Health Care Goes Retail

The increased health care facility need is estimated to be approximately 64 million square feet, and largely focused on community-based outpatient care, which is emphasized in the recent health care reform legislation, as technology outpaces the need for traditional in-patient hospital services and operational efficiency becomes critical. In fact, one consulting firm estimates that the use of outpatient services will grow by more than 21% from 2009 to 2019, while the use of inpatient services will grow by only 1.7% during that time frame.

Increased patient demand and quality of care expectations, coupled with government efforts to control spending, will require health care providers to determine how to best service a growing patient population while simultaneously reducing costs. Notwithstanding the possible repeal of the health care reform law, providers will still need to focus on managing costs and improving the quality of patient care. As the health care landscape evolves, the development of new and more efficient delivery models, such as Accountable Care Organizations (ACOs), is likely to require increased capital expenditures for medical real estate and technology. The shift in the manner health care services are delivered will require the redesign of existing facilities, and strategic location of new facilities. Reduced access to the debt capital markets is challenging health care providers in need of funds to look beyond the traditional methods of borrowing and ownership to maximize the contribution that their real estate assets make to achieve their business and financial goals.

One option health care providers have turned to is the monetization of their existing real estate facilities through a sale-leaseback arrangement or other joint venture-type transaction with third-party partners. The sale-leaseback transaction is potentially an attractive source of capital for providers as health care real estate, now more than ever, is trading at higher values than similarly sized non-medical commercial real estate. The attractive nature of medical real estate has drawn numerous types of buyers and investors to the market ‘ such as pension funds, private investment funds, and frequently, health care-focused real estate investment trusts (REITs). By engaging in a sale-leaseback transaction with a REIT, for example, providers are able to potentially raise much-needed capital to invest in operations, retire debt, increase efficiency by maximizing the benefits of existing space, acquire physician practices, realize potential tax benefits and, importantly, focus on the core mission of delivering high-quality health care.

Hospitals and other health care providers now also are seeking other non-traditional real estate strategies to extend patient market share and provide more cost-effective and convenient medical care by leasing new facilities in community retail locations. For example, a study prepared by the RAND Corporation released in November 2011 found that the use of retail medical clinics increased tenfold between 2007 and 2009. It is increasingly common for health care providers to lease space in community retail centers that are near hospital campuses and more conveniently accessible for patients. Retail health care uses may include walk-in clinics, fitness and wellness centers, ambulatory surgery centers, freestanding emergency departments and primary care physician offices, among other uses. Health care tenants have been able to take advantage of favorable retail lease rates and terms because many retail shopping centers and malls have been hit especially hard by the financial downturn and landlords are eager to fill vacancies. Retail centers may also be particularly attractive to health care providers because the site locations can be designed to accommodate new health care delivery models and provide convenient access points of service to attract patients. Health care leased assets have continued to increase in popularity with investors and landlords as the demand for quality credit-leased properties has exceeded the available supply.

Notwithstanding the uncertain future of reimbursements from federal health care programs and private insurers, the increased demand for health care services may make certain health care providers, such as a hospital or health system with a healthy balance sheet, a more desirable credit risk than the traditional retail business owner. Nonetheless, landlords that lease space to health care providers will likely want to scrutinize the credit behind the lease by evaluating the provider’s financial diversity, longevity and consistency, as well as its standing with federal health care programs such as Medicare and Medicaid, rating agencies and regulatory boards. If the prospective tenant is a physician group, the landlord may ask for a credit enhancement in the form of a letter of credit, personal guaranties from the individual physicians, or a master lease arrangement with an affiliated hospital.

Health care providers have unique real estate requirements and legal issues in comparison to more traditional retail tenants. A general, but non-exhaustive, discussion of the major distinguishing issues and factors to be considered when negotiating a lease with a health care tenant is set forth below.