Company Profile: Mercatus Group (September 2006)

Mercatus pursues 3-in-1 MOB model

DEVELOPER OFFERS ANCILLARY CARE AND OFFICE MANAGEMENT SERVICES, TOO

By Dan Emerson
As any small business owner knows, independence has its challenges.

Over the past two decades, many independent physicians have experienced this truism firsthand. Many report that they’ve struggled with multiple challenges, including steadily declining third-party reimbursements and growing expenses, paperwork and regulatory hassles.

Vernon Hills, Ill. (Chicago)-based Mercatus Group LLC, a developer of medical office buildings (MOBs) – or what the company calls Physician Centers – has positioned itself as an advocate to help independent physicians succeed.

The company not only offers doctors opportunities to practice in multi-specialty MOBs equipped with ancillary care and office-management services, but it gives them a chance to become partners in the ownership of those clinics and share in the service-generated revenues.

Mercatus officials believe that their “three-businesses-in-one” model – real estate, ancillary clinical services and business services – is unique in the industry.

The model
Mercatus opened its first MOB in October 2005: The Physician Center at Vernon Hills, a one-story, 85,000 square foot facility in the northwestern Chicago suburbs. As of late summer, the Vernon Hills MOB housed about 20 physicians, including specialists in internal medicine, family practice, neurology, gastroenterology, sleep and behavioral medicine, oncology, orthopedics, psychiatry, rheumatology.

When fully occupied, about 35 to 40 physicians will office there, according to William Maggard, Mercatus’ vice president of real estate services.

Mercatus plans to open four more Physician Centers in Lake County: Lake Bluff (now being leased for an opening in summer 2007), Libertyville (late 2007), and, in 2008, Buffalo Grove and Gurnee.

Historically, most MOBs were owned by hospitals. However, in recent years the relatively high cost of developing outpatient facilities has become a disincentive for many hospitals to be involved in the ownership structure of newly developed MOBs, Mr. Maggard says. Also, many providers, as has been well-documented on the pages of Healthcare Real Estate Insights™, have divested themselves of MOBs and other ancillary real estate as a way to generate cash and rid themselves of the management headaches of owning such properties.

At the same time, many physicians have been investing in MOBs as a way to supplement their incomes.

Mr. Maggard says Mercatus’ real estate expertise and access to capital makes it a suitable partner for physicians looking for such ownership stakes.

Each Mercatus MOB facility is, and will be, operated by two limited liability corporations: one that owns and manages the real estate and another that operates the ancillary services and business-services components.

The purpose of the LLC is not to address the liability issues involved in providing health care services, Mr. Mr. Maggard explains. Instead, “it’s to enable multiple business partners to form a joint venture for a special purpose,” he says.

Because of the way the company’s agreement with physician-partners is structured, malpractice liability is “not on our radar screen,” Mr. Maggard adds.

Looking out for the docs
In addition to developing and operating financially successful MOBs, helping physicians prosper as independent practitioners is also a key part of Mercatus’ mission, according to Mr. Maggard.

“Nobody would want to see the number of independent physicians diminish to the point where they no longer play an important role in the care of our families and our communities,” he says. “This gives physicians access to the resources and support they need to stay independent and prosper. It’s an ideal solution for independent physicians (that) enables them to increase the value of their practice, raise the quality of patient care, and provide an environment where they no longer feel isolated. Our model is built on patient and physician needs.”

As for its compensation, Mercatus receives a management fee based on the revenue of the shared services company and a profit distribution if that entity is profitable. Each investor, including Mercatus, receives a profit distribution based on how much it invested in the shared services company.

In serving physicians, Mr. Maggard says Mercatus’ role is “understanding and doing an operational assessment of each physician-practice at the outset to understand what element of our business model will be most important to them.

“In many cases, it’s all of the elements that are important,” he adds. “In some instances, practices are focused on one element over another. One physician might say, ‘It’s very important for me to have the convenience of having all the ancillary services I need in the same building.’ Others say it’s the revenue associated with that that will help their practice remain independent. Others say it’s the business services we provide.”

Another key benefit the company provides for its doctor-partners, according to Mercatus officials, is that its Physician Center model is compliant with federal laws governing physician self-referral, named Stark II after its congressional sponsor. The law was passed in 1995, but its rules did not take effect until 2004.

The law was created because studies show that physicians who have a direct financial stake in health care entities, such as labs or testing centers, tend to order more tests than physicians who do not have an ownership stake. Under the Stark laws, a physician with a compensation or ownership interest in an entity cannot refer many common health services to that entity – unless one or more numerous exceptions apply.

The regulatory structure for Mercatus’ physician centers has been designed by legal counselors at the Chicago law firm Katten Muchin Zavis Rosenman. The structure allows each group practice within the Physician Center to provide ancillary services that do not violate Stark or anti-kickback regulations. Terms and conditions within the service company are neither explicitly nor implicitly tied to business generated.

“Our attorneys spent time ensuring that this would be a Stark-compliant model,” says Mr. Maggard. “Because the tests are being done in their (physician partners’) building, it (qualifies) for the in-office ancillary services exception of the Stark rules.”

Mr. Maggard says shared services offered at each Physician Center are determined by the demand for such services generated by the practices in the center. Every center will have, at a minimum, a full imaging suite (MRI, CT, X-ray, Ultrasound and Nuclear Camera) as well as an in-house lab and physical therapy.

Because Mercatus will be operating multiple MOBs, will it benefit from certain “economies of scale” in purchasing or other aspects of the business?

“I would assume so, but I wouldn’t know how to quantify that,” Mr. Maggard says.

