How One Hospital's Bankruptcy Shows The Downside Of Institutionalized Healthcare Real Estate

When Hahnemann University Hospital announced that it was closing its doors, a pillar of Philadelphia healthcare fell and sent shock waves rippling through the industry.

Pennsylvania Academic Health System, a subsidiary of Joel Freedman's private equity firm, Paladin Healthcare, filed for bankruptcy July 1 on behalf of Hahnemann and St. Christopher’s Children’s Hospital, 18 months after purchasing them. PAHS also operated the two facilities without integrating them into a larger network, ignoring a long-standing convention of healthcare real estate, experts said.

Freedman has been accused of treating Hahnemann as a pure real estate play, considering its prime location just north of Center City. But plenty of real estate companies like Anchor Health Properties and Simone Healthcare Development operate in the healthcare space, and executives from both companies told Bisnow they would never consider owning a facility that didn't have a provider to operate it.

“The opinion around my firm was that some folks were surprised that a private equity group thought it could make a go of [Hahnemann] given the payer mix," Anchor CEO Ben Ochs said. "Folks in the know were already wondering aloud if Hahnemann would make it with the ownership that purchased it.”

Hospital and multi-specialist healthcare systems like Main Line Health System often prefer to own their real estate because of the control and security it provides, MLHS Senior Vice President of Facilities and Real Estate JoAnn Magnatta said. But circumstances may demand that providers become tenants.

“We look for locations that would provide ease of access for our patients, physicians and staff in an area that is within close proximity to our existing hospitals,” Magnatta said. “When we don’t see an opportunity to buy land and develop a building that would satisfy our needs, we would then look within the community to lease existing space.”

Aside from location concerns, not every provider has the balance sheet to pay property taxes and building upkeep that come with such control. Financial constraints for hospitals that treat more patients on Medicare and Medicaid, like Hahnemann, often force those systems to monetize their real estate in sale-leaseback deals.

Magnatta and Ochs will be among the panelists at Bisnow’s National Healthcare Series: Greater Philadelphia Summit at The Rittenhouse Hotel on Sept. 25, discussing all the ways the healthcare and commercial real estate industries overlap and interact.

The pool of investment capital for hospitals and medical office buildings has expanded significantly in recent years as investors increasingly view healthcare as an inelastic demand driver — making it less vulnerable to an economic downturn. Until Paladin, entities that viewed healthcare as a real estate investment had left it at that.

“We’re not running the healthcare operations; that’s not our business,” Ochs said. “We provide and facilitate the real estate, but our [tenants] are truly the operators.”

New York-based Simone Healthcare Development has done it all in healthcare real estate, from building and redeveloping its own projects to developing and managing properties for fees and acquiring well-performing assets as long-term holds. But Simone President Guy Leibler said his company would never "cross that line" and manage the day-to-day operations of a hospital or medical practice.

“I served as a hospital board chairman and served on a board for 25 years; I might think I know a lot about running a hospital, but I don’t think I’m qualified to do it," Leibler said. "I’m sure some in my industry would think that [of themselves], but as we are currently structured today, we would not be running a hospital.”

Hahnemann wasn't just any hospital; it was massive, centrally located and served largely low-income patients and people of color. Medicare and Medicaid don't pay healthcare providers as much as private insurers do, meaning that in order to be profitable, a hospital system would need affluent patients to offset those on federal programs.

“We know that for a health system to do well, it needs to have a good commercial payer mix," Ochs said. "It’s not that we’ll only buy in affluent areas, but we need to understand what it draws from and what the payer mix is, because that will ultimately impact the profitability of the health system."

Main Line Health System operates exclusively in the western suburbs of Philadelphia, and the series of townships that gave the company its name are some of the richest in the region. In August, MLHS was noted for having strong finances by Becker's Hospital Review.

Philadelphia Academic Health System managed only Hahnemann and St. Christopher, without offsetting facilities in affluent areas. St. Christopher is expected to emerge from bankruptcy and remain in operation under new ownership.

Though former employees of Hahnemann have claimed Paladin and PAHS made little effort to turn the hospital's fortunes around, it is unclear if even the shrewdest of operators could have done so. But the debt that Freedman took on to fund his purchase — provided by Apollo Global Management, another private equity firm — left him no margin for error.

“I’m speculating, but it’s probably not the operator who’s guiding the [bankruptcy] process," Ochs said. "My suspicion is that the creditors knew which direction that was headed long before people outside the situation did.”

Freedman has insisted that he had the best of intentions when he purchased Hahnemann and that its financials were in worse shape than he had thought when closing the deal. But Ochs, Liebler and Magnatta all stressed the level of detail in their research on acquisitions and partnerships. Simone has knowingly taken on several underperforming healthcare properties with the purpose of turning them around, Liebler said.

"Not much scares us," he said. “We look for those situations all the time, because that’s where you can create value.”

Liebler and Ochs said that they treat the providers that may become their tenants as future partners, not underperforming elements to be stripped away. Observers have speculated that Freedman or Apollo had always seen Hahnemann's prime real estate as the reason for the acquisition.

"We add value in all of the real estate elements, and we bring to the table the ability to construct a functional hospital community," Liebler said. "And when they step in to manage the hospital, we step out.”