Understanding the Hospital Sector (Part 3): Ownership or Better RoCE?
In Part 2 of this series, we explored the various structures and models that define the hospital sector, uncovering how operational frameworks influence care delivery and financial outcomes. Now, let’s shift our focus to one of the most debated topics in the industry: ownership versus asset-light strategies.
Should hospitals invest in owning their assets, or does leasing offer a smarter path to higher returns on capital employed (ROCE)? This question lies at the heart of capital allocation in the hospital sector, with implications that go beyond financial metrics to impact scalability, resilience, and operational flexibility. In this third installment, we’ll break down the trade-offs and explore how these choices shape the long-term success of hospitals.
Understanding the Asset-Light vs Asset-Heavy Models in the Hospital Sector
When it comes to building and running a hospital, one of the most fundamental decisions revolves around whether to own the assets (buildings, land) or lease them. This decision shapes everything from capital expenditure to long-term profitability, to the very strategy of the hospital. At the heart of this decision is the debate between the asset-light model and the asset-heavy model, and it is one of the most important factors influencing hospital growth, scalability, and financial performance.
Both models have their advantages and challenges, but the key to success lies in understanding the nuances that drive each model’s financial and operational dynamics.
1. Asset-Light Model (Lease Model)
The Asset-Light model, also known as the lease model, involves operating a hospital where the bulk of the assets—land, buildings, and sometimes even equipment are leased instead of owned. In this setup, hospitals focus on renting or leasing properties and facilities, allowing them to expand rapidly without heavy capital investment.
Advantages of the Asset-Light Model:
Lower Capital Expenditure (CapEx): One of the primary benefits is the lower initial investment. With leased properties, hospitals can avoid the hefty costs associated with purchasing land or constructing facilities. This allows operators to direct funds towards improving services, acquiring advanced medical equipment, or enhancing the patient experience. Generally, companies operating under an asset-light model may require initial CapEx that is approximately 10-20% of their annual revenue. Thus, it is reasonable to state that the asset-light model requires approximately 25-30% less CapEx compared to the asset-heavy model, depending on specific operational contexts and industry standards
Scalability and Flexibility: Hospitals can quickly scale up operations by leasing additional spaces in high-demand areas or regions with unmet healthcare needs. This is crucial when expanding into new markets without worrying about the long-term financial burden of property ownership. Chains like Narayana Health have used this strategy to tap into Tier-2 and Tier-3 cities
Quicker Entry into New Markets: Asset-light models give operators the flexibility to enter new geographic regions without the long lead times associated with construction and property acquisition. This is ideal for operators who want to quickly capture demand in underserved or emerging markets.
Higher ROCE & Faster Breakeven: Since the capital investment is low, hospitals can generate higher returns from a smaller capital base. This results in better efficiency in using their capital. With lower initial costs, hospitals often reach profitability faster, which is critical in the early stages of growth.
Challenges of the Asset-Light Model:
Higher Operating Costs: While the initial capital outlay is lower, lease payments can be a significant ongoing expense. This means hospitals must maintain high occupancy rates to make these models profitable. If occupancy dips, the fixed lease payments can strain cash flows.
Less Control Over Property: Hospitals don’t have the same level of control over leased properties as they would with owned assets. Rent hikes, lease terminations, or changes in property conditions can add uncertainty.
Lease Pressure vs. Financial Agility
Lease payments create fixed cost obligations, making profitability sensitive to occupancy rates. For example, if occupancy drops below ~50-60%, lease payments could lead to operating losses. However, this model offers financial agility as leases can be renegotiated or terminated in weak markets.
During the pandemic, hospitals with lease agreements in low-ARPOB regions faced challenges as elective surgeries dipped, reducing occupancy and stressing cash flows.
Operational Independence vs. External Dependence: Asset-light models often involve collaborations with real estate owners or local entities. This creates dependencies, particularly for facility maintenance, which can impact the patient experience.
Case Study: Healthcare Global Enterprises (HCG)
Healthcare Global Enterprises (HCG) is a prominent player in the oncology sector in India, operating under an asset-light business model. This approach has allowed HCG to maintain capital efficiency, scalability, and a strong focus on delivering specialized cancer care while minimizing fixed costs associated with traditional healthcare facilities.
