Affordable Care Act effects major changes

Posted on March 24, 2014

In his State of the Union address, President Obama reiterated the message that the new healthcare legislation is in effect and changes are occurring. Some of the provisions took effect in 2013 such as dependents remaining on their parents’ health plans until age 26. The major provisions such as the individual mandate became law this year. The ramifications from a medical and economic standpoint have been written about amply; so, let’s focus on healthcare operations and the impact on real estate. Two of the major trends include: 1) consolidation of providers 2) the move to outpatient as the new center of healthcare delivery.

The consolidation wave

With the passage of the Affordable Care Act, hospitals and health systems are acquiring each other and independent physician practices and various imaging and diagnostic services to operate more efficiently. The reason? Under this act, providers are being reimbursed not for individual episodes (“fee-for-service”) but for outcomes – the long-term health of the patient population. This is real: last year for the first time, Medicare penalized more than 2,000 hospitals with excessive readmissions – one of the major red flags for poor performance. Part of the institutional change to improve outcomes is the concept of the Accountable Care Organization.

ACOs are essentially consortiums promoted as a bigger, better model that manages health at the population level across a broader swathe of the healthcare specialties. So, an ACO might include a hospital, various specialty groups, surgery center, imaging, emergency department, even nursing homes, with all payments made to the head of the ACO (usually the hospital or large physician multi-specialty group), which then disburses to the rest of the group. So providers can’t operate in a silo anymore or they won’t get paid.

It’s now about the alignment of physicians and hospitals, working as a team. As a result, the ACO has caused the biggest wave of consolidation that I’ve ever seen in the sector. What’s more, in 2015, Medicare reimbursements will be reduced for physicians who haven’t made inroads with electronic medical records, which can be expensive for small independent practices to install – resulting in more consolidation so providers can be compliant.

Cleveland Clinic CEO Toby Cosgrove, MD thinks that consolidation will lead to a dozen or more integrated regional health systems dominating the marketplace. Consider that a quarter of specialty physicians and 40 percent of primary care physicians are already employed by hospitals, up from 5 percent and 20 percent, respectively, in 2000. Some larger specialty practices are combatting this trend by merging with other practices to avoid being purchased by healthcare systems or hospitals.

Nick Reed, vice president of professional banking services at Wells Fargo Bank, paints the picture: “Some independent practices are moving out of condominium office buildings and grouping together to buy office buildings. The costs of maintaining small independent space are becoming burdensome, particularly as the technological pressures on integration and connectivity are imposed.” Reed sees information technology financing as an ever increasing part of medical office loan commitments. “We see a lot of IT expenditures in the $30,000 to $50,000 range, while multi-specialty groups have larger expenditures to fund.”

Real estate trends

For the occupants, owners, financiers, brokers and larger health providers, the new healthcare era is a challenge to develop their strategies for profitability. At the real estate level, it has caused continual shifting and adjustments:

Smaller groups or independent physicians are moving to two or three years as opposed to a traditional seven-year term. Flexibility is critical since the Affordable Care Act has added a layer of uncertainty in its regulatory and cost structure. Independent practices must also prepare for the contingency of sale to larger hospital groups.

Large, multi-location and multispecialty practices have begun negotiating portfolio-wide leases with similar rates across all of their locations. Some are buying their buildings to fix their real estate costs.

While demand for space overall increases because of the growth in the number of insured, consolidation and the ACOs will have a countervailing effect. Per capita or per physician may actually not grow or decline as consolidation reduces redundant space and inefficiencies. Also, telemedicine, mini-clinics within pharmacies and grocery stores, and other technologies may drive the trend for less total square footage for traditional MOB space.

The new center of healthcare

In order to operate more efficiently and lower costs, hospitals have migrated services from expensive acute-care environments to technologically enabled outpatient facilities. The hospital-centric model of the past has already given way to a hub-and-spoke network in most markets, where outpatient centers provide convenient and accessible care to patients and refer volumes to affiliated inpatient facilities. So, what’s next? As it develops, hub-and-spoke will become a distributed model of care – that is, providers that are physically dispersed yet highly integrated through technology. Electronic medical records and advances in medical information technology will allow discrete providers to operate as a team. Primary care doctors will act as gatekeepers, coordinating and overseeing care regimens across this broad network.

The impact of this “patient-centered medical home” model is that large MOBs (rather than hospitals) have become the hubs and smaller specialty sites have become the spokes. Think of the last time you visited a hospital for a procedure as opposed to a medical office building located in your community. Some systems are even leasing space in retail malls – for example, Northwestern and its new 21,000-square-foot facility at the upscale Roosevelt Collection mall.

As a result, the MOB is the definitive center not only of care but also of healthcare real estate. Last year was a banner year for outpatient development and the investment community competed to acquire prized MOBs: we saw $4.98 billion in MOB sales through the third quarter (vs. $5.21 billion for all of 2012). That’s a per square foot sale price of $231 which is very strong with cap rates in the 6 percent range.

There were some major transactions in Chicago – Ventas, for example, paid $82 million for seven MOBs on five Advocate HC campuses in suburban Chicago, another example of how medical portfolios have become very attractive to the public and non-listed REITs. If you extend the numbers to sales of all buildings leased by healthcare providers (physician offices, convenient/urgent care clinics, diagnostic labs, imaging) the total reached $6.67 billion in 2013 – the second highest number in 13 years with a per square foot sale price of $270/SF. When you consider that 90 percent of the $1 trillion of healthcare property overall is currently owned by hospitals, it is certain that we are only at the beginning of this move toward third-party ownership of real estate.

To meet the challenges of distributed care and cost reduction, developers and operators of healthcare assets will need to think about the particular mix of services and programming in every building. This will result in the consolidation of redundant and inefficient facilities, while in other cases it will mean providing or expanding preventive health and wellness services to achieve population health management goals.