It is no secret that amongst real estate investors, "healthcare" has become quite the buzz word. In recent years healthcare leased assets have continually increased in popularity. For many investors the asset class represents a targeted investment strategy within a growing business sector. For other investors, healthcare real estate transactions represent a portfolio diversification opportunity. Regardless of the strategy, one thing is certain; current demand for quality, credit leased properties, has exceeded the available supply.

Hospitals with healthy balance sheets are the preferred driving force behind the 'supply' side of the healthcare real estate market and since 2009, that driving force has been moving at a very slow pace. Hospitals and healthcare systems have been reluctant to commit to long-term leases within to-be-built facilities. Many factors have made the considerations to build or not-to-build, commit to a lease with a third-party owner or own a property long-term on balance sheet, a very complex decision. A hospital's apprehension to commit to such projects is understandable. The long-term lease requiring annual rent escalations is hard to justify in an environment where the cost of occupancy continues to increase while cost reimbursements and revenue potentially decrease annually. The result of these considerations make the decision to build or not-to-build, commit to a lease with a third-party owner or own long-term become a complex decision.

While this quandary continues to hold up the construction of larger facilities hospitals and healthcare systems are seeking alternatives to extend their market-share. ; The free-standing Emergency Departments (FEDs) appear to be an increasingly popular option. According to a report published by the American Hospital Association (AHA), Emergency Room visits from 1998-2008 increased by thirty percent, while the number of Emergency Departments in the U.S. decreased by roughly five percent. As a result, Emergency Department wait times have consistently increased and have become increasingly overcrowded threatening the quality of care that patients receive. Hospitals throughout the country are exploring the FED asa relatively low operational cost facility to extend their reach, increase their presence into new markets, and fulfill an important and growing need for emergency medical services. Compared to the operational cost associated with opening, staffing and operating a hospital based Emergency Department, the costs to operate a FED are quite minimal.

To date, there is no standardized description or definitive set of services provided by FEDs. Basic urgent care services are offered and most provide select emergency care services as well as radiology, (X-ray, ultrasound, and CT scans) and laboratory services. The majority of FEDs are open 24 hours a day, 7 days a week. FEDs will accept patients transported by ambulance and frequently have contractual agreements with a local Emergency Medical Services company. Such agreements often define criteria under which patients can be transported to the FED rather than the local hospital emergency department. FEDs typically receive the same level of insurance and Medicare/Medicaid reimbursement as hospital-based EDs which make them an attractive option for hospitals and health systems.

An article discussing the important distinctions between Urgent Care centers, FEDs and hospital based Emergency Departments can be found by clicking on the following link.
http://journals.lww.com/em-news/Fulltext/2011/06000/Breaking_News__The_Emergence_of_Freestanding__EDs_.2.aspx

The Investor Market

As more FEDs are built in the years ahead, investors will have the opportunity to purchase these facilities as net leased investment opportunities. Hospitals will likely seek third-party developers to construct these off-campus, non-core facilities as a method to keep their available capital invested in operations or available for physician practice and competitor acquisition opportunities.

The typical FED is between 10,000 to 15,000 square feet with a cost to construct averaging $350 - $450 per square foot, depending on the market and land cost. The high price per square foot to construct posesthe biggest challenge for net lease investors analyzing this type of investment. It is important to note that the most successful FEDs are located on high-traffic retail out parcels. Therefore proposed FEDs should not sacrifice business opportunities in favor of cheaper land costs. In comparison to a Walgreens Pharmacy, (a popular net leased investment) the cost to build is considerably higher, can have far less favorable credit supporting the lease and is extremely 'special purpose' in its construction and design. With average NNN rents starting at $38+ per square foot investors of FEDs have legitimate concerns with regard to rental income stream replacmeent should the tenant default. A net lease investor will seek longer lease terms (15 to 20 years), annual rent escalations and more favorable cash-on-cash yields as protection against these negative elements associated with the FED asset class.

The FED does offer some attractive advantages over a typical retail net lease investment. FEDs typically achieve breakeven performance with annual volume of 13,000 to 15,000 patient visits. For a facility open 24/7, 365 days per year this translates into a modest average of only 38 patients per day. It is anticipated that FED EBITDA/rent coverage ratios could easily exceed 4 times rent which, when compared to the average retailer's rent coverage ratio of 1.25, this increases the appeal of the asset for the net lease investor. An additional highlight to this investment type has been the access to attractive debt. Lenders are very interested in the relative safety offered by investments in healthcare real estate and the competition for the product amongst lenders is providing favorable debt terms in the market.

Key Points
• Developers and FED tenants should look for sites near well-known retail outlets increasing customer traffic and brand awareness within a new market.
• Proximity to a popular retail center will make the real estate investment more attractive to net lease investors.
• Proposed development projects sponsored by hospitals or healthcare systems will be viewed far more favorably in the investment market than projects sponsored by independent operators or operator/hospital joint ventures.
• Long-term lease commitments of 15 to 20 years will be required. (A project this expensive requires a demonstration of commitment on the part of the tenant)
• Look for opportunities in rural communities where emergency options are limited to older, functionally obsolescent facilities.
• Credit behind the lease will be heavily scrutinized and when present, reflected in the price paid for the investment.

Conclusion
Freestanding Emergency Departments represent an evolution in the way healthcare services are delivered. They provide tremendous benefits to healthcare providers and consumers alike by offering much needed services in a more cost efficient environment. As investors recognize the impressive growth and demographics driving the healthcare industry, competition to own healthcare real estate will continue to increase. If the leases are structed appropriately, FEDs are an attractive option to net lease investor.

For more information regarding Freestanding E.D.s, please contact Toby Scrivner, Director.