"The asset-light model is instrumental for our entry into underserved markets. However, as we achieve scale, transitioning key locations to ownership allows us to balance growth with sustainability." HCG’s management
Partnerships for Infrastructure:
HCG collaborates with local investors and healthcare trusts who develop and own the hospital infrastructure. HCG leases these facilities and manages operations, focusing on delivering specialized oncology services. Example: HCG’s hospitals in Tier 2 cities like Vijayawada and Gulbarga operate on leased properties, reducing the upfront capital expenditure for the company.Utilization of Pay-Per-Use Equipment
HCG has adopted a pay-per-use model for high-cost medical equipment, such as linear accelerators (LINACs). Out of the 32 LINACs in operation, 5 are on a pay-per-use basis. This strategy significantly reduces capital expenditure (CapEx) by allowing HCG to avoid upfront costs associated with purchasing expensive machinery. The company estimates that this model could save approximately $2 million per unit, leading to total savings of around $20 million if more units are transitioned to this model.
Lower CapEx for Expansion:
A typical cancer center in HCG’s network requires ₹50-75 crores for setup under the asset-light model, compared to ₹100-150 crores for an asset-heavy model. This enables faster expansion without over-leveraging the balance sheet. for instance, between 2015 and 2020, HCG added 9 centers, mostly in Tier 2 and Tier 3 cities, with minimal upfront capital.
Capital Efficiency and Scalability
The asset-light approach has made HCG's business model capital efficient and scalable. HCG has expanded into 20+ cities across India, including smaller markets like Hubli, Baroda, etc. where the demand for specialized oncology care was underserved. By avoiding significant investments in land and building, HCG achieves higher ROCE than traditional asset-heavy hospital models.
If You Are Opting for the Lease Model: Which Type of Lease Should You Choose?
If you're considering an asset-light model by leasing your hospital premises or equipment, there are different types of lease structures to choose from, each with its own advantages and potential drawbacks. The right choice largely depends on your business needs, growth plans, and financial situation.
1. Operating Lease:
An operating lease is a short-term lease agreement where the lessee (hospital) rents an asset for a specific period, usually with no option to own it at the end of the lease term. The lease payments are considered operating expenses and are deducted from the revenue.
Advantages:
Flexibility: Ideal for hospitals that may not want to commit to long-term real estate ownership. It allows you to scale quickly and exit a location without significant financial commitments.
Lower Upfront Capital Investment: The initial capital outlay is minimal, making it easier for the hospital to allocate funds for other operational costs.
Tax Benefits: Lease payments can often be deducted as an operating expense, providing a potential tax advantage.
Drawbacks:
No Ownership Benefits: With an operating lease, the hospital doesn’t benefit from the potential appreciation of the leased property. The asset is owned by the lessor, meaning the hospital can’t build equity over time.
Rent Increases: Rent may increase periodically based on the terms of the lease agreement, impacting profitability, especially during long-term leases.
2. Finance Lease:
A finance lease (also known as a capital lease) is a longer-term agreement (often 30-99 years) where the lessee essentially takes on the risks and rewards of ownership, even though the lessor remains the formal owner. The hospital may have the option to buy the asset at the end of the lease term, often at a bargain price.
Advantages:
Long-Term Use of Assets: If your hospital needs specialized equipment or long-term space, this lease allows you to use it for an extended period without the burden of full ownership.
Option to Buy: With finance leases, the hospital may have the option to purchase the asset at the end of the term, allowing it to eventually own the equipment or property if it chooses to.
Drawbacks:
Commitment to Lease Payments: While the option to purchase exists, finance leases still come with relatively high lease payments, which may be a strain on short-term cash flow.
Asset Depreciation: As with ownership, the value of leased equipment or property may depreciate over time, which could lead to a mismatch between the lease terms and the asset’s actual value.
2. Asset-Heavy Model (Ownership Model)
The Asset-Heavy model, also known as the ownership model, involves hospitals that own the land, buildings, and other infrastructure required for operation. This model is typically capital-intensive, requiring large upfront investments but offers long-term benefits in terms of control over the property and potential appreciation in asset value.
Advantages of the Asset-Heavy Model:
Long-Term Stability and Control: Owning assets provides long-term stability and ensures full control over the hospital’s property. This reduces the risks associated with rising lease costs and reliance on third-party landlords. It also allows for more operational flexibility in terms of redesigning the infrastructure as per evolving healthcare trends.
