• Private Equity, Medical Real Estate, and COVID-19


    What does the pandemic mean for physicians who want to monetize their practice’s value?

    Monetizing a practice’s value. In recent years, many ophthalmic practices have looked into two options for monetizing their practice’s value. Some have sold—and then leased back—the practice’s real estate. Others have been bought out by a private equity (PE) platform. In some cases, this buyout included the practice’s real estate. Often, however, it didn’t—and in that situation, the physicians became both employees and landlords of the PE platform.

    What impact has COVID-19 had on these monetization options? In an AAOE roundtable on Saturday, moderator Robert E. Wiggins, MD, sought out the opinions of Steven I. Rosenfeld, MD, who is president of Delray Eye Associates and also a board member of a PE firm; Matthew Owens, Esq., who is a partner with Arnold and Porter, a law firm based in Washington, D.C.; and Collin Hart, who is CEO and managing director of ERE Healthcare Real Estate Advisors.

    Has COVID-19 slowed deals between ophthalmology practices and private equity? “Certainly, there was a moratorium on buying practices in February, March, and April,” said Dr. Rosenfeld. This was partly because PE firms weren’t sure how to make their valuations, given the pandemic’s impact on a practice’s EBITDA (earnings before interest, taxes, depreciation, and amortization). Since then, PE platforms have resumed buying practices, said Dr. Rosenfeld. “There was a pause,” agreed Mr. Owens, “but activity is now going strong.”

    How have valuations changed since the pandemic hit? So far, said Mr. Owens, PE firms have continued to base valuations on a practice’s pre-COVID EBITDA, but there has sometimes been a change in deal structure and the way that the purchase price is paid out: Instead of the physicians being paid in full right away, part of the payment may be structured as a “milestone” payment, dependent on the practice’s getting back to its pre-COVID performance. However, the longer the pandemic drags on, the more likely buyers are to start factoring a practice’s COVID-era financial performance into valuations, he said.

    Will it take longer for private equity to “flip” practices? To continue attracting investment, PE funds must deliver a high rate of return. Before the pandemic, many PE firms sought to accomplish that by reselling practices at a healthy profit three to five years after the initial purchase, said Dr. Rosenfeld. However, based on his conversations with PE companies, he thinks that the pandemic will prompt them to stretch out that timeline by one year, perhaps two.

    In the midst of the pandemic, does a market still exist for medical real estate? “There are still plenty of real estate investors out there,” said Mr. Hart. But with increased numbers of stores and families struggling to pay rent, some traditional categories of real estate—such as retail and multifamily homes—are less appealing to investors. In contrast, “We’ve seen more and more interest in medical real estate investments,” said Mr. Hart. “Patients still need care, and as a result, real estate investors see that the demand remains—and that this real estate segment is very strong.”

    Why would a practice sell its real estate and then lease it back? “The idea is that there is a lot of concentration of wealth in a practice’s real estate,” said Mr. Hart. Selling the real estate provides a way to diversify that wealth and “perhaps take some of it off the table, and continue to operate the practice uninterrupted.” However, given the current state of the world—with low interest rates and an uncertain stock market—Dr. Rosenfeld wondered what a practice would do with that cash right now.

    What’s it like to have your employer as a tenant during a pandemic? When Dr. Rosenfeld and his partners sold their practice to PE, they ultimately opted to hold on to the real estate, which means that their employer—the PE platform—now pays rent to them. Dr. Rosenfeld welcomes this monthly rental income, because it helps to make up for the drop in income due to the PE platform taking a percentage of his billing income. However, this put him and his colleagues in a nuanced position during the pandemic, as many companies—including PE platforms—were seeking rent abatements or deferrals. “It’s a very sticky wicket,” he said. “We’re using that rental income to live on . . . but we didn’t want to be too demanding and cause financial duress for the platform. You walk a very fine line.”

    Uh-oh! What do practices wish they had done differently? The roundtable concluded by giving some advice on avoiding unpleasant surprises.

    • Know who you’re dealing with. With due diligence, you should be able to find out what you need to know about your prospective PE partner, said Mr. Owens. “Not only on operational matters, such as whether they are truly hands-off, but also ask, ‘What’s their vision?’ Do they share your vision in terms of how to grow the practice and how to practice medicine in general?”
    • Get it in writing. Although you may trust your negotiating partners to honor an oral agreement, you’ll wish that you had something in writing if those people retire or move on. After all, said Dr. Rosenfeld, drawing an analogy with medical liability, “If it isn’t in the chart, then it didn’t happen.”
    • Get the right lease terms. When a PE deal includes the sale of a practice’s real estate, a common mistake is to negotiate that last—and physicians might not be thorough with their due diligence because they don’t want to jeopardize the whole deal. “At the end of the day, it is so important to get the right lease terms,” said Mr. Hart. “As you are going through the transaction, make sure the real estate is a focal point and think about it earlier rather than later—and make sure you get a long lease.” —Chris McDonagh.

    Watch the roundtable in full. If you are registered for AAO 2020 Virtual, you have access to the archived presentations on the virtual meeting platform until Feb. 15, 2021. Log in to the virtual meeting platform: Next, from the Lobby screen, select “Sessions” from the top navigation; click “Agenda” from the drop-down menu; select the “Saturday” tab; and scroll down to “482V: Private Equity and the Transformation of Ophthalmic Practice: What Do I Need to Know?”  

    Further reading. The AAOE has curated a list of private equity articles, and you also can read three EyeNet articles:

    Financial disclosures. Mr. Hart: None. Mr. Owens, Esq.: None. Dr. Rosenfeld: Blue Sea Capital: C; InFocus Capital: C; Modernizing Medicine: C; NovaBay: C. Dr.Wiggins: Ophthalmic Mutual Insurance Company: C.   

    Disclosure key. C = Consultant/Advisor; E = Employee; L = Speakers bureau; O = Equity owner; P = Patents/Royalty; S = Grant support.

    Read more news from AAO 2020 Virtual.