Chapter 2: Hospitals, corporate real estate management and alternative real estate financing structures
Healthcare systems across the globe are under continuous reform. Thus, it is important to note that healthcare systems are still evolving. Moreover, in Europe a distinction is made between so-called Bismarck “mixed” and Beveridge healthcare models. Bismarck systems are based on social insurance, and characterized by a multitude of insurance organizations, who are organizationally independent of public and private healthcare providers. Examples are such as in France, the Netherlands and Germany (“Krankenkassen”).
In Beveridge systems, however, financing and provision are handled within one organizational system and based on taxation. This implies healthcare financing bodies and providers are completely or partially within one organization, such as the National Health Service (NHS) in the UK and Spain (Lameire, et al. 1999; Finfacts, 2007). Throughout history, healthcare systems across the world have evolved from Bismarck into Beveridge systems and vice versa. Usually, such reforms are a bone of contention.
A recent example is the highly controversial debate in US politics on reform of the American healthcare system, which is unique in its application of the Private Insurance model (Lameire, et al. 1999). Democrats have long called for a universal health insurance program, which involves the expansion of coverage and restricting the power of insurance companies. Proponents argue that health insurance should be affordable and accessible to all, while opponents (mainly Republicans) fear too large a role of the government and the use of tax money to finance the – arguably – enormous costs involved. Both parties seem to agree that the power of insurance companies should be restricted by banning underwriting practices that prevent many Americans from obtaining affordable health insurance.
However, though U.S. president Obama has praised various aspects of the Dutch social security-based (Bismarck) healthcare system, a similar evolution of the American healthcare system yet has to commence (NY Times, 2009).
This section begins with a brief historic overview of the Dutch hospital (or cure) sector, with a focus on its evolution. Second, the interdependencies between healthcare real estate, (strategic) corporate real estate management, and alternative real estate financing structures will be elaborated upon by using corporate real estate management (CREM) theory and comparing various sources from academic literature.
These are intertwined since healthcare heavily depends on real estate as a resource in fulfilling its core business activity. By opting for alternative ways to finance real estate, hospitals are able to free up additional capital to support their clinical activities. As the Dutch healthcare system currently is under reform and hospitals become responsible for real estate investments themselves, they are under increasing pressure to consider more cost-efficient options and enhance their competitive position. Alternative real estate financing structures such as public-private partnerships, where hospitals profit from the knowledge and experience of private sector parties through various partnership agreements, could provide a alternative feasible alternative here to more traditional real estate financing structures. For example, hospitals could opt for a sale-lease-back agreement, where hospital real estate is sold to a private party and leased-back to the hospital for an annual fee.
By analyzing the above, this theory and literature review will provide the reader with an answer to the following sub-questions:
- How are Dutch hospitals regulated and financed?
- How can corporate real estate management add value to hospital real estate?
- How do alternative real estate financing structures relate to hospital real estate?
The Dutch hospital sector
The origins of healthcare in the Netherlands can be traced mainly to the activities of voluntary organizations, which often provided healthcare on a charitable base.
These organizations used to be run mainly on religious or ideological foundations, resulting in the creation of healthcare facilities with a Protestant, Roman Catholic, Jewish or humanistic foundation (Folter, 2002).
The Dutch healthcare tradition reflects the changing relationship between the government and voluntary organizations. Dutch hospitals largely originated from private and often charitable initiatives; virtually all are non-profit and most are still private organizations. However, today they are no longer organized along denominational lines.
Though private ownership predominates, the Dutch government heavily regulates the healthcare system. In the postwar era of the 1950s, there was a focus on hospital construction, part of the broader effort to rebuild the country. In 1971, an extensive planning system was undertaken under the Hospital Provision Act (WZV) to regulate hospital capacity, the main motive being that many people felt hospitals were too concentrated in the urban areas and too few were located in other parts of the country (Den Exter, et al. 2004).
