Senator Warren Calls for IRS to Investigate Sebastian Hospital's Bankrupt Company

Senator goes after Steward’s property owners. Is a Real Estate Investment Trust and private equity firm what drove Steward into the ground?

There are a lot of questions that need to be asked about the financial collapse of Steward Health Care Systems, LLC (Steward) who filed bankruptcy on May 6th. Their struggle to maintain cashflow since the announcement is a financial high wire act that has been watched by national news organizations, US Senators and many local residents. 

The devastating consequences of Steward’s negligence 

In Boston Massachusetts, 8 hospitals were in the Steward network. Two have already closed their doors and 6 more are in the process of being sold. The state has already floated Steward over $70 million in bridge loans to keep the remaining hospitals open and servicing the communities as best they can.

Stories abound about how Steward hospitals were out of supplies, vendors repossessing equipment for non-payment and overworked staff as uncertainty caused a professional exodus. A Boston Globe investigation reports as many as 15 deaths in Steward facilities attributable to the many problems caused by the mismanagement of the 8 hospitals.

The Boston Globe also reported on September 12th, that Steward’s CEO, Dr. Ralph de la Torre, ignored a subpoena from the U.S. Senate Health, Education, Labor, and Pensions Committee. His absence led lawmakers to discuss out loud the exorbitant pay package and expensive toys, like the 3 private jets. Lawmakers also listened to victimized patients testify about how hospitals were unable to provide basic care. A republican lawmaker said, Dr. de la Torre “should be put in jail.”  

The Boston Globe has shared stories considering how a private equity firm and the horrible mismanagement of Steward led to an inevitable collapse of the largest for-profit hospital system in the USA. Private Equity firms often come into a business with a 3 to 5 year plan to turn them around, or expand operations with debt financing to exact a return for their investors. 

Locally, Steward owned, Sebastian River Hospital showed annual increasing revenue performance while other facilities in the Steward network of 31 hospitals were barely surviving. Employees have been watching to see whether the final sale to Orlando Health actually happens. Just getting the transaction across the finish line has been an unraveling of financial assets and commitments of Steward and it’s Alabama based property owner, Medical Properties Trust (MPT). 

The stories have caught the attention of Senate Finance Committee Member, Elizabeth Warren (D), who fired off a September 3rd letter to IRS Commissioner, Daniel Werfel. She asked him “to increase scrutiny into potential violations of tax law by Real Estate Investment Trusts (REIT)” citing Steward’s collapse as her example of possible tax evasion. 

The Real Estate Investment Trust and it’s role in Steward’s collapse

MPT is a government sanctioned Real Estate Property Trust (REIT). In 1960 REITs were created by the Real Estate Investment Trust Act under the Eisenhower Administration. It was designed so the average American could passively participate in the commercial real estate market. REITs are for investors that want to diversify investments. They can provide stable returns in the form of dividends. A REIT cannot participate in business operations at their properties.

A REIT avoids corporate taxes if it meets three well-defined requirements. It must invest 75% of its total assets in real estate. It must derive 75% of its gross revenues from rents on real estate it owns, interest on mortgage financing, or from sales of real estate. Third it must pay at least 90% of its taxable income in dividends. It must have at least 100 shareholders and be managed by a board of directors. 

Since 1960, REITs have expanded to include many types of real estate investments. The National Association of Real Estate Investment Trusts names 14 categories. Healthcare properties are considered stable investments because healthcare spending exceeded 17% of America’s total gross domestic product in 2022. According to MPT’s 2023 prospectus, “U.S. currently ranks highest in overall health expenditure in the world with $4.5 trillion in 2022, or $13,439 per person.” 

Private equity firms expanded investment through 2010 with the passage of Obamacare as investors expected an increase in revenue streams. It was in 2010 that Cerberus Capital Management (CCM) purchased Boston-based Caritas Christi, a non-profit with 6 hospitals for $830 million. Dr. de la Torre had been CEO of Caritas Christi since 2008. He was turning around the non-profit Catholic hospital network by cutting costs and focusing on specialized procedures. The celebrated heart surgeon was appointed the new CEO of Steward in 2010. With CCM giving state regulators assurances of a $400 million investment in the 6 hospitals, Steward met regulatory requirements to become a for-profit company. 

While Cerberus Capital Management met its obligations and Steward grew to $1.9 Billion in revenue, it still had a responsibility to its investors. Furthermore, in 2016, Steward wanted to expand offerings in other areas of the country. Steward management raised cash by selling its properties and buildings, to Medicals Properties Trust (MPT) for $1.25 billion. CCM returned $484 million to its investors. With that cash infusion, in 2017, Sebastian River Hospital was purchased as a part of Steward’s acquisition of 8 hospitals from Community Health Systems for $311.9 million.

