Sale Leasebacks Present Financing Alternative for Behavioral Healthcare Operators

The behavioral healthcare industry faces a supply-demand imbalance. Key demand drivers include an increase in acceptance of treatment, the Mental Health Parity and Addiction Equity Act, and an increase in global prevalence of anxiety and depression coming out of the pandemic. According to the Centers for Disease Control and Prevention (CDC), more than 1 in 5 American adults live with a mental illness.

This rise in demand presents a challenge for behavioral healthcare operators to expand the services they offer. However, access to capital has been made more difficult by the current economic landscape due to higher interest rates as the Federal Reserve Board endeavors to fight inflation. Further, with a recent banking crisis tied to well-publicized bank failures, many financial institutions are reducing their lending activity and are implementing more stringent credit standards. In this environment, a viable financing option that behavioral healthcare operators can consider is a sale leaseback transaction.

What is a sale leaseback?

A sale leaseback is the simultaneous selling of an owned property and then lease back from the buyer under a long-term lease. The long-term lease that is negotiated with a sale leaseback transaction typically runs from 15 to 20 years, with options for multiple 5- or 10-year renewals, providing the company effective control over the asset upwards of 35 to 40 years.

A sale leaseback transaction allows an operator to free capital that is tied up in real estate. Common uses of this freed-up capital include paying down debt, business expansion, investments in IT, and help funding acquisitions, among others. In the case of behavioral health, the sale leaseback of one facility can finance the development of another.

One notable difference—and advantage—of a sale leaseback is access. The availability of traditional bank and bond financing is subject to a wide and uncontrollable set of factors: i.e., in the current environment, scrutiny of the banking industry, and interest rates.

Sale leasebacks are particularly apt for behavioral healthcare operators because many of them own their facilities. In 2021, Springstone unlocked $760 million of capital for expansion by selling 18 of its behavioral healthcare facilities to Medical Properties Trust.

Signature Healthcare Services, LLC sold 6 of its behavioral health hospitals to Care Capital Properties, Inc. in 2017 and raised $400 million.

Mechanics of a Sale Leaseback

Owning real estate is a prerequisite to a sale leaseback transaction. However, real estate ownership is not enough to raise capital in a sale leaseback transaction. The health of the underlying business and the strength of its credit are also important factors.

The company must demonstrate the stability of its business and the potential to pay a long-term lease. Buyers, who are institutional real estate investors, want a tenant that can fulfill the obligations of the lease agreement over a prolonged period, i.e., a company with a balance sheet that enables it to weather any variance in its sales and earnings.

Because sale leaseback transactions put more importance on the underlying business, location of the property is not as critical as in a typical real estate transaction. Therefore, sale leasebacks can be structured efficiently and effectively in tertiary as well as primary markets.

In negotiating the terms for a sale leaseback, operators have several levers to pull. This includes length of the lease, base rent and the frequency and percentage of rent increases. Working out a deal with change of control provisions that do not hinder a future business exit is also crucial.

For growing behavioral healthcare providers looking to open a facility, the capital need for the real estate can be 5x the working capital need to open. There is also a fertile capital environment to have a partner buy the site on the operator’s behalf in exchange for a long-term lease.

Opportunities in sale leasebacks

The sale leaseback offers an attractive alternative to traditional debt financing, which has become more expensive. This is apparent in the heightened activity in sale leasebacks in 2022—a record year in both transaction volume (874 unique transactions) and dollar amount ($31 billion). When compared to the debt markets, institutional leverage loan volume in 2022 was down about 70% from 2021's volume and almost 40% from 2020's volume, according to Fitch Ratings.

For companies in the behavioral healthcare industry that need capital to grow, or simply to keep pace with increasing demand, sale leasebacks merit consideration.

Stewart Riggs is a principal at SLB Capital Advisors.

The views expressed in Perspectives are solely those of the author and do not necessarily reflect the views of Behavioral Healthcare Executive, the Psychiatry & Behavioral Health Learning Network, or other Network authors. Perspectives entries are not medical advice.