Planning, regulation and management
In the 1960s and 1970s, the expansion of health technology and healthcare resulted
in a steep increase in health care costs. The main cause of the cost increase was attributed to the building of new hospitals and healthcare institutions.
The Hospital Provision Act (WZV) of 1971 became the Dutch government’s most important hospital planning tool, enabling the government to regulate construction of all healthcare institutions. The responsibility for its implementation was allocated to the provincial health authorities.
The overarching goal of the WZV was to regulate the supply and promote the efficiency of hospital care. Hospitals were not to be constructed or renovated without successfully passing a declaration and licensing process. Approval of the building project rested on a detailed plan for each hospital service affected in a specific geographic region, which included a description of the existing service capacity, the suggested change of capacity, and a schedule to complete the project.
The planning process began with the issuance of an “instruction” from the Minister of Health, Welfare and Sport to the provincial government. The instruction described the categories of hospital facilities for which plans were to be developed, the geographical region covered, and the deadline to complete this. Provincial governments considered a number of regulations and guidelines in the process. Regulations related to the planning process and guidelines to the content of the plan.
Many stakeholders were involved in the formation of regulations, including hospitals, patients and consumer organizations, local authorities, and insurance companies.
In the initial stage, the provincial government prepared a draft plan. This plan included: an inventory of existing capacities; an evaluation of the existing situation in terms of shortages and weaknesses; a description of construction, renovation and expansion proposals; and an implementation plan and time schedule.
Subsequently, the draft was forwarded to the health minister for approval. The health minister, after counseling the Hospital Provision Board (CBZ), determined whether or not the draft was acceptable. The draft plan formed the foundation for the issuance of so-called acknowledgements, which allowed hospitals to receive reimbursement for services from health insurers.
The drawbacks of the initial hospital planning process under the Hospital Provision Act (WZV) were its complexity and lack of flexibility. Therefore, in January 2000, in order to improve the planning process, a new Act, the Special Medical Procedures Act (WBMV), came into existence. The focus of this Act was on quality of care rather than cost containment and aimed at promoting healthcare with maximum quality and minimum risk to patients at affordable cost (Den Exter et al., 2004).
According to Den Exter et al., in the Netherlands policy traditionally has been prepared and implemented by a massive “neocorporate bureaucracy”, uniting government agencies, quasi-governmental organizations (the advisory and executive bodies), suppliers and providers in the private sector, and insurance companies. This national body has a significant degree of control over decisions regarding the number and distribution of hospital beds and specialist places, and on investment decisions and management costs in health care.
In the 1970s, centralized government coordination and planning became the leading principle in the Dutch healthcare system. However, the 1974 policy paper Structuring health care (Structuurnota Gezondheidszorg), contained proposals for decentralized administration by regional and local authorities (Second Chamber of Parliament, 1974). In 1986, the coalition government departed from the centralized model by undertaking major reforms, especially in the field of social health insurance.
The integration of different insurance schemes into one social insurance for all Dutch citizens (with largely income-related contributions) was a bone of contention.
The aim was to increase solidarity in healthcare financing.
Under these reforms, all insurance companies would function as independent and risk-bearing insurers and compete for insured patients under the same regulations.
A central fund (“centrale kas”) was to provide budgets for all the insurers. A key issue in the reforms was the shift of the insurance risk from the public funding system to the individual insurance plan, justified by the “less government, more market” trend.
The shift of insurance risk involved a policy of transferring regulating competencies from the collective to the private sector, such as providers and insurance companies.
In the Netherlands, this policy is called “functional decentralization”. This has mainly occurred in the cure-sector, which entails acute care and both specialist and general medicine. By means of negotiations and contracts, an increasing number of health insurers and providers have become important determinants in shaping and interpreting healthcare today, while the government and administrative agencies used to assume these roles in the past. This is emphasized by the new role assumed by medical specialists in hospital care. For example, they have acquired an independent coordinating position versus both hospital management and sickness funds (Scholten and van der Grinten, 1998).
