get to know the people that work there, and they’ve created a great group over at Physicians Realty Trust, and they were a fun group to work with. I hate to say this, but I tell some of my clients that it’s probably a good deal at the end of the day when both parties walk away equally unhappy, but this is one of the deals where both parties walked away equally happy. Truly a joint effort to get that one across the finish line, and great relationships were built. So, that’s probably the one that sticks out in my mind the most.

Andrew Dick: Chris, you were recently promoted to vice chairman to CBRE. That’s a huge accomplishment. Talk about what that means for you and your group.

Chris Bodnar: It’s a great honor. Obviously, it’s a big title, and titles really don’t mean much, but it does showcase the work and effort that I’ve put in from the beginning, and the risk that Lee and the rest of our team took. I know I couldn’t have got where I am today without the help of a phenomenal team that I work with, and some great mentors in the space that have guided me throughout my career. So, getting a title like that, it’s humbling and it’s a great honor, but I try not to think about it too much.

Andrew Dick: Chris, looking forward, where do you see yourself and your group in five years?

Chris Bodnar: That’s a great question. Obviously, the healthcare industry is always moving and evolving. We do a see a lot of growth in this sector. Obviously there’s way more demand to invest in this product type than there is supply, but when we first started looking at our business plan and getting into this space, one of the things that stuck out to me and Lee as we were putting together business plans and whatnot, was that if you look at other industries like the financial industry, look at the percentage of assets that they own versus lease, and you look at a Wells Fargo, or a Chase, or a Bank of America, they’re substantially more heavy on leasing real estate than they are owning it. The opportunity is really true for a lot of the not for profit providers in the market. They have maintained over the years that they want to control the real estate, and they’ve had the luxury of being able to do that over the years.

Chris Bodnar: Things are changing in the industry. Obviously reimbursements are changing and the margins that they were achieving years prior might not be the same margins of the future, so there could be better uses of that capital. Whether it’s an outright sale or more of a partnership or joint venture that some of these providers might explore, we do believe that there will be more activity in the market over the years. If you just look back over the last 10 years, the transaction market has doubled. We do project over the next five or maybe 10 years, the market will double again. So, there’s huge opportunity in this sector, and hopefully we’re poised to take advantage of it.

Andrew Dick: Chris, I’ve really enjoyed talking with you today and getting to know you. How can folks learn more about you and your group, and how can they contact you?

Chris Bodnar: Probably the best way is just email. Chris.Bodnar@CBRE.com. Really appreciate the opportunity to talk with you and if anybody has any questions, I’m more than happy to answer them.

Andrew Dick: Well, 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 Health Care Real Estate Advisor. To be added to the list, please email me at ADick@HallRender.com. 

The Foundation Real Estate Model

February 11, 2019 Andrew Dick Health Care Real Estate Advisor 30:58 Comments Off on The Foundation Real Estate Model

The Foundation Real Estate Model

An interview with Ben Mingle from the Centurion Foundation, Inc.: In this episode, Andrew Dick interviews Ben Mingle, the Executive Vice President of the Centurion Foundation, Inc.  The Centurion Foundation, Inc., provides real estate development and financing solutions to health care providers.

Podcast Participants

Andrew Dick

Attorney with Hall Render

Ben Mingle

Executive Vice President of the Centurion Foundation, Inc.

Andrew Dick: Hello and welcome to the Healthcare Real Estate Advisor podcast. I’m Andrew Dick, an attorney with Hall Render, the largest health care focus law firm in the country. Please remember the views expressed in this podcast are those of the participants only and do not constitute legal advice. Today we’ll be talking about a unique way for nonprofit health care providers to finance sale lease back transactions in build a suit facilities using what we will refer to as the foundation real estate model.

Andrew Dick: The foundation real estate model may be a new concept for some of you, but it has been around for a while and more widely used in the higher education space. In fact there are several nonprofit real estate foundations that support other nonprofit corporations by providing low cost financing options for real estate transactions.

Andrew Dick: Centurion Foundation is one example of a foundation that can provide a variety of outsourced real estate functions including ownership, financing, and other real estate services for nonprofit health care providers.

Andrew Dick: Today we’ll be talking with Ben Mingle, the executive vice president of the Centurion Foundation. Ben, thanks for joining me.

Ben Mingle: Andrew, good morning. Thanks for having me.

Andrew Dick: Well, as a little bit of background, Ben, before we talk about the Centurion Foundation, let’s talk about you and your professional experience. You’re a certified public accountant with quite a bit of accounting experience and real estate experience. So, talk a little bit about your accounting experience.

Ben Mingle: Yeah, so after college, I worked for large national CPA firms in their advisory and assurance practices. All in that was about 11 years of my career. My main focus was real estate, so those were developers, REIT’s, joint venture entities, and then the rest of my practice surrounded health care institutions and banking clients. So, a flavor across the financing and real estate aspects coupled with healthcare.

Andrew Dick: Interesting, and you were with firms, I think KPMG, and ENY were two examples, correct?

Ben Mingle: Yeah. I spent the bulk of my time with Ernst & Young, but early on I was with KPMG.

Andrew Dick: Great. After you left the public accounting world, you spent some time working for a number of real estate investment and development firms. Why did you make the leap to real estate? How did that all play out?

Ben Mingle: Yeah, I think the transition for me started while I was in public accounting working with developers and working on different real estate projects is where I kind of saw my passion for real estate and watching the project come from an idea all the way out of the ground. Then I got an opportunity through a childhood friend of mine to go work for CBL. I grew up next door to some of the executives there and so I made the leap from public accounting into the real estate world kind of through that process.

Andrew Dick: So, Ben, talk a little bit about CBL, because that was a pretty significant opportunity. CBL is pretty well known in the real estate world, it was a real estate investment trust and tell us a little bit about what you were doing there.

Ben Mingle: Man, it was a great opportunity for me. It was right at the tail end of the big run, from 05, 06, 07 and into 08, 09, 010, so I got to watch the real estate landscape change a lot. I had a really unique roll where I oversaw a big chunk of the accounting department, but then I also was kind of the finance and accounting leader over the entire development portfolio for CBL. So, that meant all day day every day I was working on different real estate projects, figuring out how to get it financed, figuring out how to work out a broken deal, in the 08, 09 timeframe.

Ben Mingle: So it was really a transformative roll for me to take me from a CPA in professional practice to an actual, you know, an executor of projects from a finance and structuring standpoint.

Andrew Dick: Right, and CBL for those that may not know was a pretty significant REID that was owned and operated retail properties, right, Ben?

Ben Mingle: That’s right, they were, you know, at the time I was there they were probably the 4th or 5th largest retail property owner in the United States.

Andrew Dick: Okay, and then you made the move to Hutton Company, which, again, pretty significant real estate company. Tell us what they did and what you were doing for Hutton Company.

Ben Mingle: Yeah, so some of the executives at Hutton were folks that I’d worked with at CBL. Hutton was, at the time, probably one of the largest net lease developers in the United States working for household names like Wal-Mart, and Dick’s Sporting Goods, and Family Dollar, Dollar General, folks like that. It was a very entrepreneurial environment, which I really enjoyed and kind of got out of public company modeling to into just a pure development model. It was a great experience for me. They, at the time when I came in, the company probably had 200 million in assets and was doing a decent bit of volume, but while I was there we doubled and tripled couple years there in a row, we had a big program with Wal-Mart. So, it was an excellent time for me to be in that space.

Andrew Dick: So you were serving as one of the chief financial officers or the chief financial officer, doing quite a bit of strategic planning, finance, etc. Is that right?

