A long time ago when I was a kid, our local hospital was one of the rocks of our community. While it was not usually a destination of choice, you had confidence that the hospital was there solely for the purpose of taking care of you or your family when something went wrong. The hospital was a distinct entity, separate from the various businesses in town whose primary and necessary objective was to turn a profit.
I would hazard to guess that if some speculator came in who wanted to buy the hospital, leverage it up to the hilt, squeeze every last nickel out of it by skimping on supplies, cancel vital services and risk running it into the ground, well, that speculator would have been run out of town on a rail.
Those days are gone.
Private equity firms are doing just that – and their tentacles in health care are growing. Last year, they owned 460 hospitals, according to the Private Equity Stakeholder Project’s hospital tracker. Now, they own 488 hospitals. That represents:
- 8.5% of all private hospitals
- 22.6% of all for-profit hospitals
- At least 27.7% of private equity-owned hospitals serve rural populations, which generally have a higher percentage of financially vulnerable patients and fewer healthcare options
The growth in PE-owned hospitals raises a myriad of ethical questions. While the bottom line is important to all hospitals, whether non-profit or for-profit, PE-owned hospitals are on a different level in emphasizing profits, and the consequences can be devastating as we are about to find out.
Cerberus and Steward Health Care
Steward Health Care, the nation’s largest for-profit hospital group, filed for bankruptcy in May 2024. The story of Steward is a tragic tale and is seen by many as indisputable proof that when a private equity fund, such as the one managed by PE giant Cerberus Capital Management, purchases hospitals and treats them strictly as financial assets, terrible things can and do happen.
According to Cerberus, they were Mother Teresa, investing to save a struggling healthcare provider, while making a profit for their investors and leaving Steward in fine shape when they exited in 2020.
Shortly before the 2024 bankruptcy, Cerberus slobbered:
Cerberus’ initial investment in Steward in 2010 not only rescued but restored six struggling Massachusetts hospitals on the verge of closing that were critical to their communities. During our nearly 11-year ownership of Steward, we supported the revitalization of failing community hospitals into a leading healthcare system. Cerberus’ long-term investment made it possible for Steward to continue to serve its communities, employ tens of thousands of professionals, and positively impact millions of patients’ lives.
Cerberus also felt the need to mention that an investment from a Cerberus fund was essentially an investment made possible by “millions of teachers, firefighters, law enforcement personnel, and municipal workers as well as other pension funds, universities, and endowments.”
Salt of the earth helps salt of the earth.
However, Cerberus danced around the important fact that they and their investors were not charities.
The teachers and first responders (their pension funds), as well as Cerberus expected a significant return on their investment, and they expected it within five to 10 years. Therefore, it’s reasonable to ask what kind of return the Cerberus fund and its limited partners (the teachers and first responders) could expect from an investment in 37 struggling, indebted hospitals in Massachusetts, and later Arizona, Arkansas, Florida, Louisiana, Massachusetts, Ohio, Pennsylvania and Texas.
Struggling hospitals don’t jump out as a good private equity investment. They required significant time, money and a lot of risk. So, if you’re wondering why PE firms would buy so many hospitals, think of McDonald’s.
In the 2016 film “The Founder,” Ray Kroc is struggling to turn a profit on the 13 McDonald’s franchises he has granted. A young man named Harry Sonneborn immediately diagnoses Kroc’s problem and reveals the magic formula that makes him a billionaire:
“You’re not in the burger business. You’re in the real estate business.”
The same is true for Cerberus. Hospitals are an annoyance to get what they really want, which is to use the hospital’s real estate to suck out their investment and profits.
Many of the hospitals purchased by private equity have owned both the buildings and land with low levels of debt, some with none at all. Getting at that unencumbered real estate is where private equity hits pay-dirt using an age-old real estate strategy called “Sale and Leaseback.”
Working hand in hand with private equity firms are real estate investment trusts (REITs), which have $185 billion in healthcare holdings. Private equity managers like Cerberus sell a hospital group’s land and buildings to the REITs and turn a huge profit.
Meanwhile, the REIT portfolios the property, earning a steady stream of lease income from the target hospital and because they are a REIT, the income is tax free. The hospitals no longer own their real estate and are now on the hook for millions of dollars in lease payments to the REIT for years to come.
This is exactly what Cerberus did.
