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Shifting Ownership

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Leaders at Texas Health Resources believe in the old adage that many hands make light work. That’s why for five years now, the 13-hospital system based in Arlington has commissioned select medical real estate developments that don’t have a single THR-owned brick in them. The buildings, whether a short-stay hospital, ambulatory surgery center, imaging center or medical office building, are majority-owned by the developer with some ownership share going to the tenant—usually a THR-affiliated physician group.

Through such arrangements, THR and other nonprofit hospitals are redrawing the battle lines of hospital-to-hospital competition. Such deals help hospitals or hospital systems broaden their market footprint more quickly than their debt capacity and operational funding normally would allow. Additionally, many senior leaders say such projects allow hospitals to form mutually beneficial relationships with outside developers and their physicians without having to make sometimes-risky capital expenditures that tie them to long-term leases—actions that would add debt to the balance sheet and could depress bond ratings.

Select projects

THR hasn’t completely abandoned the real estate and development business, however. Dave Ashworth, THR’s executive vice president of strategy and system development, says when the price tag for nine on-campus development projects THR wanted to develop and own internally added up to about $500 million, the system faced difficult choices between necessary on-campus construction and off-campus projects.

“We knew we could fund the campus development projects through earnings, debt and philanthropy,” Ashworth says. But THR had growth plans in four local markets off main hospital campuses that its funding sources couldn’t support on an expedited timeline. So the system decided to revisit the joint venture philosophy it had been using on a small scale since the late 1980s—this time in a big way.

THR developed a request for proposals to third-party developers like Dallas-based Cambridge Holdings Inc., the eventual winner of the bid, for four projects totaling $121 million. THR wanted the developer to design not only the bricks and mortar, but also the partnership arrangement itself. Designing a comprehensive RFP for all four projects was intentional so developers would view the arrangement as a long-term relationship with THR and physicians, Ashworth says.

The Cambridge proposal included some physician ownership of the buildings in the deal, though Cambridge retained a controlling interest. Control over use of the buildings and the lease terms, over which THR had significant sway, was negotiated prior to construction, says Ashworth. While giving up a big measure of control related to the projects was the biggest negative for THR, he says, it’s necessary to make such arrangements work.

“We’re not an organization where we need to own and control everything we do,” Ashworth says. “That allows us to access talent, human resources and capital that is outside of our control.” The biggest advantage, he adds, “is that it’s helped us implement these projects in a pretty impressive time frame.”

RFP is the key

RFP construction arrangements where the hospital doesn’t own the land or bricks are becoming more common, especially among nonprofit hospital systems, says John Cobb. As senior managing director of real estate at GE Healthcare Financial Services, Cobb helps arrange financing for such projects. Sometimes GE owns the facilities, sometimes Cobb finds another company to own them for his hospital clients.

“Nonprofits are doing this because with high construction costs and increasing regulations, it’s getting complicated,” Cobb says. “Hospitals want to focus on being a hospital.”

Some, like THR, still have strong real estate and development arms, he says. But as hospitals develop off-campus centers that aren’t part of the core facility, many are saying, “Let’s hire a developer to do it because that’s what they do best,” Cobb says. That said, some hospitals, especially those with investment-grade bond ratings that aren’t on a construction tear, still may be better off developing and owning internally, he says. “High investment-grade hospitals can borrow easily, so they’re not doing this as much.”

A bigger footprint

Vanderbilt University Medical Center recently used the RFP process to attract a developer and owner for a primary-care practice in Spring Hill, Tenn., about 60 miles south of the main hospital in Nashville. For such smaller clinics, it’s more economically feasible for large organizations like VUMC to use outside landlords, rather than deploying its capital and being the landlord itself. The outside landlord also can serve as an additional buffer between physicians and the hospital.

For J. Cyril Stewart, VUMC’s director of planning and space management, the decision to outsource this function was an easy one. VUMC has been using the RFP process to commission development of small facilities, like the physician office for Vanderbilt Medical Group-Spring Hill, for about two years.

“Certainly one of the things is trying to recapture capital dollars to reallocate for further growth,” he says. “That said, it’s pretty rare that your long-term costs are going to be less if you don’t own the facility, because you’re paying management fees.” But meanwhile, Vanderbilt’s footprint gets established in growing markets far from the main campus—and the medical center doesn’t have to scale back on-campus construction projects.

“This gives us flexibility with our capital,” says Liz Dishman, J.D., VUMC’s director of business development. “You’re able to free up capital and have more flexibility.”

Stewart and Dishman stress that by forcing developers to meet a set of well-defined parameters established by VUMC, they’ve eradicated the possible effects of personal relationships that might have swung momentum for outsourced real estate projects toward one developer over another.

“If I could offer one piece of advice,” says Stewart, “emphasize the importance of the RFP process. It’s very easy in large organizations for alliances to be formed informally with outside developers. If you pursue one developer for each project, you don’t have the advantages of having them compete against each other for the privilege.”

Philip Betbeze is finance editor with HealthLeaders. He can be reached at pbetbeze@healthleadersmedia.com.