Ben Mingle: Yeah, I was the CFO there, and we were going through that tremendous growth period, so my main job was to set the strategic plan so that we had enough capital to continue to develop for our client. So that covered the full suit of finance, tax, treasury, accounting, you name it, it was all encompassing.

Andrew Dick: Okay, and then you work for a couple years there and make the move to The University Financing Foundation, also known as TUFF, tell us a little bit about that transition and what you were doing for TUFF.

Ben Mingle: Yeah, so, back to Ernst & Young, again, through some relationships that I kept up through Ernst & Young I’d gotten to TUFF and over a long period of time I learned more about their business and really saw how unique it was and what a powerful solution that a 501C3 real estate foundation can provide to its clients and really felt like it was an opportunity to take my finance skill sets and use that in a way that had a bigger impact. So, I made the move to TUFF in 2017.

Andrew Dick: Then after working for TUFF for a while, you decided to move to Centurion Foundation, which is a little bit of a similar model compared to TUFF. Talk about how you decided to make the move to Centurion Foundation and what that was like, because it sounds like you were considering forming your own foundation to provide resources to nonprofit corporations, but then found Centurion. Tell us a little bit about that.

Ben Mingle: Yeah, so being at TUFF, they were one of the early 501C3’s and they were exclusively focused on higher education, so really kind of at the epicenter of that world. While I was there, I realized the solutions that exist in the higher ed space were really needed in the healthcare space. A lot of hospitals face many of the same kind of challenges that higher education institutions face, from a funding standpoint. So, really kind of saw that that opportunity and that need was there and was thinking that I would potentially set up my own foundation to focus exclusively on healthcare and as I was going through that process, I got introduced to Greg Grove and the Centurion Foundation. Greg had a background in healthcare, tax exempt financing, he had been an investment banker at the beginning of his career.

Ben Mingle: He had set up Centurion Foundation in 1996 with the mission of helping other 501C3 organizations deliver mission critical facilities. So, it was a fortuitous chance that Greg and I met. We worked together for over a year and really kind of honed in on what we thought the vision for Centurion could be and I decided to come on board in 2018 at Centurion.

Andrew Dick: Ben, Centurion Foundation, it’s headquartered in Atlanta, Georgia, it’s been around for a while. Talk about the types of projects that it has financed in the past and what your vision is going forward.

Ben Mingle: Centurion was founded in 96, like I mentioned earlier, with a very broad mission, and that broad mission was intentional so that we had the biggest opportunity to help the most organizations out there. That’s important for listeners on the call today to think about because we want to be able to look at many different types of transactions in healthcare and in other spaces and be flexible and be open to the needs of those clients. Our mission being very broad is really important.

Ben Mingle: Centurion has financed a number of projects in the past. When I say financed, some of the are ownership structures with leasing, like we’re going to talk about later today, and then some of those are more direct lending transactions. So the transactions include long-term care facilities, student housing in charter schools to date.

Ben Mingle: Centurion also has a sister 501C3 organization with some common board membership and that’s The Guardian Foundation. The Guardian Foundation has bene around since 89, and it owns and operates long terms care facilities, and it’s financed over 20 facilities throughout the United States.

Andrew Dick: That’s interesting. So, talk a little bit about your vision for taking Centurion to the next level and really focusing on the healthcare industry. What type of transactions will Centurion be focusing on in the healthcare space? New development projects, sale lease backs, all of the above, talk a little bit about what you’re out there chasing today.

Ben Mingle: I think the all the above comment kind of hits right in with us. We look at new development projects a lot, we also were looking at sale lease backs, you know, the focus for us is where the hospital is the anchor tenant for the project. So we can do a hospital, an entire hospital, a hospital wing, a medical office building, an outpatient clinic, a surgery center, a free standing ED, really any project where the hospital is the key anchor. We can have private docs and private use in the facility, but the key for the facility for us, is that the hospital is the main beneficiary of that facility.

Andrew Dick: Okay, let’s talk a little bit about the structure, because the foundation model has been around for sometime, but some of our listeners may not be familiar with the structure. Typically, you’re going to form a nonprofit entity, the hospital which needs to be, typically, a nonprofit hospital that would be the tenant in the project. Centurion could partner with, like on a build to suit project, a developer and help the hospital really shape the project from design to completion. Talk a little bit about some of the flexibility that you have in terms of you could help source architects, fee developers, et cetera.

Ben Mingle: Yeah, so I think the most important thing for people to hear today when we talk about this is the flexibility concept. We are not set with a particular model of this how we do a project. We look at each project, and more importantly, we look at the needs of the health system and crash the model to fit those constraints that mold the ask. So, in a typical transaction, we would expect to ground lease from the hospital, we would own the project, and we would lease the project back to the hospital system. In the case of a development deal, we would bring in a fee development, fee only developer, and they would work with us and work with the hospital to manage the architect and manage the design process and manage the construction process and ensure everything is completed in the way that you would expect of a building of that caliber. The flip of that is if the hospital has all those resources in house, the development resources, the hospital can manage the design of the building and manage selecting the contractor, we’ll be involved and help all along the way, but if the hospital wants to play in that role, that’s something that we’re open to.

Ben Mingle: So, in either case, if there’s a developer involved or not, Centurion would finance with taking that lease and that support of the transaction by the hospital due to lease. We would finance the portions of the building the hospital’s going to occupy with tax exempt debt, but then portions of the hospital that might occupied by for profit uses, we would finance with taxable debt. What we feel about this is that blend ultimately creates greater flexibility in how the hospital can use the facility, and it also creates the lowest cost to capital. We feel like that’s one of the key competitive advantages that we have.

Andrew Dick: I think you’re right, Ben, I think you’re right. I think the low cost of capital is where these nonprofit healthcare systems can really benefit from the Centurion model, and at the end of the, for example, if it’s a 25 lease, at the end of the lease, one of the benefits is the hospital owns the project at the end, is that right, Ben?

Ben Mingle: Yeah, I mean, when you kind of think about the key benefits, what we like to say is number one you’re working with another 501C3 that isn’t necessarily motivated by profit. So, we’re aligned, you hope to feel alignment in working with us from day one. We’re extremely transparent. You’ll know everything that we know, there won’t be any mystery as to how the transaction gets done. The second point that you just kind of mentioned is our goal is for the ownership of the facility to revert back to the hospital at the end of the lease term. Without getting into lease accounting on this call today, we can structure that in several different ways just to meet whatever desired structure the hospital wants, but through that, the hospital is ensured long term control of the facility.

Ben Mingle: Then, what I’d say about the rent structure is we can structure the rent in any manner that the hospital wants. So we could have a flat rent over the entire term, we can have built in increases, all of that is just to manufacture the lowest cost debt service, which equals lowest rent payment and we can structure that based on whatever their needs are for that particular asset and whatever their overall corporate constraints are.

Ben Mingle: The other benefit would be, generally, we’re going to be able to pass through real estate tax exemption, every state’s different, but generally we’re going to help be able to maintain that real estate tax exemption, so that’s critical. Then in the case of a development deal, we should also be able to help avoid sales tax on construction material.

Ben Mingle: So we kind of see those as our key benefits when the hospitals are thinking about ways that they’re going outsource and looking at us, comparing us to another alternative they might have.