Hospital budget reforms
In the Netherlands, today all hospitals and other healthcare institutions are required to have an overall annual budget. This is in line with the government’s cost-containment policy. If the hospital exceeds its budget, there is no possibility of recalculation or compensation. Specialist fees are an exception to this overall hospital budget. Below follows an overview of the budget reforms that have taken place up until 2009.
Function-directed budgeting (1988 – 2000)
The old budget system, which was in use since 1988, was a function-directed budget system. The budget was divided in four cost components: location costs, fixed costs, semi-fixed costs, and variable costs.
Location costs concern infrastructure, for example buildings and equipment including depreciation and interest. In the old budget system, these investments required approval by the health minister under the Hospital Provision Act (WZV). Second, fixed costs are costs that do not generally vary with the activity volume. For example, the number of people served by a hospital in the region. Thirdly, semi-fixed costs are not affected by the scale of production of a hospital in the short run. These are capacity-based costs, and include the number of beds and specialist units. Finally, variable costs are directly related to the activity volume or the production (“production units”) of the hospital.
Parameters for variable costs include admissions, outpatient visits, nursing days, day care and day treatments (Den Exter et al., 2004).
In the old system, the hospital budget was determined as follows:
- Number of persons in service area (x tariff)
- + number of licensed hospital beds (x tariff)
- + number of licensed specialist units (x tariff)
- + negotiated volumes of production units, for example hospital admissions (x tariff), inpatient days (x tariff), first outpatient contacts (x tariff), day surgery (x tariff) and special treatments (x tariff)
Tariffs varied with hospital size, implying larger hospitals were allocated higher tariffs than smaller hospitals.
In addition, hospitals were allocated capital expense budgets. For example, rebuilding projects and new hospital construction projects were covered by a 100% mark-up applied for 50 years. This implies payment was guaranteed for 50 years through a mark-up in the day rate. As a result, hospitals were not exposed to financial risk regarding major capital expenses. Further, hospitals received a standardized budget for small investments, such as maintenance. These investments did not require the approval of the health minister.
Performance-driven budgeting (2000 – 2005)
Until 2000, hospitals still received the full budget when it produced less inpatient days than estimated under the principle budget=budget. However, this was changed into a performance-driven payment system implying hospitals would get paid less if they would produce less inpatient days than agreed upon with health insurers. The underlying notion of this change was to increase hospital production, in order to put a halt to waiting lists.
However, this transition brought a number of new problems along:
- Hospital budgets were unable to keep up with the increase in demand for hospital care. While patients paid insurance, they were unable to benefit from hospital service directly because of waiting lists.
- The admissions, inpatient days and day surgery tariffs used to set the budget proved completely artificial, not reflecting true costs.
- Incentives for efficiency were weak.
- The budgeting system did not stimulate hospitals to inform insurers and patients about their performance. This is a politically sensitive issue, as hospitals received extra money to combat waiting lists but were reluctant to explain for what goals they used this money.
DBC-budgeting and dot (2005 – present)
Therefore, a new gradual transition is currently taking place to a Diagnosebehandelings-combinatie (Diagnosis Treatment Combination, DBC) financing system. The DBC system has the following implications: a transition to output pricing with defined and priced patient-treatment categories; location costs remain fixed and all other maintenance costs will be integrated into the location cost center of hospital budgets (set by the College Tarieven Gezondheidszorg, CTG, Healthcare Tariffs Council); and hospitals are contracted by sickness funds based on patient-treatment categories. The main notion is that hospitals are reimbursed for the costs they incur resulting from medical treatments. The DBC-A segment tariffs (acute care) remains government regulated (through the NZa, Dutch Healthcare Authority) and concerns acute care, whereas hospitals are largely free to negotiate tariffs with healthcare insurers in the DBC-B-segment (non-acute care) in an effort to promote market forces. Currently, about 34% of the DBCs is allocated to the B-segment; the Dutch Health Ministry aims to increase this proportion to 50-60% by 2011 (Van Poucke, 2009).