Appreciation in Asset Value: Real estate, especially in metro cities or key healthcare hubs, appreciates over time. Hospitals owning property benefit from this appreciation. For example, a hospital located in a prime location may see a rise in property value, which can significantly boost its overall asset base and market value.
Quality Assurance & Vertical Integration: Asset-heavy businesses can ensure higher quality standards since they directly oversee the production and supply chain. This capability helps build brand trust and customer loyalty. By owning assets along the supply chain, companies can achieve vertical integration, reducing reliance on external suppliers. This integration can lead to cost savings and enhanced operational efficiencies.
Cost Control: Although there are significant upfront costs, the ownership model helps to control operational costs in the long term. Hospitals with owned properties are less susceptible to rent escalations and can invest in capital improvements that enhance efficiency and service delivery.
Fly-Wheel Effect: With a large pool of assets generating revenue, asset-heavy businesses can absorb short-term disruptions more effectively. This stability allows for sustained growth even when individual assets face challenges.
Challenges of the Asset-Heavy Model:
High Initial Capital Outlay: The primary challenge with the asset-heavy model is the high capital requirement. Hospitals need to make substantial investments in land acquisition, construction, and medical equipment, which can take years to break even.
Low Return on Assets (ROA): While asset-heavy businesses may achieve higher gross margins, generating a good return on the substantial upfront costs remains challenging. Efficient utilization of assets is critical to improving ROA.
Long Payback Periods: The payback periods for investments in physical assets are often long, leading to delayed returns on investment (ROI). Companies may take years to break even on their initial capital expenditures.
Slower Expansion: Expanding under the ownership model is more capital-intensive and slower. Hospitals cannot scale rapidly unless they have access to substantial capital, which makes it challenging to respond to changing market dynamics or urgent healthcare needs.
Significant Debt Exposure: Many asset-heavy companies finance their investments through debt, which increases financial risk. A downturn in revenue can lead to difficulties in servicing this debt, potentially resulting in insolvency.
De-risking revenue dependency: With no lease obligations, these hospitals are insulated from market-driven rental escalations, which can erode margins in asset-light setups during inflationary periods.
Asset-heavy setups create high entry barriers due to the high upfront investment. However, this can also turn into an exit barrier in underperforming markets, where sunk costs lock capital into non-viable geographies, reputation risks and regulation restrictions. Hospitals have a duty of care, and abrupt closures could leave patients stranded. Regulatory bodies often impose conditions to ensure continuity of critical services during transitions. In many geographies, hospital licenses come with obligations that restrict closures without significant notice or alternative arrangements. For instance, Fortis Healthcare’s underperforming projects in Tier-2 cities faced this issue, as divesting assets in these regions proved challenging due to limited demand (Selling off these hospital assets, such as buildings and equipment, is not always easy. These assets may not be easily liquidated. Re-usability is limited to hospital sector if any hospital wants to exit and make disinvest it has to exchange its hands with other hospital).
Case Study: Apollo Hospitals
Apollo Hospitals, founded in 1983 by Dr. Prathap Reddy, is one of the largest healthcare providers in India and a pioneer in the private healthcare sector. With a network of over 70 hospitals across the country, Apollo operates on an asset-heavy business model, characterized by significant investments in physical infrastructure, advanced medical technology, and skilled personnel.
Substantial Capital Investment: Apollo Hospitals has made extensive investments in building and equipping its facilities. The company outlined a capital expenditure plan of ₹1,800 crore to add 2,500 beds over three years, reflecting its commitment to expanding its physical footprint and enhancing service capacity.
Vertical Integration: The organization employs a vertically integrated model that encompasses hospitals, outpatient services, pharmacies, and diagnostic centers. This integration allows for better coordination of patient care and maximizes the use of its assets.
Dr. Reddy once remarked, “Healthcare is not just about treating diseases; it’s about building institutions of trust and excellence. Ownership allows us to maintain quality and innovate without compromise.”
Apollo’s decision to expand through ownership has helped it solidify its brand as a trusted healthcare provider in India’s competitive healthcare sector. Owning property in key metropolitan areas also gives Apollo a competitive edge in terms of patient loyalty, high-margin services, and premium pricing.