Andrew Dick: I mean those are significant benefits. I know, Ben, over the years when I’ve represented healthcare providers, most for profit developers can’t bring those benefits to the table. So when I think about the Centurion model, some of my clients might say, well, why wouldn’t my healthcare system simply issue bonds itself to fund the project instead of using Centurion. I think the response is, well Centurion handles the issuance of the bonds and provides a turnkey solution that is often much more simpler for the health system to execute when compared to a bond issuance through a large health system. Am I thinking about that correctly?

Ben Mingle: Andrew, you’re right. I mean we would always say that hopefully the hospitals cost to finance is the lowest, but there could be other things that are constraining them. So, if they have a need not to have direct debt, then they likely are considering outsourcing, and what we would like to say is, Centurion or someone like us would be their next best option, because we’re also going to have effectively that really low cost to financing like they will have, but it won’t be direct debt. Then we also have the opportunity to simplify it for them, where they can just sign a lease and they have a development partner that we can work with together and they have some assurance that that development partner that they may have had some past experience with or one that I could introduce them to, has surety of execution.

Ben Mingle: So when you think about an operating lease benefit that potentially saves credit capacity for them to focus on other mission critical facilities or investments or initiatives and not potentially have to tie up their credit for whatever this project would cost them.

Andrew Dick: Yeah, I think that’s an important distinction, and I think some of my clients would say, you know, going through a bond issuance for a larger health system is a ton of work. A lot due diligence needs to be performed, where as with the Centurion model, it’s much simpler, like you said, more of sign the lease and you’re off to the races.
Andrew Dick: In terms, let’s quickly talk about build to suit transactions, I think we’ve mentioned some of the benefits but Centurion could act, when it provides a turnkey solution, it could engage architects, it could engage contractors, take some development risk, help with development selection if that’s needed. Isn’t that right, Ben, I mean one of the benefits is you can just provide the financing on one end of the spectrum, on the other end you could provide a turnkey development solution for the healthcare system. I am thinking about that correctly?

Ben Mingle: Yeah, that’s right. We like to think that we provide a solution that may be different than the way they’ve been executing projects and that we bring an institutional thought process to how a building should be designed. We’re going to listen, we’re going to make sure that building is designed to meet your needs, but we’re also going to be able to point out things that your internal team may not be considering just by, we’ll bring a national developer onto our team that’s developing across the country and that perspective, a lot of times, can help lower cost or refine the criteria for the building.

Ben Mingle: So, we bring that but we also bring the humility to know that some hospitals out there today are very dialed into the things that I just mentioned and they may want to be in total control and so we’re flexible either way. So, we work architects, we work contractors, we work with developers and attorneys, all day that’s the business of real estate, but we’re so flexible, that I think that, again, separates us from some of their other options that we’ll literally do this transaction in a way that they want to execute it versus the way we want to execute it.

Andrew Dick: That’s helpful. We’ve talked about build to suit transactions, let’s talk just a little bit about sale lease back transactions, because we know a number of healthcare systems over the last 10 years or more have decided to monetize some of their real estate assets for example, medical office buildings. Centurion can also provide a solution there as well, where Centurion comes in and becomes the surrogate owner of those assets, leases them back to the healthcare system. Ben, in terms of sale least back transactions, why would someone use Centurion over any other for profit real estate company, what are the benefits?

Ben Mingle: Yeah, I think it first is rooted in our not for profit mission. I mean, when you look at a transaction with us versus a REID or another private owner, our ultimate goal in the way we will look at it is, how do we achieve sale accounting for the hospital, any gain recognition that they’re looking for, but then also structure that lease, that operating lease so that ownership will revert back to the hospital at the end of the lease term. Then, when you think about that and look at that over the life cycle of the building, you’re going to have a much lower cost of occupancy because our lease payments will be really calculated on the cost to finance and not the cost of the spread and the marketplace and what rental rates are doing today.

Ben Mingle: So, the hospital has a great opportunity to benefit over the long term because our lease payment could be fixed for effectively 20, 30 years, and a REID or other ownership model, that won’t be the case. Then, at the end, you know, we’re not going to be trying to negotiate a fair value buy out if the hospital ever wants to buy the facility back. Another big benefit in doing a similar transaction with us is, we’re likely to be able to maintain property tax exemption as well, so when they think about all those things and look at all of them, we feel like we’ve got a really compelling story when they’re thinking about potentially selling a building on a sale lease back basis.

Andrew Dick: Interesting. Talk a little bit about the lease terms, Ben, how much flexibility is there? Are we talking 15 year leases, 20 year leases, 30 year, or is it really however you structure the deal, I mean there can be flexibility there in other words.

Ben Mingle: Yeah, that’s the most important thing for the folks on the call to come away with today, is our flexibility and our willingness to look at many different structures. The simple answer is, we kind of look at it and think that the 20 year lease makes the most sense because it provides a really low cost to finance and then it also maintains a reasonable rent constant. You know, the shorter 10, 12, 15 year leases get pretty expensive on an annual basis. So, we really will look at anything though, and we’ll look at any structure whether it’s a public bond financing, a private bond financing, a CTL, or other source of capital. We have effectively all the different capital solutions available to us to work with in the Centurion platform.

Andrew Dick: You mentioned CTL financing for those listeners that may be familiar with that term or may not be, it’s credit tenent lease, CTL for short. Ben, some of the listeners may say, well, how is Centurion different than a CTL lender or how can you distinguish yourself between a traditional CTL transaction and what Centurion offers?

Ben Mingle: Yeah, so if a hospital’s thinking that they may be just put a CTL loan on the building versus selling it, there’s a couple other things that we provide that are compelling when they think about is, if there’s good tax exempt use in that building, then we should be able to finance the sale lease back with tax exempt debt and therefore lowering the cost of occupancy lower than a CTL rent loan payment. Then, it also typically would be indirect debt, because it would be an operating lease in that we hope, depending on the way your debt covenants are structured, can preserve some of your debt capacity.

Andrew Dick: Ben, in terms of, we talked a little bit about this earlier, as much as Centurion Foundation is focused on nonprofit healthcare systems, if those healthcare systems have a project that has mixed use, meaning some good 501C3 tax exempt use in the building but some for profit use or private use, maybe it’s a physician practice group that’s independent that happens to be in a medical office building. Does that limit your ability to underwrite a deal.

Ben Mingle: I think the short answer is no. We’re going to look at a couple different things on something that has for profit use. The first things we’re going to look at from our perspective is, is this facility helping achieve the mission of the hospital. So we’re going to make sure there’s a mission match and generally there will be. So we’ll need some form of C3 component in the facility to kind of accomplish that. Then, from a financing standpoint, we’ll look at, who are tenants today and which of those tenants are good C3 users and which of those users are for profit users. Then, we’ll look out into the future with the health system and ask question of what do you think will happen, you know, five, ten years down the road in this facility. Then, we’ll craft and mold the blend of taxable and tax exempt debt based upon those answers so that we can still accommodate for profit use in that building.

Andrew Dick: Great. Talk about geographic restrictions if any, will Centurion finance project in any state, or are you focused to projects in the southeast, since you’re in Atlanta, talk a little bit about that.

Ben Mingle: So, we’re having conversations right now in the southeast, and also in the west. So we’ll look at anything in the US and that kind of goes back to our flexibility comments earlier on, is we won’t have boots on the ground on the west coast, but we will partner with a developer if we need it or with the hospital system for boots on the ground. So we think that model keeps us nimble and flexible, so we’re not dictated by our own structure as far as looking at a different transaction.

Andrew Dick: In terms of other services that Centurion can provide, we’ve talked a lot about healthcare today, will you also look at higher education projects or projects that involve other nonprofits or are you just going to focus on healthcare?

