Bricks and mortar health care services companies like THC and CYH are, no doubt, always ready to consider sale of assets to a REIT. The tax reform bill signed by President Trump just before Christmas gives them a reason to take another long look.
Specifically, the tax reform bill:
- Limits the deductibility of interest to 30 percent of EBITDA through 2021; 30 percent of EBIT thereafter.
- Excludes REITs from the limitation on interest deductibility at their election and in which case tangible property would depreciate using ADS
- Grants a 20 percent deduction against taxable income to individuals for REIT dividends paid, regardless of election to itemize
Rent expense remains fully deductible.
In short, current federal tax policy is designed to discourage debt unless you are a REIT. At the same time, Congress is granting tax preferred treatment to REIT dividends, making them more attractive to investors.
Any one of those changes would have had an impact on the health care sector. Combined, they expand the strategies for services companies facing the dual threat of antsy investors and slowing growth in insured medical consumers.
Having such a strategy will become increasingly more urgent as the interest deduction limitation is applied to EBIT in 2022.
THC reported interest expense of over 40 percent of EBITDA in 2016 and 90 percent of EBIT.
In contrast, HCA will be less motivated to change their approach as they are not likely to hit the 30 percent cap, barring a major acquisition.
The interest deduction will, of course, be less valuable due to the reduced corporate rate.
Selling assets to a REIT is a time honored way to shed pesky activist shareholders as Gaylord Entertainment did when it grew weary of Bob Rowling's meddling and converted to Ryman Hospitality. The REIT option helps effectuate other, more mutually agreeable exits as when Capella Healthcare sold its portfolio for $900MM to MPW at the behest of private equity owner GTCR. JER Partners and Formation Capital's sale of GEN's real estate to HCN for $2.4B facilitated their exit in 2011.
In other words, the playbook is well known for THC or CYH if they are looking for options in dealing with their restless shareholders and changes in tax law.
REITs, for their part, are going to be more attractive to investors in 2018. Their new after tax yield reduces the upward pressure on rents that may have prevented THC or another services company from considering such a transaction.
It is a perfect set-up for some major transactions and perhaps a ray of hope for some services providers. It may not be enough to overcome all the structural issues – slowing growth of insured medical consumers, mix shift toward Medicare, etc. – but it is something.
Call with question. Too cold outside so we are sitting by the fire reading all 503 pages of tax reform.
Emily Evans
Managing Director
Health Policy
@HedgeyeEEvans
LinkedIn