Steward immediately sold the property and buildings to MPT for $301.3 million and became tenants. MPT’s purchase enabled Steward’s acquisition. Some observers noted the price of the healthcare service business versus the value of the land being a pittance in the overall valuation. In her letter to the IRS, Senator Warren referenced a 2022 study done by the Center for Economic Policy Research by Eileen Applebaum and Rosemary Batt titled, The Role of Public REITs in Financialization and Industry Restructuring. The authors pointed out, 

“While CHS had retained ownership of the hospital properties, Steward immediately sold them off to Medical Properties Trust for $301.3 million, which means that MPT essentially financed the eight- hospital purchase and implies that the hospitals’ operations were only worth $10.6 million to MPT and its investors.” (Applebaum, Eileen & Batt, Rosemary. The Role of Public REITs in Financialization and Industry Restructuring. CEPR Working Paper. July 9, 2022. pg. 39)

Using this financing model with MPT, by 2020, Steward had purchased 34 hospitals with revenues of $6.6 billion and became the largest for profit system in the USA. MPT grew right beside Steward as 40% of its portfolio consisted of Steward properties through “sale-lease” agreements. MPT also had a 9.9% equity stake in Steward to help leverage the debt. On top of that, Cerberus got entirely out of Steward in 2020 when it gave its remaining stake of $350 million in the form of a promissory note to Dr. de la Torre and his team. MPT purchased the note a year later for $335 million.

The lines between what makes a REIT and the business operations were becoming blurred. As defined, the investment is passive in its legal construction. In her letter, Senator Warren remarked,

“In Massachusetts, Medical Properties Trust (MPT) – a REIT that bought hospital properties from Steward in 2016, saddling the hospitals with expensive lease agreements that ultimately drove Steward into bankruptcy – has a complex investment history with Steward that raises questions about whether it has met IRS requirements regarding the limitations on a REIT’s ownership of a tenant or an operator.”

Steward’s imminent collapse

Steward was renting its facilities and property back from MPT. The rent was a triple-net-lease agreement. A very common agreement in commercial real-estate, Steward was responsible for taxes, insurance, utilities, maintenance and all capital improvements with the approval of MPT. As the MPT 2023 prospectus said, “Our primary business strategy is to acquire and develop healthcare facilities and lease the facilities to healthcare operating companies under long-term net leases, which require the tenant to bear most of the costs associated with the property.”

The leases are usually long-term ranging from 10 to 18 years with many 5-year extensions. According to MPT, the leases also have annual increases based on the Consumer Price Index (CPI). In this era of inflation, where in 2022, the CPI increased 9.8% in June and averaged 8.5% that year, rents obviously rose with all other healthcare expenditures. According to Steward’s bankruptcy filings, MPT had two “Master Lease” agreements for all of their properties. 

Saddled with debt financing, the sharp decline of revenue due to the pandemic, the concern of real inflation, and an executive team cost cutting while looking at international expansion, Steward began spiraling out of control. In their report, Applebaum and Batt quoted MPT’s 2020 10K report that warned, 

“If any one of these tenants were to file for bankruptcy protection, we may not be able to collect any pre-filing amounts owed to us by such tenant. In a bankruptcy proceeding, such tenant may terminate our lease(s), in which case we would have a general unsecured claim that would likely be for less than the full amount owed to us. Defaults by our tenants under our leases may adversely affect our results of operations, financial condition, and our ability to make distributions to our stockholders. Defaults by our significant tenants under master leases (like Steward, Circle, Prospect, Priory, and MEDIAN) will have an even greater effect.” (Applebaum, Eileen & Batt, Rosemary. The Role of Public REITs in Financialization and Industry Restructuring. CEPR Working Paper. July 9, 2022. pg. 38)

On a local level, Lisa Zahner at Vero News did an excellent report covering how local and national vendors went unpaid by Sebastian River Hospital and the difficulty in determining the hospital’s performance using Steward’s financial statements. In a lengthy profile of Dr. de la Torre, The Boston Globe discovered that the CEO was using company funds for private donations and various high-priced personal expenditures.

Sebastian River Hospital’s hopeful salvation could happen soon
 

Back at home, the battle over Steward being able to sell their hospitals under the bankruptcy proceedings was always about MPT receiving proper compensation for their properties. MPT wanted unpaid rents and other monies. Steward was behind in rent $50 million by January 2024 and had loans with them in excess of $900 million. 

The Orlando Health deal to buy the “Space Coast Hospitals” hinges on a negotiation with MPT. This negotiation could only move forward after Steward and MPT reached a Global Settlement Agreement approved by the US Federal Bankruptcy Court in Southern District of Texas on Sept. 10th. The agreement saw 15 hospitals transferred in ownership to MPT. In turn, the investment trust had to immediately contract new healthcare providers to manage them while they look for long-term healthcare tenants or new owners. There are 5 hospitals in the Miami area. MPT also received the closed hospital properties in Massachusetts. There was additional financing of operating expenses worked out between the two parties. With the agreement approved, the sale of the “Space Coast Hospitals” to Orlando Health is on track to be secured by October 23, 2024.

This precariously extended involvement of a REIT is exactly what Senator Warren refers to in her letter to the IRS. She wrote, “I urge you to increase enforcement scrutiny of REITs, especially large health and hospitality REITs that may be illegally claiming significant tax breaks while meddling in the operations of their tenants.” 

In their 2023 prospectus, MPT noted how they had reduced Steward’s portfolio presence down to 19%, though it still held the largest footprint of its holdings. It also highlighted a new hospital facility in Valencia, Spain that was not a Steward acquisition. In his reasons for skipping out on his subpoena for a Senate hearing, through his legal team, Dr. de la Torre noted he did not want to comment during the ongoing bankruptcy proceedings. The Senate committee is expected to hold him in contempt. Dr. de la Torre recently changed his residency to Spain to oversee Steward International.  One international deal was with the government of Malta to purchase & manage 3 hospitals. According to the Boston Globe, there is an arrest warrant for Dr. de la Torre issued by the government of Malta for criminal conspiracy concerning Steward's management practices. As a result, US Department of Justice has launched a probe into Steward.