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EP62 - Why Do Healthcare Companies Need to Understand the Value of Their Properties? with Victor McConnell (Part 1 of 2)

This week’s episode is the first in a two-part series that features Victor McConnell, Managing Director and Head of Real Estate Services with VMG Health.  We discuss evaluating healthcare properties and the importance of understanding the value of your real estate.


In this episode, we talk about…

[2:21] What VMG Health offers for the healthcare industry as well as real estate services

VMG is a healthcare and advisory valuation firm. They were founded in the early nineties, doing primarily business value evaluations with everything from physician practices to entire hospital systems.  Over the last twenty or so years, they have added other service lines. 


Sometimes VMG is engaged by hospital systems, physician groups, or private equity. It could be real estate focused or operationally focused.  They also do a fair amount of litigation support work, and other consulting work based around valuation.


[3:36] How Victor got his start in healthcare real estate

Victor began his real estate career as an appraiser, and he did some healthcare real estate starting around 2008. He was a creative writing major at Dartmouth and fell into the real estate world by happenstance.  Victor’s work with VMG began in 2012 or 2013. 


[4:10] The importance of healthcare companies understanding the value and costs of their real estate investments

The way real estate is thought of within the healthcare world, whether it’s on the investor side or on the operator side, has changed a lot.  REal estate is typically the largest item on a hospital balance sheet.  So in any sort of hospital transaction, the real estate has been more of an afterthought.  Now, hospitals tend to think about it more strategically – they realize how real estate fits into strategic plans, both from a geographic footprint perspective as well as from a hospital campus perspective.


There are more investors who are interested in owning healthcare real estate, and so they may be more willing to invest in say an orthopedic hospital, a surgery center, a cancer center, or other property types that may have previously been perceived as highly specialized in such a way that a very small group of investors would have even been interested.  Now, Victor believes that the pool of potential investors is larger.  Wherever you sit in the healthcare real estate spectrum, there is a greater understanding of complexity and of strategic importance when it comes to how real estate fits into the overall healthcare business.


[6:33] How a hospital or health group can use their valuation to their benefit

As Victor shares, if a hospital system is thinking about what can be done with its real estate, it is a tool to provide patient care as well as a tool for physician alignment.  You can choose to enter into a joint venture with some physicians in developing a new property that may align with the strategic objectives of the hospital and the physician group.  Those can be complex, and they can require parties to consider the value of a lease guarantee, or who will be responsible between the parties for which aspects of development.


Some hospitals may prefer to own, maybe because of nonprofit considerations involving a tax-exempt status that they have to consider or money from large donors who can put their names on a cancer center.  As an operator, you look at what sort of return you are achieving through investment and operations.  If you have that money invested in real estate, what is the implicit return you are receiving in your own real estate?


Then, you have to think about compliance.  If you have physicians who are lessees, what sort of risk do you have? Do you have to hire an outside consultant or broker to help sort through your real estate and compliance issues?  There is a wide array of financial strategic compliance.


[12:02] Quarterly analysis and updates

The most important underlying factor is understanding the current value of your real estate.  Victor advises us on the importance of understanding it in the context of both an owner occupant as well as from an investment markets perspective.  Sometimes those two are aligned, and sometimes there are differences.


Theoretically, if the investment market is a stronger kind of valuation then you could make an argument that the owner-occupant should more strongly consider looking at a potential investment scale.


[14:05] The pandemic’s effect on healthcare real estate

When it comes to the effects of the pandemic, Victor discloses that he would be pretending if he said he perfectly understood all of the short- and long-term consequences of the pandemic on all aspects of social and economic life, including the healthcare and real estate sectors.


The healthcare real estate sector is no exception to the variability seen across our economy right now.  Another common theme is that the larger financially well-positioned hospital systems seem to be doing okay coming out of the pandemic.  In some cases, they have an even stronger market position.  The impact on real estate depends on what your market looks like from a fundamentals perspective, and on what sort of asset class you are in.  There are different reimbursement environments and payer environments depending on your asset class.  Geographically, there are markets with a lot of population growth and factors that drive real estate demands.  Those markets, generally speaking, are doing better.  The hospitals in those markets, therefore, are grappling with a different set of decisions compared to a tertiary or more rural hospital, which is struggling to keep its doors open and may have excess space.  It is complicated.


Things that people have been talking about for a decade, such as outpatient migration, are of course still happening.  They are manifested in different ways.  The freestanding ED, or  urgent care, is a good example of one model that has had some serious struggles.  Another that has had more consistent growth is surgery centers.  There is still that flow of surgical procedures that used to be performed in a hospital – now they can be performed in an outpatient setting.


This change means that you may need design changes to your surgery center in order to be competitive in the world of outpatient settings.  There are a lot of different considerations, but Victor’s short answer would be that a lot of the pre-pandemic trends remain in place.


[19:26] Telehealth opening the door for using the most expensive real estate for the highest acuity clinical use

Victor thinks telehealth is a great addition as a tool – it can’t replace in-person interactions, but it’s great for triaging.  If healthcare companies had a non-clinical space that they wanted to use to reallocate or convert, they may be able to dedicate their most expensive real estate for the highest acuity clinical use.


[21:38] Working with capital and development partners

A lot of hospitals prefer to own their on-campus real estate. In some cases you have a development partner on the real estate side, and then you also have an operating partner.  Maybe the hospital is partnering with an entity that specializes in whatever the platform is – a primary care clinic or an urgent care clinic.  You may have participation in the real estate landlord position from the hospital, physician, or operator, who has partnered with a developer.


On the lessee side, it could be any combination of those entities as well.  Ultimately, I think what’s going to drive what the write structure is, is going to be the strategic objectives of the physicians.  If there is a platform company operating the real estate, everyone will have to come to a consensus on the growth targets and the capital availability.


[25:14] Advising healthcare companies based on the value of their real estate

With hospitals, it depends on how large and sophisticated their real estate department is and what kind of internal capabilities they have.  Generally, real estate is not the driver – it’s whatever the kind of operational or strategic focus is.  They need to consider, how does the real estate help them to achieve that objective?


If there are physician partners that are interested in participating in real estate, then that is the structure that is going to make sense strategically.  You probably don’t need a lot of financial analysis to figure that out.  If you have a private equity platform company that doesn’t want to own real estate, then that eliminates some options off the bat.  It depends on who is hiring VMG or who is asking the questions.


If you live and breathe the projections in that industry, then you can look at them and benchmark certain projections to help understand how likely the tenant is to pay or to default on the rent (the core question you want to ask if you are a landlord).  How you answer that question depends on who you are representing.

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