6 Key Trends Affecting Healthcare Real Estate in 2017

Written by Kelly M. Blumline, Hall Render, Victor H. McConnell, VMG Health and Andrew Dick, Hall Render

1. Repeal of the Affordable Care Act

On January 20, 2017, President Trump signed an executive order indicating “prompt repeal” of the Affordable Care Act (ACA) and instructed federal agencies to use “all authority and discretion available to them to waive, defer…or delay the implementation of any provision … that would impose a fiscal burden on any State or … individuals.” Republicans have made efforts to repeal the ACA since its enactment, but Congress has not yet acted in 2017 to make significant changes to the law. One may only speculate as to the extent to which the ACA will be unraveled and how it will be done. Republicans have circulated multiple plans to replace the law, and Republican leadership has indicated that a replacement plan should reverse the expansion of Medicaid, strengthen Medicare, and give taxpayers “more control and more choices” in selecting plans, while maintaining the ban on preexisting conditions. Rep. Tom Price, M.D. proposed a bill last year which would fully repeal the ACA and replace it with a plan which includes individual health pools, expanded HSAs and elimination of the healthcare exchange. This legislation passed in Congress under budget reconciliation rules but was vetoed by President Barack Obama.

There is a wide range of forecasted financial impact related to repeal of the ACA. The American Hospital Association (AHA) commissioned a report which estimates the impact on hospitals if the ACA is repealed, using the Price bill as a model. Should Congress pass legislation similar to this bill, the AHA report estimates that healthcare coverage would return to pre-ACA levels and further suggests that the result would be a rise in uncompensated care and a decline in revenue for hospitals, as the number of uninsured patients would increase. Furthermore, a report released by the Robert Wood Johnson Foundation (RWJ) estimates that if a reconciliation bill similar to Price’s was passed now, the result would be an increase in uninsured people by 29.8 million in 2019. The RWJ report suggests that even partial repeal of the ACA, which would eliminate the Medicaid expansion, the individual and employer mandates and the Marketplace tax credits, while maintaining the ACA’s insurance reforms including prohibition on pre-existing conditions exclusions “could lead to a fourfold increase in the amount of uncompensated care providers finance themselves compared to current levels.” Avalere Health has also released the results of its research on the effect of block grants and per capita caps which would decrease funding to states for Medicaid. Avalere projects that Medicaid spending would be lowered by $150 billion and per capita caps would lower spending by $110 billion. According to Avalere’s President, block grants and caps operate to shift power from the federal government to the states in determining covered services and program eligibility.
To date, the current climate of uncertainty does not appear to have significantly altered strategic planning on the part of health systems, as market participants indicate that real estate projects in planning phases continue to move forward. However, some caution within the industry is noted; for instance, Colliers International’s 2017 Healthcare Marketplace Report predicts delayed decision making as healthcare providers grapple with implementation of site-neutral payment legislation and with potential repeal of the ACA. The potential repeal of the ACA and the implementation of site-neutral legislation will significantly impact inpatient hospitals. Instead of expanding existing inpatient facilities, we predict that acute care providers will continue to look for off-campus opportunities within their community. In particular, we predict an increase in the construction of micro hospitals and other ambulatory facilities.

2. Value Based Reimbursement and Changes to Healthcare Delivery Setting
As noted above, significant uncertainty exists surrounding the potential repeal of the Affordable Care Act. However, healthcare industry consensus is that the trend to value based reimbursement will continue to accelerate, regardless of what reform ultimately looks like. HHS’ goal is to shift 50% of Medicare payments away from fee-for-service and to value-based payment models by 2018. This point was reiterated at the 2017 JP Morgan Healthcare Conference in January, where it was noted that the “focus on value – high quality affordable care and health for a population – has to continue.” Executive pay is increasingly linked to quality metrics, as outlined in a February 2017 feature in Modern Healthcare. The drive to value has influenced the ongoing convergence of payors and providers, as evidenced by UnitedHealth Group’s acquisition of Surgical Care Affiliates (SCA) for more than $2 billion, which will combine OptumCare and SCA to form a comprehensive ambulatory platform. Within the post-acute sector, programs such as the Quality Incentive Payment Program (QIPP) for nursing homes in Texas provide financial incentives for nursing facilities to improve quality.

