Alternative financing offers another source of revenue growth - Special Advertising Section - health care providers who own real estate should put it to work financially - Brief Article

Healthcare Financial Management, April, 2002

Real estate assets, an often overlooked source of capital, can be used to help grow revenue. Many healthcare providers own real estate with little or no associated debt. This equity can be unlocked and put to work in strategic business opportunities with rates of return in excess of the costs associated with accessing the capital.

Some healthcare providers have reaped rewards from the use of alternative financing structures as they apply to their real estate holdings. Although there are caveats in their use, such as the need for full disclosure in financial statements, when these alternative financing structures are applied properly, healthcare providers can increase or maintain profitability.

Because there are many different types of alternative financing structures, it is important to match the right type to a hospital's strategic, financial, and operational objectives and overall mission.

Some alternative financing choices

* Third-party at-risk developer/owner. An experienced healthcare developer funds the project without a master lease, credit support, or other guarantee from the hospital or healthcare provider. This structure provides the organization with an avenue to seek lower-cost capital. In addition, the healthcare provider maintains the necessary controls over the real estate.

* Physician/developer joint venture. The developer partners with the organization's physicians to own the building. The hospital or healthcare organization does not provide funding, guarantees, or credit support. Under a similar approach, physicians become the sole owners of the asset.

Joint ventures must be structured in accordance with applicable accounting rules, tax, and other Federal and state regulations. For example, it is important that a not-for-profit organization considering such an arrangement consult legal counsel to verify that this financial structure does not jeopardize the organization's tax-exempt status.

* Synthetic lease. A synthetic lease is used to finance to-be-built real estate. The property owner retains the benefits and burdens of ownership, while transferring title to a third party, which serves as the lessor. The lessor typically is a special-purpose entity, created to facilitate the financing of a real estate project, but it also may be a trust or an affiliate of the lender's leasing subsidiary.

A synthetic lease qualifies as an operating lease for financial accounting purposes but as a loan for tax purposes. The assets and attendant financing are moved off the balance sheet, improving return on assets and capitalization ratios.

The greatest potential negative is that rating agencies may overlook the operating nature of a synthetic lease and treat part or all of the base lease payments as equivalent to debt service in the calculations of the user's debt-service coverage ratio.

* Sale/leaseback. Under a sale/leaseback structure, an intermediary buys a real estate asset and leases the property to the seller. The asset typically is sold for its market value, and the buyer pays cash, which the seller can then use to pay down its debt. In addition, the seller/lessee maintains satisfactory control over how it operates the facility.

The seller/lessee typically retains the right of first refusal to repurchase the property. Lease rental payments are "triple-net-lease;" that is, the seller/lessee remains responsible for paying all of the property's associated taxes, insurance, and routine and nonroutine capital expenditures along with rental payments made to the purchaser/lessor.

It is important that sale/leaseback arrangements be structured to comply with financial accounting rules and other regulations. Rental rates must be based on fair market value. In addition, leases to physicians cannot be based on the volume of physician referrals, because such leases would be in violation of the Stark laws.

* Operating lease. An operating lease provides more up-front capital for funding the healthcare organization's capital needs. It also affords a secure and flexible way to occupy or maintain 100 percent control over the use and tenancy of an existing or to-be-built facility without using capital.

Fred Campobasso, president of AMDC, a healthcare real estate development company, makes this recommendation. "Hospitals need to understand the amount of expertise and time it takes to execute a strategic initiative from concept to completion. Too often, hospitals tend to underestimate the expertise and time required to execute a project. Most hospital staff lack the required real estate and project management resources, which unnecessarily increases their risk."

RELATED ARTICLE: Determining if alternative financing is right for your facility

Healthcare providers can ascertain if these types of financing structures are a viable strategy worthy of mare detailed analysis by answering the following questions:

* What real estate assets does the organization own and what return do those assets generate?

* Do these assets carry associated debt?