Third-party capital often is applied to strategic facilities situated on land owned and controlled by a health system. A reasonable concern of health system executives is the ability to control branding and use of a facility, including uses applicable to faith-based organizations.
Ground lease terms. With a ground lease, the health system can impose long- and short-term limitations on property use to prevent detrimental use by third parties while permitting the providers of private capital to assume asset and financial risks. With full control of the property reverting to the owner at the termination of the lease, the health system retains ultimate control over use and disposition of the property.
These protections are not without costs, because they affect the value of the facility asset owned by the third party.
Ground lease terms that operate as control features include:
- Lease term and direction
- Use restrictions
- Non-compete provisions
- Lease options
- First rights of refusal on tenant, space, and the like
Under such terms and conditions, ground lease arrangements provide a health system with significant control without imparting the credit and liquidity implications associated with ownership.
“Moral hazard” considerations. Beyond ground lease issues and related obligations, a strong argument can be made for the value of strategic flexibility framed in the context of a health system’s moral obligation regarding its programs and assets, characterized here as a “moral hazard” consideration.
Moral obligation for not-for-profit health systems, in the eyes of the board and leadership, often extend by associated legal and financial obligations. Simply stated, the commitments of the organization to programs and locations extend beyond contractual agreements. Therefore, as health systems expand strategies (especially market share strategies), their boards and executives will need to discern how best to parse the organization’s long-term obligation across mission and strategic assets.
The context here goes to the implied risk of a long-term obligation to the financed asset a not-for-profit community health system assumes when financing a strategic facility with tax-exempt debt—that is, the obligation to use the facility regardless of the strategic returns derived, with an implied future inflexibility, including inflexibility to exit occupancy of the facility because its strategic asset value has been diminished or impaired. With third-party capital, the obligation for facility use extends to the owner for the term of the lease only.
Because third-party capital is typically associated with the development of “strategic assets” (with varying levels of risk and strategic utility) and the developer/owner is paid to take on the related financial risks, not-for-profit health systems should feel less of a moral obligation to retain sites and programs beyond their time value and strategic return.
Daniel K. Zismer, PhD, is Wegmiller Professor in Health Administration and director, Masters of Health Administration and Executive Studies Program, Division of Health Policy and Management, School of Public Health, University of Minnesota, Minneapolis.
James Fox is a director and senior CFO consultant, Warbird Consulting Partners, LLC, Minneapolis.
Paul Torgerson, JD, is a partner, Dorsey & Whitney, LLP, Minneapolis.
For more information, see Daniel Zismer, James Fox and Paul Torgerson's "Financing Strategic Healthcare Facilities: The Growing Attraction of Alternative Capital", hfm, May 2013