Given the market forces in motion which are driving the push toward value based reimbursement, what are the implications for healthcare real estate? For starters, outpatient migration will continue, as outpatient settings are generally lower in cost and preferred by consumers. However, the January 2017 implementation of the site neutral payment legislation may cause health systems to modify their real estate strategy to ensure the financial viability of proposed projects that will be subject to decreased reimbursement. Nonetheless, incentives and patient preference will continue the multi-decade shift away from the acute care setting. As of 2014, the national average occupancy for hospitals was 61%, per MedPac. This was down from 64% in 2008 and from 77% in 1980. Large, older hospitals can be outdated or oversized, requiring innovative real estate strategies to determine how best to utilize these structures. An increasing number of hospitals are seeking to use unused floors or wings by leasing this space out to another provider for uses such as long-term acute-care, inpatient rehab, skilled nursing, hospice, or behavioral health. These arrangements can be complex, as many factors outside of a typical real estate lease must be taken into account. The challenges facing the acute care industry have also contributed to consolidation, as hospitals seek greater negotiating power, scalability, and improved access to technology. A 2013 academic study found that 60% of hospitals are now part of larger health systems.

3. Tax Exempt Hospitals Under Pressure

Nonprofit hospitals that have long relied on the benefits of tax-exempt status have begun to feel pressure from municipalities in recent years. Public pressure has prompted judicial and legislative scrutiny into the tax-exempt status of nonprofit hospitals across the country. In 2011, the well-known Provena case in Illinois sparked an intense debate as to the legitimacy of hospital-based property tax exemptions. Following the decision, stakeholders crafted legislation that was passed by the Illinois legislature in an attempt to clarify the scope of property tax exemptions for hospitals and health care providers. The legislative fix has also been challenged in recent years, which resulted in an Illinois appellate court declaring the statute unconstitutional. The Supreme Court of Illinois agreed to hear the dispute and a ruling is expected in 2017. In the meantime, property tax exemptions for hospitals and health care providers in Illinois are on hold and the debate continues. In New Jersey, AHS Hospital Corp., d/b/a Morristown Memorial Hospital, settled a property tax dispute with the Town of Morristown for $15.5 million. In the wake of the Morristown settlement, over 35 nonprofit hospitals have been sued by municipalities in New Jersey. The Morristown case disputed the nonprofit status of many nonprofit hospitals, arguing that their operational profile was more typical of the for-profit sector. Other municipalities in other states have begun scrutinizing nonprofit hospitals and health systems, compelling hospitals to defend their charitable nature in terms of dollars given away, rather than focusing on the scope of benefits given to the communities in which they serve.

In 2017, we believe that tax-exempt hospitals and health care providers will continue to face headwinds in terms of pursuing and preserving property tax exemptions. Tax exempt hospitals should be aware of these challenges and should be prepared to clearly demonstrate the benefits that they provide to the communities that they serve. Additionally, tax-exempt providers need to be vigilant in terms of complying with state law requirements and Internal Revenue Code and regulations including IRC Section 501(r) in order to maintain exemptions and demonstrate that they are providing a high level of charity care.

4. Capital Markets

In the last decade, healthcare real estate has become a more widely recognized asset class by both the domestic and international investment community. With this rise in potential buyers combined with reimbursement pressures on the operational side, many health systems and physician groups have elected to "monetize" their real estate assets. In 2016, the healthcare real estate industry's largest single sale/leaseback occurred, when Catholic Health Initiatives sold 52 medical office buildings to Physicians Realty Trust (a Milwaukee-based REIT) for $724.9 million.

Though the Federal Reserve increased interest rates in December 2016 (and has indicated that three more rate hikes are likely to occur in 2017), investor optimism in the commercial real estate sector has not diminished, as cap rates and interest rates are only moderately correlated. However, health systems may be affected by increased borrowing costs and a rise in inflation. These factors create an incentive for healthcare providers to lock in occupancy costs, though the overall uncertainty around healthcare may create caution in the market in evaluating long term leases or acquisitions.

Within the healthcare real estate investment community, the consensus forecast is for a slight uptick in overall cap rates in 2017. Investors remain bullish overall, due to the fundamental demographic drivers which underlie the sector's growth. Nonetheless, given the current state of the market, health systems evaluating a potential monetization may wish to accelerate their decision timetable.

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