Ben Mingle: Yeah, I think our main focus is healthcare. We have some university relationships, and we are looking at a couple different university projects, but our focus really is healthcare but we will, you know, an academic medical center is a good example of that. You’re blending the needs of a health system and a university, so we’re looking at some of those, and then other not for profits definitely fit in our scope, so we will look at any transaction or potential transaction that has a 501C3 use.

Andrew Dick: Great. Well, Ben, looking forward, five years from today, where do you see Centurion Foundation? What will you all be working on, is the outlook positive, I mean how much interest in this model has there been? Talk a little bit about that.

Ben Mingle: Yeah, I feel really good about where we are and where we’re going. I expect that in five years, this solution that we provide and that some others provide, will be a very commonly used tool in the healthcare space. I think it will be more of a household solution that hospitals can understand and use that to their benefit. So, I hope we’re still doing what we’re doing five, ten years from now. I just expect that there’ll probably be other people in this space and there’ll be a lot more prevalence of this approach.

Andrew Dick: Ben, how can folks connect with you and learn more about what Centurion is doing?

Ben Mingle: I think the easiest way is to just drop me a note, an email. It’s Ben, it’s bmingle@centurionmail.org. I think if they just drop me a note, I’ll be quick to follow up with them.

Andrew Dick: Great, hey, Ben, thanks for joining us on the podcast today. This is really good information for our listeners. I want to thank our audience as well 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 call The Healthcare Real Estate Advisor, to be added to that list please email me at adick@hallrender.com. Thanks so much and have a great day.

Outlook for Nonprofit Health Care Sector

December 11, 2018 Joel Swider Health Care Real Estate Advisor 27:53 Comments Off on Outlook for Nonprofit Health Care Sector

An Interview with Ken Gacka and Allison Bretz of S&P Global Ratings: 

In this episode, Joel Swider, a health care real estate attorney with Hall Render, talks with Ken Gacka and Allison Bretz of S&P Global Ratings about S&P’s Nonprofit Healthcare Outlook for 2018 and what to expect in 2019. Ken Gacka is the Senior Director & Analytical Manager of Healthcare Ratings at S&P, and Allison Bretz is an Associate Director for U.S. Public Finance at S&P. More information on global health care finance is available at S&P’s website: www.spratings.com/healthcare.

Podcast Participants

Joel Swider

Attorney with Hall Render

Ken Gacka

Senior Director & Analytical Manager of Healthcare Ratings at S&P

Allison Bretz

Associate Director for U.S. Public Finance at S&P

Joel Swider:                        Hello, and welcome to the Health Care Real Estate Advisor podcast. I’m Joel Swider, and I’m an attorney with Hall Render. Today we’ll be talking with Ken Gacka, senior director and analytical manager for health care ratings at S&P Global Ratings, and Allison Bretz, associate director at S&p Global Ratings. We’re going to be talking about S&P’s 2019 outlook for the U.S not-for-profit health care sector, which is expected to be released early next year. Ken, and Allison thanks for joining me.

Allison Bretz:                     Thank you for having us.

Joel Swider:                       Walk me through the types of services that S&P provides to health system clients. Of course today we’re focused on the nonprofit health sector, but I assume this process will be similar in the for profit sector as well. Let’s say a hospital or a health system comes to you, says, “We want to issue tax exempt debt, we’re going to pay for a new hospital building. Take us from there.”

Ken Gacka:                         Sure, thanks Joel and thanks for having us. To give you some context, S&P is not for profit health care team it’s a part of S&P’s U.S public finance practice. U.S Public finance issues ratings on over 22,000 entities across the U.S, the not-for-profit health care team focuses on the health care especially. We cover a wide range of hospitals and health systems across the U.S, we have over 500 organizations that we rate. They range in size, and range in services offered, so we rate organizations with revenue basis as high as $75 billion to those as small as $30 million. So we have a wide range of clients that we interact with, and you have all shapes and sizes in between, large multi facility health systems, critical access hospitals, academic medical centers, integrated delivery systems that have both the provider arm and an insurance arm. We cover a wide range of organizations, and we find that to be very important as we analyze the sector and keep our finger on the pulse of the trends and emerging credit risks that may be out there. Our team is comprised of 16 health care specialists located across the U.S.

Ken Gacka:                        When we interact with our clients, you’re right it is typically tied to a debt issuance. So organizations will come to market, and we’re a key part of that process giving our opinion of the credit worthiness of the issuer. That starts really an ongoing relationship, so every year then we speak with the client, get an update on their financial position, their strategies, and so forth. And determine whether the rating needs updated, either upgraded, or downgraded, or through an outlook revision. It’s really part of an ongoing relationship that we have with each of our clients once we first initiate the rating.

Joel Swider:                       I suppose that depending on your analysis, then that may affect the borrower’s interested rate, or maybe the amount of debt that they’re able to issue. Is that right? What is the next step after that?

Joel Swider:                       (silence)

Joel Swider:                       And that’s all right if you don’t know. I realize that you’re not bankers here.

Ken Gacka:                        I’m sorry. No, that’s … sorry, I was on mute Joel. I’ll just start again here from your question. Yes, the rating is one piece of information that goes into determining interest rates that an organization may have to pay for their debt. I find often as well that the rating serves as a good benchmark for an organization, in fact we have some organizations that don’t have rated debt. They carry an S&P rating so that they have that discipline that comes with the process so that they can compare themselves to others in their peer group across the standard methodology like we have.

Joel Swider:                       Sure. I guess Allison, could you give us some more background as to … we’re looking at the sector outlook, what are these outlooks and what are they designed to do?

Allison Bretz:                     Sure. The sector outlook is a piece that we release at the beginning of every year that summarizes our expectations for the not-for-profit sector, the outlook encompasses our view of the whole sector and where we think the balance of rating actions might lead for the upcoming year. It’s an opportunity for us to address the big picture, the post to much of our work with covers individual hospitals or systems. It’s really our way of stepping back, looking at the sector as a whole and saying to the market, “Here’s where we think ratings might fall next year, and based on what we’ve learned in the last year here is why we think that.”

Joel Swider:                       Okay. Your … primarily in terms of the raw data that you’re looking at for the outlook, I assume you’re going to look primarily to the hospitals or health systems, whoever your clients are who you’ve been examining throughout the year. Is that right?

Allison Bretz:                     Right. We look at financial data that’s publicly released, audits and interim financials, as well as data that’s shared with us from these hospitals and health systems. We look at our conversations with the management teams, and the materials that they’ve provided to us. Since this is a more wholistic perspective, we also take a look at the industry as a whole. We look at the industry trends beyond just hospitals and health systems, state and national legislative moves, or things that we might see upcoming in the U.S economy as a whole. All the things that play a role in shaping the sector beyond just the players that we work with.

Joel Swider:                       Who’s the primary audience then for your … again, talking about the outlook in particular, who’s the primary audience for that?

Allison Bretz:                     Our audience is the investor communities, so the individuals that read our reports. But as Ken alluded to earlier, our hospital and health systems also read the outlook with great interest and so of course they can frequently get bogged down in their own individual issues. So I think it’s a helpful perspective for them to look at how we’re viewing the industry as a whole, and what we’re hearing from other players in the market.

Joel Swider:                       As we’re looking toward 2019, I was reviewing your 2018 outlook. We’re not 20 … 11 months into the year, 10 months since you released the 2018 outlook. I’d like to look at some of the topics that you have focused as being significant factors that contributed to your outlook, and maybe get a feel for whether those predictions really came to fruition, or whether we’re going to see maybe some changes in those particular areas for next year. Starting with M&A activity within the sector, you had mentioned in your 2018 outlook that M&A activity remains heightened within the sector, and at that generally supports credit quality depending on merger effectiveness. Could you explain that a little bit? How does the heightened M&A activity support credit quality?

