Four Tips for Optimizing Healthcare Real Estate

Healthcare real estate is on the cusp of a shakeout, with more hospitals and multi-location medical practices turning their attention to leases and owned buildings that no longer fit their business strategies.

One example is Cleveland’s MetroHealth System, which this past August announced plans to shutter six outpatient medical centers Over the prior decade, the public safety-net hospital system had expanded into surrounding areas in a bid to reach more patients, duplicating services and creating operational inefficiencies.

MetroHealth’s consolidation represents the kind of difficult-but-necessary real estate optimization strategy that can be critical to stabilizing the balance sheet today. Challenges such as sluggish reimbursement rates, Medicaid cuts, skyrocketing costs, labor shortages and hospital closures translate into a greater need to sell excess properties and exit or renegotiate non-core or above-market leases.

Here are four tips for ramping up the efficiency of your real estate portfolio:

Market your non-core properties to a broad base of buyers

Many hospital systems and medical practices rely on healthcare-focused real estate appraisers—firms that specialize in studying how potential buyers from within the industry will view property-specific factors such as lease terms, location characteristics and specific uses (i.e., outpatient clinic, surgery center or diagnostic lab). But in today’s disrupted healthcare marketplace, potential buyers are more likely to hail from outside of the healthcare industry.

These operators’ expansion plans might create opportunities in your location to pursue adaptive reuses that were not on the radar of the original appraiser. Historically, the trend has been to convert big-box retail stores, sound stages, offices, hotels and the like into healthcare facilities. Now, the trend is starting to run in the opposite direction, as developers convert healthcare properties into non-healthcare uses such as residential and retail. Communities across the country need more multifamily residential units, and retail space is in high demand as well thanks to the relative lack of new retail development.

In San Antonio, for example, plans are underway to convert the 24-story Nix Medical Center at the River Walk into an apartment tower. Likewise, a half-empty medical complex in Silver Spring, Maryland, is slated to become a 148-unit apartment development, according to plans approved this past May.

As part of an in-depth portfolio review, third-party real estate advisors can help you better understand the potential for buyers to adaptively reuse your excess assets. The healthcare industry and broader economy have been changing quickly, so be skeptical of appraisals and comps that predate these changes. By taking a fresh look at your owned properties and professionally marketing your real estate to a wide array of buyers, you stand a better chance of maximizing value. The key is to put yourself in the shoes of a real estate investor.

Explore an accelerated sale process

The sale process itself also matters. Simply listing a property online and hoping for the best can lead to lower purchase offers and inadequate control over timing and terms. Ask your real estate advisors about an accelerated process in which bidders agree to sale terms in advance, having securely accessed a digital “due diligence room” protected by a nondisclosure agreement (NDA) that contains the required financial and property documents.

Tackling due diligence upfront rather than post-contract can allow healthcare companies to avoid the kind of late-stage haggling that often delays or even scuttles real estate transactions. It can also spur more competition for the asset, with the competing offers of multiple bidders increasing the potential for a high-value return.

Strongly communicate the need for lease concessions/exits

The next step is to start engaging with landlords to either terminate or renegotiate problematic leases. It is also important to determine if subleasing the space makes sense. If the healthcare system or medical practice is in significant financial trouble, ask lenders to provide clarity on what will be required to avoid lapsing into default.

Since landlords try to charge significant sums to terminate generally long-term healthcare leases, it is important to make sure you have adequate cash on hand to fund the lease termination process. Third-party real estate advisors can help you better understand the picture as it emerges through their dialogues with landlords.

Lease renegotiations can be difficult discussions. Landlords need to grasp the realities of your financial position as well as the challenges now faced by the broader healthcare industry. Be prepared to come to the table with specific financial data in hand after, in some cases, first securing a signed NDA from the landlord and/or its representative.

In lease renegotiations, it helps to explain everything your executive team, board and lenders are doing to strengthen the organization’s financial position. Show that key stakeholders are firmly behind the real estate strategy and educate the landlord on your macro and micro challenges. Landlords read the news and see the stress the healthcare industry is under every day. They will not be surprised when you ask to have a conversation with them. Go into that discussion with a clear outline of the steps you are taking to bolster your long-term financial position, and if possible, be prepared to recount how you are mitigating those headwinds. This could include:

• details of the overall plan to right-size the real estate footprint
• how you have relocated services and staff to continue providing needed services
• what you are doing to communicate successfully with the media, existing patients and the larger community
• how you are maintaining the availability and quality of patient care
• your broader strategy for financial stabilization beyond real estate (for example, the savings from your planned or executed workforce reductions, or how you are using AI and other technology to bolster efficiency)
• your basic vision for the future of the organization, and the role your real estate footprint will play

Be willing to negotiate (and be flexible)

Given the changes afoot today, it makes sense to be aggressive and pursue more favorable lease terms even for offices and outpatient centers that are healthy or “on-the-bubble.” As you optimize your real estate portfolio, stay attuned to the way factors such as remaining or non-monetary lease term can strengthen your leverage.

The loss of your healthcare lease could undermine the resale value of the landlord’s building by making it tougher to attract new tenants, renew existing ones and/or secure favorable refinancing terms. Does that owner want to close a deal with a major new tenant in the months ahead? Is the plan to sell the asset sometime soon?

If so, the landlord will need to show that the property is strong enough to maintain high occupancy. Such situations can create negotiating opportunities where you receive lease modifications, rent concessions or possibly a lower termination fee. You could, for example, agree not to vacate your space early and to stay for some shortened period of time, giving the landlord more time to find a replacement tenant or reconfigure the footprint. There are a myriad of potential bargaining chips.

Scrutinizing every owned property and lease is a smart move given the challenges that are reshaping today’s healthcare sector. Real estate should be a central part of the budget-stabilization plan. This is not to suggest that all properties will be easy to sell, or that securing lower rents will be automatic. But by engaging in comprehensive portfolio reviews and taking a holistic and methodical approach to real estate optimization, healthcare companies can uncover opportunities to bolster efficiency and position themselves for greater resilience. Ultimately, that is the best way to achieve the core mission of serving more patients and providing better patient outcomes.