The founding

Mercatus Group LLC was founded in 2003 by Chris Joseph, a Chicago-area entrepreneur who began his career in 1987 with First Chicago. There, Mr. Joseph helped non-profit hospitals obtain debt financing.

He later worked for the Chicago venture firm Wind Point Partners, and in 1994 was one of four co-founders of the Integration Alliance Corp., later acquired by GE Capital. In 1998, he joined Parson Group, a national business-consulting firm, as an executive.

Before joining Mercatus Group, Mr. Maggard was a senior associate with Brookfield, Wis.-based Hammes Co., one of the nation’s largest health-care real estate developers. Prior to that, he was co-manager of the LaSalle Medical Office Fund, deploying pension-fund capital in medical office building acquisitions and development.

The health care service-delivery side of Mercatus’ business is overseen by Sandra Davis, vice president of ancillary services. Previously, she was vice president of operations for Centegra Northern Illinois Medical Center in Mchenry, Ill.

Along with the physicians who practice at the Vernon Hills clinic, Mercatus’ other partner in the facility (as well as in the four other markets in Lake County) is Evanston Northwestern Healthcare (EHN), which operates a number of hospitals and outpatient facilities in the region. ENH’s radiology department provides image-interpretation and its clinical laboratory provides the lab services. The provider, however, is not involved in the real estate partnership.

J.P. Gallagher, senior vice president with Evanston Northwestern Healthcare, says the health system has a “longstanding history in this market of working closely with physicians; this provides another outlet for supporting independent physicians in a way that not was previously available to us.

“One of our major objectives is working to support physicians in ways that are consistent with their practice preferences, and what the market can support,” Mr. Gallagher adds. “And Mercatus brings a lot of expertise to work with those physicians.”

Since opening last year, the Physician Center at Vernon Hills has proven popular with patients who like “the accessibility and ease of use” of having diagnostic and other ancillary services in the same building as their physician’s clinic, Mr. Gallagher observes. “This is good for everybody.”

Is care more spendy?
Mercatus’ model might beg one question: Does care cost more as a result?

“The ancillary services that we provide in this market, as is the case with services provided in many ambulatory settings, are significantly less expensive than hospital-based testing of the same type,” Mr. Maggard explains. “There is no premium for physicians, either from an occupancy cost perspective or any other component of the business model.”

Mr. Maggard says there is no “typical” ownership-stake arrangement with the physicians.

“We’re not setting limits on investment by physicians; that will depend on the demand,” he says. “These projects are so capital intensive it’s unlikely physicians would be contributing the lion’s share of the capital required.

“That’s one thing Mercatus brings to the table: the capital necessary to invest in the top-of-the-line imaging equipment and business-services software,” Mr. Maggard adds.

The fact that each clinic’s design and floor plan is based on the specifications of each physician/partner is another “important component of our approach,” Mr. Maggard says. “Prior to putting pen to paper, we spend several hours with each practice understanding their operations so they can gain efficiency through design.”

One of the doctors with an investment in the Vernon Hills MOB is family practice physician Deborah Winiger. So far, she says the arrangement is working.

Dr. Winiger was approaching the end of her lease in an MOB two years ago and had begun a search for new space when she received a direct-mail pitch from Mercatus.

“I was interested when I found out about the shared venture, shared business services and potential for ownership,” she recalls, adding that an opportunity to switch to an electronic medical record system was another lure.

“I had been planning on doing it myself, but I found out it would be cost-prohibitive,” Dr. Winiger says. “Mercatus provided a better IT system than I could have gotten on my own.”

Although he’s not familiar with the specifics of Mercatus’ business plan, well-known health care-management consultant Daniel Zismer says the company’s concept appears to make sense.

“I think we will see more independent physician groups as partners with hospitals and hospital systems in ‘big box’ ambulatory centers, offering high-end imaging and therapeutics,” says Mr. Zismer, an executive vice president with Duluth, Minn.-based Essentia Health Consulting.

“These are not doctors’ offices, per se, although they have doctors’ offices in them. They are sophisticated centers that have a large-market brand-presence. In a market like the Chicago market, where relatively few health systems control most of the market and most physicians are still organized in smaller groups, this model allows smaller groups to aggregate in a ‘big box’ and behave in the market more like large groups. The big boxes are a terrific venue for creating integrated practices.”

Mr. Maggard was asked what the Mercatus team has learned through implementing its business plan.

“There are all kinds of lessons we are learning every day,” Mr. Maggard. “The big realization has been what a daunting task it is to start three businesses at the same time – a real estate development company, an ancillary services operation, and a business services company.”

Will there be copycats?
Does Mercatus expect competitors to adopt its three-in-one business model?

“We anticipate there are going to be firms that adopt some of these elements of our business model,” Mr. Maggard says. “We’re not aware of anyone we can point to, but we wouldn’t be surprised if there were some. We’ve been working in these markets for more than two years, establishing relationships with physicians. That is a time horizon that may surprise some developers or MOB owners.”

Aside from healthcare trends, there’s another factor that makes Mercatus’ new venture timely, Mr. Maggard contends.

“There is more discipline in this (healthcare real estate) industry, now, reflecting the discipline that has long been present in other property types,” he says.

Given the potential benefits to physicians and patients, Mr. Maggard says, he expects demand for the company’s Physician Centers to “continue to grow” – perhaps beyond the Chicago area.

Although he adds that, “for now, we are going to focus close to home in Lake County.” q

Dan Emerson writes about business and commercial real estate for a variety of regional and national publications.