Ken Gacka:                        Sure. I might take a step back with this one, and talk a little bit first about the reasons why we’re seeing so much M&A. I think then that would dovetail nicely with the question of the supporting credit quality. M&A in health care has been around for a long period of time, we’ve been seeing mergers and acquisitions for decades. Now, I think the reasons why you see M&A has evolved over the last several years, in the past I think the players were often very clear it was going to be a large, strong health system acquiring a perhaps struggling smaller standalone hospital. You were going to see the M&A driven by desire to scale up so that you can take advantages of economy’s scales, and have more leverage to pay or send suppliers. What we’re seeing now is those reasons are still very important, but we’re also seeing that these mergers and acquisitions are driven by competency based needs, so organizations that may be looking to add a service line, or a geography that they don’t have that’s important to their longterm strategy.

Ken Gacka:                        Also, I think there is a real play based on the nature of the operating environment being difficult, I think a lot of organizations do see the need in the time of tightening margins to be able to partner with a larger organization to be able to expand or to invest in IT infrastructure which is very costly. When we see some of these organizations pair up with another organization, we often see the smaller troubled credit maybe getting bought up by a large organization still today. In fact as we look at our rating actions this year, we’ve got quite a few that were upgraded just by virtue of being acquired by another organization. For instance, present health, a triple B category credit was acquired by Ascension this year and that was an upgrade. That sort of lens to one of those reasons why one may consider partnering with another organization.

Joel Swider:                       Sure. I’m going to ask a dumb question, if we see a general increase in terms of credit quality because of … as you mentioned, you might have an entity with weaker credit quality being acquired by a higher rated hospital or system. Is there any sense in which you want to maintain a bell curve? Or does it look bad if we’ve got all of these tax exempt hospitals having very high credit ratings, and very few in the lower categories? Or does that not even really come into play?

Ken Gacka:                        It muddies the numbers a little bit because you do … if you did look at our rating distribution over time, you would see a pretty clear bell curve. Oftentimes those on the far right of the curve, so the non investment grade credits are acquired and that double B rating goes away and it becomes an A if it’s taken on by a stronger organization. I don’t think it’s a bad thing, but it muddies the water a little bit on … it mutes how loud the view is of the negativity in the sector.

Joel Swider:                       Another issue that you had discussed in your 2018 outlook was legislative and administrative risks, you had said that they would remain ongoing and that the ACA repeal and replace initiatives, and the likelihood would also impact as well as the likelihood of raising uninsured rates. What are we predicting for next year? Obviously we just had an election, any difference in that category?

Allison Bretz:                     I would say that the election did present some changes, I think we’ve identified a few key factors. With Democrats now in control of the House, I don’t think we expect further repeal and replace legislative efforts. We did see several of those over the last two years, but I think that will cease now that Republicans no longer control the House. With that said, I think we do expect some movement from Washington still that could decrease insurance coverage. There’s been a lot of conversation about allowance of short term, or skinny insurance plans which may not fully cover basic benefits meaning that even if individuals appear to be insured, they still are not paying out of pocket, or not being able to pay for many services. We’re also seeing supportive, more stringent requirements for Medicaid work requirements which may result in lower coverage. But on a state level, we did see voters in Idaho, Nebraska, and Utah vote to expand Medicaid. We saw general improvement in ratings in states that initially expanded Medicaid under the Affordable Care Act, and so also I think expansion will be generally positive for hospitals and health systems operating in those systems; Utah, Idaho, and Nebraska.

Allison Bretz:                     We’ll be watching to see how quickly the expansions are implemented, and the ultimate size of the newly covered populations. But I think that’s generally a credit positive for operators in those states. Overall I think the election was mostly positive from a health care perspective, but we will continue to see some push out of Washington to decrease insurance coverage … maybe not through explicit legislation, but through some of these efforts at the margins.

Joel Swider:                       Sure. It’s interesting to think that sometimes gridlock is a good thing when it comes to not seeing seismic shifts in some of these policies. Another point that you made in your outlook last year was looking at nontraditional players and their significance in the market, you had said at that time you didn’t really see that happening within the year, in other words by 2018 year end. Does that remain for 2019 too? Or is this going to be the year we start seeing some more shifts in terms on those nontraditional players; Amazon, CVS, and those types entities?

Allison Bretz:                     I think we’re expecting this to not be a major issue in 2019 as it has not been in 2018, at least for our hospitals. Let’s say we are I think likely to see some more tangible things, the CVS at the merger was recently approved, the Berkshire Hathaway, JP Morgan, and Amazon company has named it CEO and seems to be forming a structure. 2019 should provide some clarity on strategy from these nontraditional players, but I don’t think we expect yet to see them really eat into the market of our traditional providers at the hospitals. We are seeing more movement to nontraditional revenue streams from our hospitals, and I think inpatient revenue used to be their bread and butter, and where they made most of their money. That’s really no longer the case, we’re seeing much more revenue driven from outpatient ventures, other joint ventures that are not necessarily the traditional heads and beds that hospitals have provided.

Allison Bretz:                     I think we do expect that to continue in 2019, and to see competition from ambulatory surgical companies, urgent care, and other providers that maybe do provide care outside of the traditional hospital setting, but maybe not from these disruptors that have been making the news so much. I think that might be a little bit slower to move into the industry.

Joel Swider:                       And you’re talking Allison too … I mean do you think that there is any sort of siphoning off of some of the maybe healthier patients? In our own office, every year we’ve got to get a physical for insurance purposes, or it gives us a benefit in terms of our insurance rate. Some people will go and get their physical at let’s say at Walgreens, or CVS, or one of these doc in the box type places. Are we going to see any kind of siphoning off of some of the healthier patients in these nontraditional settings, which I guess would in turn leave hospitals with the older, sicker patients, which presumable are less profitable? Any truth to that?

Allison Bretz:                     Absolutely, there’s truth to that. I think that’s already very much happening, and it has created some of the revenue pressure that is reflected in our median, the decreasing operating margins over the last few years. We have seen hospitals and health systems invest more meaningfully in getting a piece of that pie, so they’re buying up Urgent Cares, they’re partnering through joint ventures with Urgent Care providers. Some of them are putting their own clinics into Walmart, CVS, Walgreens, et cetera. They’re really making an effort to get a foot in the door and provide services in more convenient lower cost settings of care because they recognize that many young healthy commercial insured individuals don’t want to come to the hospital for basic services, and if they don’t need to they’ll seek it in a more convenient setting. So I think going forward the providers we expect to be most successful are those that are able to provide care in more creative ways, and a different setting than just traditional hospital.

Joel Swider:                       In terms of some of the raw data that you analyze through your outlook, I looked toward the end of your 2018 outlook. You have several charts, and you showed an increase in the 2017 data regarding the number of ratings downgrades and revisions as compared with recent years. There were also more negative than positive downgrades and revisions, has that trend continued so far in 2018?

Allison Bretz:                     Yes, it has. To the first nine months of 2018, we’re seeing a similar trend with slightly more negative rating actions than downgrade. We’ve had 29 negative outlook changes, and 21 positive outlook changes. Of the 279 rating actions, we’ve had for the first nine month of the year about 7.5% were upgrades, and 10.4 were downgrades. So that trend has continued, but it’s important to note that 82% of those rating actions were affirmations. Overall there is tremendous underlying stability of the sector, and that really reflects the stable outlook we had coming into the year. We have seen more downgrades than upgrades, more negative rating actions, but overall 4-5 rating actions, or a little more than that were affirmations reflecting that real underlying stability in these credits.