The DBC system is comparable to the DRG (Diagnosis Related Group) system used abroad. However, there are a number of differences:
- DRGs are coded at the beginning of the treatment, while DBCs are coded afterwards.
- A patient can be coded in more than one DBC.
- In the DBC system the coding is not done by special personnel but by a medical specialist.
- The physician salary is included in the DBC, giving physicians an incentive for “upcoding”.
In the DBC system, more flexibility is granted to parties that negotiate at the local level on production, number of treatments, and number of specialists. Furthermore, efforts are being made to integrate the fee-for-service system for specialists and the hospital budget system into a single integrated budget (Den Exter 2004).
However, since the system is still in early development, the effects of DBC financing on hospitals are still ambiguous. As a result, improvements have been proposed which will be implemented as of January 1 2011 under the DOT (DBCs Op weg naar Transparantie, DBCs on the road to Transparency). This implies that the 100,000 DBC products will be sized down to only 3,000 in order to increase transparency for the patient, healthcare practitioners and healthcare insurers (DBC Onderhoud, 2009).
Real estate investment reforms
Until 2008, the Dutch healthcare system applied a publicly supported healthcare real estate budget system. However, since 2008, Dutch healthcare institutions have become financially responsible for the return and risks of their real estate investments (see Chapter 5: Real estate investments).
Moreover, the Dutch healthcare system is changing toward a regulated market system with increased competition between healthcare providers. According to Van der Zwart et al. (2009), these developments are likely to change the way healthcare institutions will manage and finance their real estate, the location choices they make and the building typology they choose. Furthermore, real estate is becoming an increasingly strategic “fifth” source of profitability and overall performance, similar to capital, human resources, information and technology (see figure 2.1). For hospitals, considering and using real estate as a strategic production asset can reap added value, as will be explained in section 2.2.2.
Financing hospital real estate: from supply-driven to regulated market forces
As health insurers now negotiate quality and quantity agreements with hospitals and patients are broadening their horizons, the importance of an integrated approach to the “product” hospital care. Hospitals should be able to use their real estate as a distinguishing element in attracting customers (the patient). As a result, real estate is being transformed into a strategic resource for hospitals as well and hospital executives are paying growing attention to real estate management, including location management (what to do where), business plans (do investments yield positive returns) and real estate asset valuation. Building plans are based on functional clustering: hospitals divide new buildings into “hotels” (patient rooms), “hot floors” (operating rooms), “offices” (simple treatments, patient consults), and “industrial plants” (medical support/facilitating functions). As hospitals are no longer required to own their real estate assets, some are seeking partners willing to take over some of their real estate management (Windhorst 2006).
The Dutch government used to be in charge of allocating the budget of healthcare real estate investment, but is moving toward a regulated market system to keep healthcare affordable in the future. This deregulation gives healthcare institutions the opportunity to make their own decisions, translating into more individual responsibility and a higher risk exposure of investments. The government no longer guarantees financial support for real estate investments, and thus real estate investments have to be financed by the production and delivery of healthcare services. As a result, the need for competitive advantage will also increase (Van der Zwart, et al., 2009).
The Dutch government used to apply a strict approval system in the former real estate budget system in order to regulate the capacity and costs of hospital health care. All initiatives to build, renovate or demolish a hospital building were evaluated “in terms of their fit with a regulated overall capacity per service area, square meter guidelines per hospital bed and per function, and a maximum standard of costs per square meter” (Van der Zwart, et al., 2009: 2). The initiatives were approved by the Minister of Health, Welfare and Sports, who was advised by the Netherlands Board for Healthcare Institutions. The real estate capital costs (depreciation, rent, maintenance costs and so on) were guaranteed by the government. The healthcare provider’s real estate budget was independent of the production of healthcare services.
