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Column | Cost Effectiveness of Health

When real estate is part of a physician affiliation strategy, 'renters or owners' is a key consideration

Sponsored by Kaufman Hall
Column | Cost Effectiveness of Health

When real estate is part of a physician affiliation strategy, 'renters or owners' is a key consideration


John Andersen

Matthew Bates

When health systems consider using real estate as an incentive in a physician affiliation strategy, they must decide early whether to create physician owners or renters. Strategic considerations will differ significantly depending on the path chosen.

Most people start out as renters, whether in college or early in their adult life. Renting clearly has its advantages: Renters do not have to worry about maintaining or improving the property’s value, and they can easily move on to something new when their lease expires.

At some point, many people decide to become homeowners. Homeownership also has its advantages. Owners have more control over the space they occupy and can enjoy the appreciation of a property’s value over time, assuming they make the investments needed to keep the property in good shape. 

When health system leaders are thinking about building a medical office building (MOB) or ambulatory surgery center (ASC) as part of their ambulatory and physician affiliation strategy, the first question they should ask is, “Do we need to incentivize physicians in this market with real estate to make them owners instead of renters?” To answer this question, health system leaders should think carefully about what physicians in their market want and what other options are available to them in the local market.. The extent to which physicians require incentives in a given market can greatly influence the types of real estate financing options that are appropriate.

What physicians want

Recent data from the American Medical Association show that, as of 2020, fewer than 50% of physicians were working in private physician-owned practices. A report commissioned by the Physicians Advocacy Institute found that an even lower percentage — just 30% of physicians — practiced medicine independently at the start of 2021, with the remaining 70% employed by hospitals or corporations such as private equity firms or health insurers.  

As the percentage of independent physicians goes down, the healthcare industry may be reaching a core percentage of physicians who are committed to remaining independent. This group will be the focus of health system real estate initiatives designed to strengthen physician affiliations.

Independent physicians will be looking for opportunities different from those sought by employed physicians, who have traded the administrative burden and business risk of independent practice for the stability of employment.

First — and what’s most obvious — they have chosen to remain independent. They do not want to give up control over decisions affecting their patients and their business.

Second, they often want to manage two lines of business. The first is the business of their practice. Once physicians have developed a patient panel, they can easily move the business of their practice within the geography of a market. The second is a real estate business. Besides paying themselves rent for owned real estate, many independent physicians look to real estate assets as a retirement pool and want to maximize their equity in them.

Third, independent physicians have many options. Investors unaffiliated with a health system— REITs or private equity investors for example — may offer an equity split on real estate, with clinical decisions left to the physicians. In addition to granting a general equity buy-in, investors may offer other models. Some may be offering a rent-to-own option or a professional condominium option, in which the physician can use the condominium itself to secure financing. Under both options, physicians can limit the amount of capital needed for the initial investment.

The decision for health systems

Given these considerations, health system leaders can return to the initial question: Do they need to incentivize physicians with real estate to make them owners instead of renters? This question must be answered before any financing decisions are made, because the strategic considerations will differ depending on the path chosen.

In certain respects, the “renters” answer is the easier of the two. If the strategic goal is revenue diversification and there is sufficient demand for space in the market, the health system can develop the real estate and receive a rental stream without the entanglements of a partnership. The downside is that the renting option will do little to develop loyalty among the tenant physicians, who are free to move to a better offer when their lease expires. Health systems also should be very clear-eyed about actual market demand for space and not fall into a “if we build it, they will come” mentality.

If the strategic goal is stronger affiliations with independent physicians, the “owners” answer deserves serious consideration. The structure of the ownership model will require health systems to give equally serious consideration to what physicians want.

Historically, joint ventures between health systems and independent physician practices have had a mixed track record. At least two questions have been primary sources of tension in these ventures:

  • How do the physicians create and realize meaningful equity in the joint venture?
  • In joint ventures that involve an ASC, who determines which cases go to the ASC and which cases stay at the hospital?

It is important for health systems that are considering the “owner” option to anticipate such questions, with a recognition that independent physicians will want a true partnership.

Health systems need to be both flexible and creative in how they design their partnership opportunities, keeping their strategic goal of stronger physician affiliations front and center. For example, they might give physicians an increased say in clinical decision-making, beyond the health system’s ordinary expectations. It also might mean looking at models, such as condominium ownership or rent-to-own, that eventually shift a significant portion of the equity in the MOB or ASC from the health system to the physicians. If strong physician affiliations are the goal, the real estate venture should be seen as a means to the end. Often the preferred financing model of the health system is different from what may be proposed by developers or other private capital providers.

Healthcare continues to migrate to ASCs and other outpatient settings. Health systems may not be able to control the flow of that migration, but with the right partnership structure — one that acknowledges what independent physicians want and understands the extent to which those or other options are available to them — they can stay involved. An affiliation strategy that relies on owners, not renters, will almost certainly prove more stable and durable over time.     

 

About the Authors

John Andersen

is a vice president for Kaufman, Hall & Associates, LLC, Chicago, Ill. (jandersen@kaufmanhall.com).

Matthew Bates

is a managing director and physician enterprise practice leader for Kaufman, Hall & Associates, LLC, Chicago, Ill. (mbates@kaufmanhall.com). 

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