Joel Swider:                       Another interesting chart that you guys had published in your 2018 outlook was days cash on hand, it looked like that had been increasing while longterm debt and capitalization percentages had been decreasing. Do you have any idea why that is? And whether that might have an impact on, for example, building, and construction in the future?

Allison Bretz:                     Days cash has been increasing for a few reasons. I think over the last few years we’ve had very strong investment markets, and not for profit hospitals … not universally, but generally tend to carry thoroughly large investment portfolios. So as the markets have done well, they’ve seen real growth and liquidity so that’s helped support growth of days cash on hand. At the same time we have seen construction slow down somewhat across the industry, large projects do continue but I think they are fewer than they were several years ago. We’re not seeing as many major towers, or large scale patient bed construction projects. Instead investment is a little bit more strategic, so many hospitals and health systems as I alluded to before are looking to invest in smaller scale outpatient facilities either on their main campuses, or in the markets were they’re located. Then we’re also seeing investment in IT, so not physical improvements to buildings but investments in software system and other technology that helps them remain competitive have and become more efficient.

Joel Swider:                       One last chart I wanted to focus on from your 2018 outlook, you had shown that nonprofit median operating margins fell sharply … pretty sharply anyway from 2015-2016, and S&P put out another set of medians in July of 2018 which showed a continuance of that trend. To the untrained eye this looks bad, is this a red flag?

Allison Bretz:                     Sure. I’m not sure it’s a red flag, but I do think it’s a trend that we expect to continue. It’s one that we’ve seen for last few years as operating margins continue to decline. Revenue growth has really plateaued, reimbursement continues to worsen, so payer mix deterioration which includes movement from patients on commercial insurance to patients on Medicare, as well as weaker reimbursement from those commercial payers is affecting that overall revenue base. Then on the expense side we’re seeing really significant growth and supply costs, especially for pharmaceuticals, specialty pharmaceuticals in particular, and salary and wage pressure as competitions for providers … especially nurses, and other mid level providers grows. Those two things combined as you might expect is very much squeezing operating margins across the industry, and I think we do expect that to continue. What we’ve seen over the last few years, particularly with healthy investment market is that non-operating returns have offset some of this, and so debt service coverage remains reasonably healthy and overall cashflow is fairly strong. I think the red flag, or something to be concerned about as we look into 2019 is the fact that investment markets may slow.

Allison Bretz:                     We’ve seen a downturn just over the last few months, and I think there is some concern that we’re not going to see the kind of investment returns we have historically or certainly over the last few years which would both affect liquidity as we’ve talked about, we might see slower growth on days cash on hand, but also will affect cashflow. Those investment returns are going to decline, and may no longer be able to offset the fact that operating margins are getting weaker.

Joel Swider:                       Let’s shift and talk a little bit more about 2019, I’m assuming that you’re well underway in terms of looking at your outlook for next year. We’ve talked about a few issues, any other thoughts about what you’re seeing for 2019? You had mentioned briefly in the 2018 outlook about the Tax Cuts, and Jobs Acts, and also the removal in advance for fundings. What are we seeing in those areas, and in the other areas in 2019?

Allison Bretz:                     As we mentioned, I think we’ll continue to see softening operating margins, I think the challenges that we’re seeing across the industry will not abate and competition is becoming more fierce everyday. These nontraditional providers are coming in, and there are just more places than ever as you alluded to for people to get some of the services that they have traditionally received at hospitals. That continues to be a challenge, and I think we expect operations to be difficult. Mergers and Acquisition activity is likely to slow somewhat, partly because there are just some markets where there is no one left. There’s not any further layers, or any further mergers that can take place. But there are certainly still plenty of small hospitals that will continue to struggle, and many of them may seek part partners in these larger systems. And they need that support from a larger scale provider, so maybe some slowdown on M&A but I think we do expect it to continue. Then from the Tax Cuts, and Jobs Act, from that perspective, advance refundings are gone, they’re no longer legal except in cases of murders and acquisitions.

Allison Bretz:                     For six months after a merger acquisition you can’t do a tax exempt refunding to consolidate debt, so leading up to that in late 2017 we saw a flurry of issuance from players concerned that there would be no tax exempt funding at all. That fortunately turned out not to be the case, but we did see a fairly slow pace if issuance in early 2018 since many people accelerated those plans and went ahead in late 2017 although things have picked up later in the year. Going forward, I think we started to see some less traditional or different debt structures as a response to the Tax Cuts, and Jobs Act. We’re seeing more taxable refundings, or taxable that issuance is generally. That market continues to mature, and then variable rate debt structures have also become more popular. So some changes in the structure of the debt that we’re seeing issued which I think is somewhat a response to that Tax Cuts, and Jobs Act.

Joel Swider:                       Interesting.

Ken Gacka:                        The only thing I would add Joe is … I agree with everything else and said on trends that we expect to continue, and we are in the phase now of evaluating the data in preparation for the launch for 2019 outlook. That will be coming in early 2019, so be on the lookout.

Joel Swider:                       Okay. Well, great. Before I let you guys go, whenever I get the chance to talk with somebody who’s an expert in their particular field, I just love to hear how they came to be at their current position. Allison, curious how you came to be in the public finance world, and also in particular in the health care sector?

Allison Bretz:                     Right. My undergraduate degree was in public policy, I’ve always been very interested in policy, and the nature of the public sector. I worked briefly after college for the city of Chicago, and then in finance for a large private university. So really started to get some experience in the not-for-profit sector. During that time I was also volunteering extensively in hospitals, and got really interested in the business of hospitals, and how hospitals operate. I ultimately went to graduate school and got a degree in health policy and administration, and I’ve been at S&P ever since. I really became interested in the inner section of health care policy in business, and hospitals sit really nicely in at that intersection. This has been a great role for me to learn about that world.

Joel Swider:                       Well, great. Thanks again Allison. And Ken I was looking at your bio, I saw that you had a background working at a health system in the past in Pennsylvania. Tell me about that and how you came to S&P?

Ken Gacka:                        Sure. I’ve been in health care for a long time, over 15 years in different capacities, different sides of the table. My first job out of undergrad was working as a financial analyst for the Commonwealth Health System in western Pennsylvania, I worked there for about five years in the finance area. Went back to grad school, I got my MBA and realized I really really enjoyed health care, the dynamic nature of the operating environment and decided that I would continue in the sector but on a different side. I got into health care consulting doing strategy consulting, reimbursement consulting, visibility studies. That got me to the point where I started to interact more with the rating agencies, and opportunity came up with S&P about 10 years ago and I was thrilled to join the not-for-profit health care team as an analyst. I’ve been here for 10 years, and pleased to say I now have the opportunity to lead a great team of analysts covering the evolution of our health care operating environment. It’s been a great journey, and we still have a lot of exciting times to come in our health care world.

Joel Swider:                       Yep, you’re absolutely right we do. Well, before I let you go, is there … where can people go to learn more? Is there a subscription list? Or other … where can people access your 2019 outlook when that is released?