According to Van der Zwart et al., hospitals did not bear any responsibility for the risks of their real estate investments in the old system. Furthermore, they were not responsible for the running costs and a possible deficit if production decreased. As a result, hospitals attempted to obtain the maximum amount of square meters and were not encouraged to be either cost efficient or cost effective. In March 2005, the Dutch Minister of Health, Welfare and Sports announced the modification of this real estate budget system and the introduction of a healthcare system with regulated market forces (Hoogervorst, 2005). The main goal is to keep healthcare affordable by stimulating competition and, as a result, reduce healthcare costs.
This deregulation provides healthcare institutions with more flexibility in the briefing, design and management of hospital buildings and real estate investments. Similar to the old system, private not-for-profit initiatives are still the main force behind the capacity of hospitals, but in the new system hospitals are themselves responsible for the return on real estate investment and the effects of real estate decisions on utility value, investment costs and running costs. Since January 2008, hospitals have to finance real estate investments and capital costs from their product and service revenues. This implies a switch from a “centrally steered real estate budget system with governmental ex ante testing of building plans and investment proposals … into a performance driven and regulated finance system on the output” (Van der Zwart, 2009: 3).
To ensure a smooth transition, there is a transition phase until 2012 with a standardized and maximized budget for capital costs per m².
This trend will have a strong effect on the briefing, design and management of hospital real estate (Van der Voordt, 2009). Hospitals will get new opportunities while experiencing higher risks at the same time and hospitals will have to aim more at competitive advantage. Furthermore, partnerships with private partners will be more common. According to Fritzsche et al. (2005) and van Hasselt (2005), this transition has a number of implications, as illustrated in table 2.1 and figure 2.1.
Moreover, “organizational changes (e.g. mergers and network organizations), demographic changes (ageing of the population, multicultural diversity), technological developments (e.g. new medical equipment, new installation techniques), fluctuations in the economy and changing views on healthcare and the responsibility of government, healthcare organizations, market players and healthcare consumers play their role, too” (Van der Voort, 2009: 2). As a result of mergers and the growth in hospital functions, hospitals are likely to grow even larger than before. Van der Voordt argues that all these changes affect the healthcare real estate stock and cause a need for new health care real estate management strategies.
Christensen et al. (2000) warn for the entrenched and change-averse nature of healthcare systems. They argue governments and institutions should be more open to business models that may seem to threaten the status quo at first, but will eventually enhance the quality of healthcare for the end-user: the patient. New institutions with “disruptive” business models adapted to new technologies and markets should replace entrenched and old-fashioned institutions. Thus, they conclude that government and healthcare sector leaders should help insurers, regulators, hospitals and health professionals to facilitate disruption instead of preventing it.
The practical implications for hospitals of the current transition to a new healthcare system in terms of capital financing and real estate investments will be further explained in chapter 4 and 5. First, the following section will elaborate on the theoretical foundations of corporate real estate management.
Corporate real estate management
In order to make well considered decisions with regard to new building projects, rebuilding projects and the sale of real estate property, a deep knowledge of the real estate property and the many related internal and external developments is required.
For example, what actions need to be taken in order to eliminate or reduce discrepancies between demand and supply? And how effectively does real estate support the main business processes?
Corporate Real Estate Management is one of the disciplines that addresses such questions. The key issue at stake here is to align the supply (e.g. locations, properties) with the requirements related to the primary process (demand) and the strategic goals of the organization. The overall aim is to create maximum added value for the organization while ensuring a maximum contribution to total organizational performance (Van der Voort, 2009).
Increasingly, (corporate) real estate is becoming a substantial resource for firms and other institutions. For example, firms are looking at real estate to provide both stability and capital growth to their portfolios.
It thus presents an attractive return compared to the volatility in equity prices (DTZ, 2006).
Already in the early 1990s, researchers began to call attention to the largely unrecognized importance of corporate real estate to many businesses. They pointed at the substantial balance sheet value of real estate and the large proportion of operating expenses resulting from real estate services (Roulac, 2001). For example, Veale (1989) concluded corporate space costs account for 10% to 20% of operating expenses or nearly 50% of net operating income.
