Ailing Sherman Oaks Hospital seeks cure in REIT leaseback.

The Grossman Burn Center at Sherman Oaks Hospital has an international reputation. Now, the hospital is counting on the unlikely combination of an Indian-born doctor and a Birmingham, Ala., real estate investment trust to help keep it afloat.

After appearing on the road to closure in the next years, the board of the financially troubled not-for-profit hospital sold the facility to Dr. Prem Reddy's for-profit Prime Health Services Inc. on Dec. 20 for $20 million.

Prime immediately turned around and sold the hospital and neighboring medical office building to Medical Properties Trust Inc., which in turn leased the 153-bed hospital back to Prime on a 15-year contract with a buyback option.

While such an arrangement is not unheard of for medical facilities, it is unusual, and now, for the first time in years, the Sherman Oaks hospital appears to be on secure financial footing.

"We had gotten to the point to where we needed to do some capital improvements, but because of the financial challenges we realized that it wasn't going to be possible," said David Levinsohn, the hospital's longtime chief executive, who has seen the 47-year-old facility struggle through a variety of financial challenges over the years.

The hospital had been burdened by bond debt, lagging insurance reimbursement rates, increased operating costs and the need to absorb growing levels of charity care and unpaid patient bills.

In addition, the hospital's Grossman Burn Center has seen a more than 40 percent drop in the amount it is paid to treat workers compensation patients because of a reimbursement change that was part of state worker's comp reform legislation. The hospital reported losses in three of the last five fiscal years, with losses for 2005 estimated at more than $5 million.

Unlikely solution

Sherman Oaks' troubles began when the previous for-profit owner, Nu-Med, sold the hospital to Triad Healthcare Corp. in the early 1990s in a deal backed by the Cal-Mortgage Insurance Division of the Office of Statewide Health Planning and Development. Triad, which converted the hospital to a non-profit, declared bankruptcy in 1994. Eventually, the hospital ended up with debt that stood at $124 million last year.

Assistance came from the entrepreneurial Reddy, a Victorville cardiologist who had rebuilt a failing small hospital there in 2001, and over the past year reversed the fortunes of a bankrupt hospital in Chino.

Reddy was out of the country last week and could not be reached for comment. But the 57-year-old doctor, a fellow of American College of Cardiology and American College of Chest Physicians, in published interviews has described his career as a classic example of an immigrant's "American Dream."

Reddy grew up in a rural Indian village and married his college sweetheart and fellow intern at Christian Medical School in India, then immigrated to the U.S. in 1976. After a residency at the State University of New York in Brooklyn, they set up a medical practice in Victorville.

He built the 85-bed Desert Valley Hospital in Victorville after founding Desert Valley Medical Group, which later became PrimeCare International Inc. with a managed care operation that had annual revenues of more than $500 million, according to the firm's Web site. It was sold in 1998 to Tennessee-based Phy-Cor, but was reacquired by Reddy after the new owner ran into financial difficulties.

In 2004, Reddy gained control of bankrupt Chino Valley Medical Center in Chino, and last year entered into a sale-lease back agreement with Medical Properties Trust for both it and the Desert Valley facility. The Sherman Oaks deal was the third between Reddy and the REIT.

The trust is a fast growing specialty REIT that began making investments in March 2004 and expects to report nearly $500 million in acquisitions as of the end of fiscal 2005, according to Chief Financial Officer Steven Hamner.

The company has bought both existing hospitals and projects under construction, and specializes in suburban community hospitals and specialty facilities such as rehabilitation and orthopedic hospitals.

"Prime is one of the most efficient, effective and profitable hospital operators we've come across," said Hamner, who noted his company would not have bought the Sherman Oaks Hospital if Prime had not agreed to manage it.

"In Chino, (Prime) was able to take a hospital that was in bankruptcy and, by the time we acquired it, was operating at a substantial profit. It was a very good investment for us."

As part of the sale to Prime, Cal-Mortgage, which is largely funded by institutional bondholders, agreed to accept the $17 million in net proceeds from the sale as payment of the debt, said Cal-Mortgage Deputy Director Dale Flournay.