Allison Bretz:                     I would encourage people to visit our website with is spratings.com/healthcare that site is great because it provides a combination of materials from our team not-for-profit health care, as well as our for profit team which includes for profit hospitals, medical devices, and pharmaceuticals, as well as our insurance team which covers the insurance industry. It’s a really nice marriage of materials from all three of our groups, and it also includes reportings of webcasts that we’ve done over in the last year, announcements and events that we host. We do host a few events around the country every year, and I would encourage people to attend if that is of interest to them. As well as articles that we’ve published, both sector outlooks, the medians, and other subject specific articles about the health care industry. So that’s sptratings.com/healthcare for all your health care needs.

Joel Swider:                       Great. Well, Ken and Allison, thanks again for joining me.

Allison Bretz:                     Thank you so-

Ken Gacka:                        Thank you.

Allison Bretz:                     … much for having us.

Joel Swider:                       If you like what you heard on this podcast, please subscribe on iTunes. If you’re interested in additional content from Hall Render, you can send me an email at jswider@hallrender.com J-S-W-I-D-E-R@ hallrender.com to subscribe to our month newsletter. Thanks again.

 

Coworking Space for Health Care Professionals

December 11, 2018 Andrew Dick Health Care Real Estate Advisor 23:36 Comments Off on Coworking Space for Health Care Professionals

An interview with George Scopetta from WeShareMD about Coworking Space for Physicians and Health Care Professionals:  

In this episode, Andrew Dick interviews George Scopetta, the co-founder and CEO of WeShareMD. WeShareMD is a company that provides coworking space to physicians and health care professionals.

Podcast Participants

Andrew Dick

Attorney with Hall Render

George Scopetta

Co-founder & CEO of WeShareMD

Andrew Dick:                     Hello, and welcome to the Healthcare Real Estate Advisor podcast. I’m Andrew Dick, and I’m an attorney with Hall Render. If you’ve been following real estate news over the past year, you might have noticed that co-working space is really hot right now. Companies like WeWork are creating trendy space for tech start-ups and small businesses looking for a place to call home. A recent article suggests that WeWork is now being valued at $35 billion. Today we’ll be talking about co-working space for healthcare professionals and its impact on healthcare real estate.

Andrew Dick:                    If you’ve worked in healthcare, you know that hospitals have provided co-working space for physicians for many years. Now, the space offered by WeShareMD is not your typical hospital co-working space. WeShare is different. It’s high end space within MOBs for healthcare providers to use on an ‘as needed’ basis. Before we jump into the business, I’d like to welcome our guest George Scopetta. George is the co-founder and CEO of WeShareMD and the Managing Partner and founder of Medicus Partner Group. George, thanks for joining me.

George Scopetta:             No. Thanks for having me.

Andrew Dick:                    George, before we start talking about your business, give us a little bit of background about yourself. Where did you grow up? And what did you want to be when you grew up?

George Scopetta:             So, I grew up in Miami, Florida, and when I was a kid I wanted to be an investment banker. And so, when I went to school, my focus was what I wanted to do. I kind of went the long way, in that I went to Law School and I ended up becoming a Tax Attorney and working as a Tax Attorney with Big Four for a couple of years and then I went into banking after that.

Andrew Dick:                    So, what was attractive about investment banking, and tax? What did you like about doing that kind of work?

George Scopetta:             I come from a family of entrepreneurs and of running businesses, and I always wanted to be in the corporate world. And so, that always attracted me because that was what my grandfather did; that’s what my dad did. And so that’s always what I wanted to do. Mainly because that’s what I saw growing up. And when I got into the corporate world, I realized I was very good at it, but I always wanted to do my own thing eventually.

Andrew Dick:                    So, you work in the corporate world for a number of years- in accounting and then in the banking industry, and at some point you met a physician, who ended up becoming your partner. Talk a little bit about that George.

George Scopetta:             Absolutely. I was in banking, I was turning around troubled financial institutions for private equity and we had sold our last bank. I was retained by the creditor committee of the holding company to basically, dissolve the rest of the holding company of the bank. And, at that time I was working from home. I had the opportunity to travel because I really didn’t have to be in an office every day, but I was still getting paid. And I came out to LA on vacation and my friend that I was visiting, had an investor event down in San Diego, so I decided to go with him because it sounded like a fun trip. And so I came down to San Diego and went to a baseball game as part of the investment conference, and I ran into a doctor- Dr Jean Schau. And we started talking and he started telling me about his office buildings that he had, and his ideas on lifestyle healthcare medicine, and how to integrate lifestyle medicine into the real estate. And I just thought it was the time, right after Obamacare was passed, and healthcare was a big issue at the time and I just thought it was a great idea.

George Scopetta:             I actually stayed a couple days extra, changed my travel plans and went and did some due diligence when I was here, and the more I looked at it, the more I liked the idea and the deal. And, so I ended up investing. And we started with one building at the time, and I took over the real estate company… well it wasn’t really a real estate company at the time, but it was like a guy that owned a building. And I made it a business. And we started medical office buildings here in San Diego. And we started with one and then we refinanced and bought another. Most of the stuff was value-add real estate. We bought 50% occupied buildings or 30% occupied buildings, turned them around, filled them, created value, created equity, and then moved on and bought another one with the equity that we built. And we’ve just built the business over the last couple of years.

George Scopetta:             WeShare came from that, in that James always had the idea for WeShare, and we’ve had it for the last three years, but we wanted to stabilize the real estate portfolio and get multiple locations out there. Because, the whole thing with the co-working space, it’s a good idea but if you just have one co-working space… the idea with the medical co-working space is really that we’re bringing the doctor to the patient. Not so much the co-working space aspect of it. And so I think that the real idea that we have, is that we’re creating a model with the multiple locations and the membership model that a doctor can basically, practice in any one of the locations, in any one of the markets that we have an office in. And I think that, that’s the attractive thing about our model versus just, “Okay, we’re just a normal co-working space. We’re gonna place one office in San Diego, open it up and people are gonna come, because it’s co-working.” It’s not that.

George Scopetta:             Our model’s more sophisticated in that, what we’re trying to do is change the way that doctors practice, because nowadays, you can’t… and I see it in my MOB business. You can’t really just plant a flag and hope that your patients are gonna come to you any more. That’s the one thing… I just spoke at a conference yesterday, and that’s the one thing that resonated with me from all the other conversations on the other panels, was everybody’s trying to figure out, how to bring medicine and healthcare to the patient in a different way. In that it’s home healthcare, concierge medicine, telemedicine… it’s all trying to bring the doctor over to the patient and not the patient to the hospital. And I think that, that’s what our model does, is it really allows a doctor to go and have access to different locations, to actually go out to the different patients. So, he’s traveling to the different locations, similar to concierge medicine, except they’re not going into the home, they’re practicing in an office that’s near the patient.

Andrew Dick:                    So, George, what does the model look like? I think some of our listeners will say, “Well, hospitals have had some type of co-working space for years, but it’s usually space in the back of a hospital, it’s really dated space… your model’s different. This is high-end space from what I can tell, and it’s space that a physician would think is very attractive, as well as a patient. So talk a little bit about the space- what it looks like when you walk in, and what makes it different from other options that are out there right now?

George Scopetta:             Oh, absolutely. I think that in all our MOB’s, in the real estate business, we always sought out to basically be the nicer option. We try to make the patient experience feel very comfortable. Our waiting rooms look like living rooms. They aren’t like the typical patient room, where it’s just a line of chairs and some old magazines from eight months ago. We try to make it look like a living room feel, with coffee and really nice plush leather couches that are comfortable. All the counter tops are granite counter tops, including in the patient rooms and everything like that. We try to make it look very comfortable, and one of the things that we do, is we have TV screens and stuff like that. Because really, when you walk in, you want the doctor to be the focus of everything, not WeShareMD. No one wants to know that they’re going to the doctor in a co-sharing space.