In their paper, Rediscover your Company’s Real Estate, Zeckhauser and Silverman (1983) estimate corporate real estate accounts for 25 to 40 % of the total assets of the average firm. Many firms underestimate the intrinsic value of their real estate portfolio, even though the magnitude of costs related to owning properties are second only to payroll costs (Veale, 1989). Zeckhauser and Silverman’s survey results mention 7 important steps a firm can take to make more efficient use of its real estate assets. For example, firms should manage real estate responsibly and set achievable goals in order to generate profits from its real estate assets or limit costs. Furthermore, a firm’s choice of real estate activities other than managing property depends on the nature of the business it operates in and the historical record of its real estate portfolio. This implies that firms that more heavily depend on real estate for their business activities might be more actively involved with their property management. Zeckhauser and Silverman conclude that every firm should review and adjust its real estate policies to reconcile operating objectives with real estate values and opportunities, and evaluate the intrinsic value of its property.
Though the return on real estate is generally lower than the return on the core business activity, real estate may provide other forms of added value, such as efficiency and effectiveness of the activities in the firm. Kaplan and Norton’s (1992) balanced score card approach describes the performance of a corporation as being defined by a combination of financial, internal business, customer, and innovation and learning perspectives.
In addition to the financial value of real estate, unique characteristics such as the design of a building transform real estate into an asset that can be difficult to imitate, substitute, or trade. Furthermore, the physical image of a building may function as a marketing tool, attracting attention to a firm’s services. Thus, when buildings reflect the business’ purpose and promote important work relationships they can contribute significantly to corporate strategy and serve to distinguish a firm from its competitors (Krumm & de Vries, 2003).
Strategic corporate real estate management
Roulac (2001), with his Aligning corporation real property with corporate strategy-model, links real estate strategies with sources of competitive advantage.
A corporate business strategy addresses key elements such as customers, employees and processes.
A corporate property strategy affects employee satisfaction, production factor economics, (realized and foregone) business opportunities, risk management decisions and other effects on business value.
Thus, it is crucial in enhancing or inhibiting the company’s expression of its core competency and the extent to which it can realize its core capabilities to their full potential (Roulac, 2001).
The existing scientific research in this field has resulted in the conclusion that it is generally more advantageous for firms to rent, rather than own the real estate they use, enabling them to free up capital to invest in the things they are good at (Brounen and Eichholtz, 2003). The shares of firms who sell their real estate typically outperform the average and firms with large corporate real estate holdings are typically associated with relatively low performance.
However, within the field of real estate finance, little research has been conducted on the effects of alternative real estate financing structures on the performance of non-profit organizations, such as hospitals. Though Eichholtz and Kok (2007) examined the performance effects of alternative real estate financing on the American senior healthcare sector, little is known about the performance of hospitals owned and/or operated through alternative real estate financing structures such as, for example, public private partnerships (PPPs).
In 1993, real estate expert Michael Joroff (1993) expressed the need for a move in real estate management from a purely operational approach to a more strategic one, including a strong emphasis on the role of real estate in achieving corporate goals. According to Joroff, this requires a switch from a day-to-day focus on building management (“manager”) and controlling accommodation costs (“controller”) towards standardized real estate utilization (“trader”), adapting real estate assets to the market (“entrepreneur”), and eventually ensuring strategic real estate decisions contribute to corporate goals (“strategist”). See figure 2.2 below.
An organization often finds itself in a combination of different stages. According to Fritzsche (2005) hospitals still need to make the move to the upper stages. Thus, when hospitals make a transformation to more business-like entities, they will find themselves in the entrepreneur or strategist stage. However, it is debatable whether hospitals should be located in the final stage, as hospitals in essence are non-profit foundations and do not have the same goals and core-business activities as business organizations. This is where the classical debate regarding public versus private provision of a public good (healthcare) enters the arena; this will be discussed further in section 2.3.
The added values of real estate
According to De Jonge (2002), several ways