How healthcare systems are improving margins in today’s economy
From bundled leases to divestment of non-core assets, companies are employing creative real estate strategies
Healthcare operators are getting creative with their real estate, using strategies that include portfolio overhauls and divestments of non-core assets to address rising costs. It’s an effort that comes amid economic challenges such as inflation, rising labor costs, and patient volumes for non-urgent care that have recovered in many, but not all, specialties.
Take Trinity-Holy Cross, a nonprofit integrated healthcare system, which engaged JLL to slim down its national headquarters footprint, ultimately saving over US$50 million.
Part of the urgency comes from the razor-thin margins such groups are already operating under. The median year-to-date operating margin index for U.S. hospitals was -0.98% through July, according to Kaufman Hall. “Some hospitals are seeing more than margin compression—they are seeing margin disintegration,” says Matthew Coursen, Executive Managing Director, Mid-Atlantic Healthcare Group, JLL. “Community hospitals are getting hammered the hardest but leading national and regional health systems are also alarmed about the reality of their operating results. No one expected to be here.”
Real estate assets account for as much as 40% of the balance sheet for most hospitals and healthcare systems. As the hunt for margin relief and cost savings is underway at both scaling and established companies, hospital systems are looking for creative real estate opportunities to save millions. These solutions include outpatient portfolio overhauls and optimizations, lease restructures, bundled leases, strategic locations chosen by advanced data and analytics, purchase options, and divestments of non-core assets.
“Healthcare systems can’t control the perfect storm of economic factors like the investment market and interest rates,” says Mindy Berman, Senior Managing Director, Capital Markets, JLL, who leads the firm’s healthcare group. “But the good news is that there is something they can control, which is a portion of their operating expenses tied to real estate.”
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Healthcare cost cutting with data
Real estate savings can boost operating margins and liquidity, impacting bond ratings and borrowing costs, says Coursen. But data is key to getting it right.
For instance, some operators may have opportunities to shift to lower-cost freestanding and non-acute sites, which are in demand as patients increasingly gravitate toward more convenient options for primary, urgent, and even emergency care. These locations have higher EBITDA margins up to 25% compared to 10% for acute and post-acute facilities, according to McKinsey & Company.
“Advanced data and analytics tools provide early opportunities to move toward portfolio optimization because they aggregate disparate data points to create actionable insights about a health system’s performance improvement potential, allowing for smarter, more strategic real estate decision-making,” says Greg Gerber, Senior Managing Director, Healthcare, JLL, who leads the firm’s Midwest Healthcare Markets Practice.
For example, Trinity-Holy Cross worked with JLL to provide data-driven insights into the relative success of the existing network of clinics, present opportunities in the market to expand strategically, and identify how to optimize the portfolio. An early step in this process was to create custom dashboards to synthesize data.
“This helped us to identify high and low performers in the region,” Gerber says.
Similarly, Children’s National Hospital used location analytics for a build-to-suit ambulatory surgery center in Prince George’s County, Maryland. The health system’s leaders felt uncertain about a site identified by their previous real estate advisor without the benefit of robust data analytics.
“Our goal is to help understand where the competition is, where they can grow, find new patients, or shift existing patients to a new facility to unlock efficiency,” Coursen says. “Advanced data analytics can’t tell you where to locate on their own without human interpretation, but they are an essential tool for decision making.”
Another cost savings strategy is to bundle same-landlord leases and renegotiate extensions “under a master, multi-location lease,” says Jay Johnson, JLL's Healthcare Practice Leader for the U.S.
Hospital and health system real estate portfolios have grown dramatically in the past decade through mergers and acquisitions with other hospitals, systems, and physician practices. At the same time, the largest medical property investors have also grown their assets significantly through acquisition and new development. Portfolios have grown to hundreds and sometimes thousands of locations in multiple markets, often across state lines.
As a result, without realizing it, many health systems have substantially increased their exposure to specific landlords. Bundling allows significant relationships involving multiple leases with the same landlord to be combined under a new lease that meets specific objectives the health system may have, including but not limited to reducing overall square footage and rent.
“Health systems should manage and scrutinize portfolio data in a centralized database, using an appropriate, real estate-purposed technology to identify all landlord relationships and potential bundling opportunities,” Johnson says.
Purchase options and short lease terms
Health systems often have hidden gems within lease arrangements that can be transformed into immediate, substantial rent savings, including embedded purchase options and short remaining lease terms, Berman says.
For example, Atrium Health negotiated a pre-determined purchase option following the completion of build-to-suit developer leases. By doing so, and identifying a preferred long-term landlord, the company was able to cut its base rent by 20% in lieu of taking out cash proceeds at market rates.
Similarly, Atrium Health placed a core leased location with only four years of the remaining term under contract at a favorable price, and saved 15% on its rent by assigning the contract to a new landlord with an extension of the lease term.
The time to sell
Healthcare systems, especially non-profit hospitals, in need liquidity to support ratings and access to bond markets are turning to selling non-core assets, which are the “the low hanging fruit,” Berman says.
“We’re selling a warehouse in a sale-leaseback, as well as a nursing home and a clinic for a client because it’s a significant source of capital for them,” she says.
Many hospitals have significant land holdings for unspecified future use. One client, Berman says, had 32 acres of surplus land in addition to vacant buildings.
“The market is right for selling, as real estate investors are increasingly drawn to alternative property classes such as healthcare,” he says.
Contact Greg GerberSenior Managing Director, Healthcare, JLL
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