George Scopetta:             So we strive to put… when the doctor comes in and reserves the space for four or eight hours, we put his name on the TV screen behind the front desk and we try to make it look like it’s his office when he comes in and not like they’re coming in to a co-working space.

Andrew Dick:                    Okay. Talk a little bit about how the model works, George. You have a number of locations, how does a physician sign up to be a part of the co-working venture? Do they pay a membership fee and then pay for blocks of time? How does it work?

George Scopetta:             So, essentially, what ends up happening is any physician can go to our website and there’s a member log-in. You create a member log-in to our website and that member log-in will send you to our member site. It’s free to have a member log-in. We do have a couple of different options. We have a virtual office option, which allows you to use our address- our addresses of the different areas and to advertise this as the WeShare address as your office address. And that’s important to physicians because when they’re signing up and designating a location for their Med Mail, you have to have an address in an MOB. You can’t have your address as your house. You have to have an office, and so that’s super-important for doctors, because they can list this as the office that they practice in, and that’s $150 per month for the doctors.

George Scopetta:             Once they do that and they name WeShare as where they practice, they can rent rooms by… we have clinic blocks which are four hours, because that’s what typically what a clinic is. It’s usually a four hour clinic. So we have a morning clinic, an afternoon clinic and a evening clinic. And doctors can reserve four hours at a time, and they can log onto the site and all the scheduling is done online at the site. So if they log in, they can go schedule a clinic, click on the building that they want, click on the day, click on the time and then they pick if they want two offices, or one office, and a patient room, or two patient rooms. And then they check out and they pay. And you can pay with your credit card. So the doctors will actually get points now for paying for their space on their credit cards, if they want.

Andrew Dick:                    George, how far in advance, would a physician need to sign up for space?

George Scopetta:             They can sign up and reserve space within 24 hours of their next appointment.

Andrew Dick:                    And once they show up, George, I know that one issue that we run into with what we call timeshare clinics, over the years is some of the space needs to be turned over. So, if the physician’s there in the morning, and a different physician comes in, in the afternoon, I’m assuming that you have a receptionist, or a staff member that’s going to clean up the space and make sure it’s usable for the next user?

George Scopetta:             Yes, we have a receptionist, who’s… she’s not really a receptionist, she sits at the reception desk but she’s really the office manager of the office. And she’s there to greet you and the doctor when they come in. show them where their office is, show them where their space is and make sure that they’re comfortable and she or he is the presence at the front desk, that greets the patients when they come in, shows them what they need to do, and then when the doctor’s ready for them, she or he takes them back into the patient room for the doctor and sets them up. That person is also… after the four hours, is responsible for making sure the rooms are tidy and cleaned up and wiped down, so that when the next physician comes in, everything is perfect and as it should be in the different rooms.

Andrew Dick:                    George, what type of physician is ideal for this arrangement? Is there a certain type of specialty like dermatology, or primary care, or does it really run the gamut?

George Scopetta:             I think it really runs the gamut. I mean, everyone asks me this question and says, “Is this for specific doctor types?” And it’s “No.” We offer regular offices, and we offer a typical 10 x 10 examination room. And so, really, with the type of set up we have, it kind of accommodates… there are certain specialties, like super specialty that may need some specialized equipment that they can’t get into the space. But, it pretty much runs the gamut from everybody. So, I think it accommodates… the partner’s a doctor and he’s like, “This type of set up will accommodate pretty much 80% of all doctors out there.” And that’s what we strive for, is to accommodate everyone.

Andrew Dick:                    George, what about mid-level providers? In my world, we work with nurse practitioners and physician’s assistants. Could they rent space as well?

George Scopetta:             Absolutely. I don’t say that it’s just for doctors, I say it’s for healthcare professionals. I think that there are a number of nurse practitioners and other healthcare providers out there, that this space is attractive to. And we’re open for everyone, as long as they’re licensed to practice their craft.

Andrew Dick:                    And George, talk a little bit about add-on services that are available, so if a physician or a mid-level provider wants to lease some space, do they have the option to rent storage space or rent a nurse or a technician? What are the other add-on options?

George Scopetta:             Absolutely, so we have conference rooms in the space, so if you’re practicing telemedicine, we’re set up to actually do that. We have storage space in the space, including lockers… so you can lock up your equipment so you don’t have to lug it around from your house to the office. And we are going to start providing nurse practitioners or MA’s really, for an additional charge, so that doctors if they want the help of an MA for their clinic, they can rent that out for an additional charge as well. And we’re gonna continue adding other services. I think that we have a full McKesson account and so, if doctors want specific supplies and they want to order some specific items to have available when they come, I think that we’re gonna start doing that as well.

Andrew Dick:                    Well, that sounds great. It sounds like, when you set one of these clinics up George, there’s some risk that you’re taking. How do you know that physicians will continue to come back, because it sounds like it’s an arrangement between WeShare and the physician, or the healthcare provider. It’s really on-demand whenever the provider needs it. Is that right? And how do you make sure hat they come back? Is it the quality of the space and the services?

George Scopetta:             I think it’s the quality of space and the service. And that’s what I’m counting on. I think that we offer something that’s not available in the marketplace and not available to them. And so I really think that it’s sticky in the fact that they have the access to the multiple locations. They have the access to the really nice medical space, and the other options in the market, especially in the major metropolitan areas, are really bleak. And so I really think that we offer a tremendous service. And that’s what brings people back. I think what makes us attractive, is that there is no obligation. You don’t have to sign a five year lease. You don’t have to sign a 10 year lease, which nowadays with the changing healthcare system, you never know what’s gonna happen… the doctors don’t know what’s gonna happen, five, 10 years down the line. And to be committed and locked into a liability that long, that’s really tough. And to be locked into a liability in one location- make it or break it, that’s a tough proposition.

George Scopetta:             I think that what we offer them is a unique value. Because of the multiple locations and the high end space, that ‘re gonna come back. And that’s what I’m counting on.

Andrew Dick:                    George, how many locations do you have? Where are they at and what’s the plans for future growth around the country?

George Scopetta:             Absolutely. So, we currently have offices in Mirarmar- San Diego, UTC- La Jolla, Temecula- Antonides, and then we have two under construction right now which should be open by the end of the year in Oceanside and right on Tricity hospital campus, and in La Mesa on the Campus of Grossmont hospital. So we pretty much blanket all the major medical markets here, in San Diego. I think, in the future, we’re in the process of closing our seed round right now, and we’re in talks on expanding into Orange County, LA, San Francisco, and Seattle.

Andrew Dick:                    And George, will these new locations be in buildings you own, or a mixture of buildings you own and other space that you lease from unrelated landlord?

George Scopetta:             I think that the new locations are in spaces that we would negotiate with landlords.

Andrew Dick:                    Well George, this is a very interesting concept. I think it’s one that certainly will gain traction. How can folks learn more about you and your business?

George Scopetta:             Absolutely. They can go to the website at www.WeShareMD.com or they can look me up on Google- there’s a lot on there about me and my business. Or they can go to my real estate site at www.medicuspropertygroup.com if they want to learn more about my real estate business.

Andrew Dick:                    Well George, thanks for joining us today. We wish you and your company, the best in the future. And I want to thank 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 Adviser. To be added to the list, please email me at adick@hallrender.com. Thank you and please remember that the views expressed in this podcast are those of the participants only, and do not constitute legal advice.