A capital idea bonds and nontraditional financing options: increasing capital demands are prompting cash—strapped hospitals to take a closer look at bond offerings and nontraditional sources of capital

Healthcare Financial Management, May, 2004 by Therese L. Wareham

In a sale-lease back transaction, the third party investor purchases the hospital's project (or property) and then leases it back to the hospital or a related organization. The sale gives the hospital a cash infusion, which is then available to its general needs and can generate additional investment income. Because OBS financing is not shown as a liability on the hospital's balance sheet, debt ratios, such as debt-service coverage and debt to capitalization, are improved, which is critical to credit status. (It should be noted that a sale-lease-back could also be an on balance-sheet transaction, depending on when the asset is "sold.")

The third party investor in a sale-leaseback arrangement typically provides an equity component to the project and borrows the remainder of the purchase price, The hospital's rent payments for the project are sufficient to fully amortize mortgage debt over a specific lease term. Return on the investor's equity occurs in three components, including an interest write-off and a depreciation deduction.

With sale-leasebacks, the investor typically purchases the building only and usually has a ground lease of 50 years. Purchase of the land is also possible, but makes the transaction more expensive because land is not depreciable. Ownership of the building reverts to the hospital or an appropriate affiliate at the end of the ground lease. Closing costs are shared by the investor and the hospital, and transaction fees are usually significant. Lease payments are structured in two parts--a fixed base rent and an inflation rent.

Highly dependent on the credit of the lessee, synthetic leases are typically structured with relatively short initial terms and lower lease payments. This structure reflects "interest only" economies on the underlying debt, unlike other lease types that include amortization of principal. Synthetic leases contain purchase options concurrent with the renewal dates. The purchase price equals the fair market value of the leased asset, which can never be less than the amount of outstanding underlying debt. This requirement often causes termination payment to become a contingent liability on the lessee's balance sheet.

Master leases can be used for real estate or ongoing equipment programs, and can also be on or off balance sheet. Typically involving joint ventures with a developer, master leases for real estate have been used most frequently with long-term care and retirement facilities. The joint-venture relationship spreads the financial risk and ensures the involvement of someone who understands the real estate business. Typically, the developer puts up the capital, supervises the construction of the project, and operates it once it is complete. The provider obtains the certificate of need, if required, offers services, and develops referral networks to ensure a steady business flow. The less capital a provider contributes to the joint venture, the less profit it stands to make, but the objective often is vertical or horizontal integration without significant financial risk. Many equipment vendors use master leases for the ongoing lease of equipment. After the master lease is executed, various schedules with specific terms are appended when particular equipment is leased and payments are to begin.