How Private Equity-Backed Practices View Real Estate and Tenant Improvements - And What Independent Groups Can Learn

In today’s evolving healthcare landscape, private equity (PE) firms that have yet to complete a secondary sale are often looking for alternative methods of enterprise value creation. One particularly insightful example of this approach is how PE-backed healthcare companies sometimes handle tenant improvements (TIs) when physicians own the real estate in which their practice operates.

The PE Perspective on Tenant Improvements

When a physician-owned real estate entity constructs or purchases a new building for its practice, traditional practice management would call for a split of tenant improvement costs between the landlord (physician-owned real estate company) and the tenant (physician-owned practice company). This dynamic changes significantly under PE ownership. Here's how:

• PE companies often contribute 100% of the TI dollars, removing the burden from the physicians’ real estate entity, while continuing to increase the value of the real estate investment.
• These costs are not treated as operating expenses, which would otherwise reduce physician compensation or impact practice profitability.
• Instead, the TI investment is treated as a capital expenditure by the parent company, outside the scope of normal overhead.

Why this structure? Private equity views the opening of new offices as a revenue-enhancing strategy. New facilities help attract additional physicians and increase procedural volume, both of which directly drive EBITDA, a key metric for company valuation. The PE company will pay for EBITDA at inception. Why not provide more capital to grow EBITDA as long as the ROI is attractive?

Capital Spending as a Value Driver

For PE-backed entities, boosting EBITDA is the name of the game. Every dollar spent on growth that results in a recurring increase in revenue and profitability adds to the valuation multiple of the overall enterprise. Tenant improvements, while costly up front, are seen as a high-ROI investment if they lead to expansion and scale.

This value-driven approach to growth incentivizes investment in new space, even when physicians own the building, because it aligns with the PE firm’s long-term objective: to maximize the exit value of the platform.

What Independent Groups Should Consider

Independent physician groups, especially those who own their real estate, can adopt a similar lens when evaluating expansion opportunities:

• View tenant improvements not as a drag on profits, but as an investment in enterprise value, especially if they lead to increased EBITDA.
• When modeling the economics of a new project, consider isolating the TI investment from traditional overhead to get a clearer picture of ROI.
• If projected EBITDA is increasing (exclusive of the tenant improvement cap ex), the practice is likely creating meaningful value, just as a PE firm would see it.

Conclusion: Adopt a Growth-Minded Framework

By reclassifying tenant improvements as capital investments and focusing on EBITDA growth, private practice groups can build more valuable enterprises. Prioritizing smart growth and evaluating projects through a value-creation lens can build sustainable, physician-led organizations. Physician groups need to look beyond expenses and start viewing capital expenditures as having a measurable return on investment.

Interested in discussing how this strategy could apply to your practice? Schedule a call with our team or email solutions@cmacpartners.com to start the conversation.