Challenges Faced
High Fixed Costs & High Initial Capital Outlay
Operating an asset-heavy model involves high fixed costs associated with maintaining hospital infrastructure and equipment. These costs can strain profitability during periods of low patient volume or economic downturns. Capex per bed is on higher side (80L to 1.5cr+ per bed) as compared to an asset light model. For instance, the Delhi and Hyderabad facilities cost ₹200–300 crores each during their initial setup. Also, these units take longer period to get that RoI, payback period ~7-10 years for new hospitals (Greenfield capex). Which has led to lower initial margins (ranges 10-15%) and RoCE (8-13%).
Premium Infrastructure and Equipment
Apollo hospitals are equipped with cutting-edge medical technology, including robotic surgical systems, advanced diagnostic labs, and modular OTs. The upfront investment in technology creates a differentiated offering, allowing Apollo to charge premium prices.
Regulatory Compliance
Operating within a heavily regulated industry requires continuous investment in compliance measures and quality assurance processes, which can add to operational costs.
Barrier to Exit
Apollo and similar organizations with heavy investments in physical assets, their capital is tied up in these locations. This creates a significant barrier to exit due to sunk costs and reputation risks. In essence, they must continue to optimize and drive efficiency in those regions to justify their substantial investments.
On the other hand, asset-light hospitals have the advantage of flexibility. By leasing facilities or partnering with asset owners, they can more easily adjust their scale and operations based on market conditions. This reduces the exit burden significantly.
Final Thoughts
The choice between asset-light and asset-heavy models is not binary. Each has its unique strengths and weaknesses, and the optimal approach often depends on the hospital’s strategic goals, financial resources, and target market.
Asset-Heavy Suited For:
Hospitals in metro cities with high ARPOB and premium services.
Planning premium offerings requiring large upfront investments (e.g., oncology, transplants).
Providers focusing on long-term value, building a legacy and market leadership.
Institutions targeting medical tourism or specialty care.
For long-term stability and branding, the asset-heavy model is ideal but requires deep pockets and patience.
Asset-heavy hospitals benefit from patient stickiness in high-demand, specialized services. These hospitals can create a niche, such as becoming a regional leader in neurology or orthopedics, where demand is consistently high (e.g. Kovai Medical Center & Hospital).
The Asset-Heavy Model becomes more attractive in regions where real estate prices are appreciating and where hospitals can consolidate market share over time by creating a network of owned facilities (E.g. locations like Mumbai, Gurgaon)
Asset-Light Suited For:
Expansion into Tier-2 and Tier-3 cities where ARPOB is lower.
Fast-scaling hospital chains targeting underserved regions. (best for testing the water). Entering newer geographies or experimenting with niche segments (e.g., day-care surgery centers).
Providers prioritizing operational flexibility and lower financial risk.
For rapid expansion and flexibility, the asset-light model provides a viable path with lower upfront costs but higher operational risks.
Testing markets with lower demand certainty.
Maintaining financial agility to manage macroeconomic risks.
By understanding these models, hospitals can craft strategies that align with their mission, market realities, and financial objectives. Whether leasing or owning, the ultimate goal remains the same: delivering quality healthcare while ensuring sustainable growth.
Hybrid Models in Practice
Till now you might have known that the choice between asset-light and asset-heavy models is not binary. Many hospital groups are adopting a hybrid model, combining elements of both approaches to balance risk and return. The hybrid approach allows flexibility, scalability, and the long-term benefits of owning property. For instance, hospitals might own flagship facilities in urban centers (asset-heavy) while leasing satellite centers in Tier-2 and Tier-3 cities (asset-light). E.g. Max Healthcare has successfully implemented a hybrid model. While owning key assets in Delhi-NCR, it has leased facilities in smaller towns to expand its footprint without over-leveraging its balance sheet.
Ultimately, the decision depends on the market dynamics, geographic focus, and long-term strategic goals of the hospital. A well-thought-out combination of both models could allow healthcare operators to scale efficiently, maximize returns, and position themselves as leaders in an increasingly competitive market.
Unit Economics of Lease and Ownership Models
Key Takeaways:
Revenue Sources & ARPOB:
Lease model hospitals typically have lower ARPOB compared to ownership model hospitals. This is because asset-light models tend to focus on high-volume, shorter-term treatments, while ownership models can capitalize on specialized, high-value services.
ALOS:
Lease models often have a lower ALOS because they cater to shorter-term and outpatient care, while ownership models focus more on inpatient care, specialized treatments, and chronic care, leading to a higher ALOS.
Operating Margins & CapEx per Bed:
Lease models have higher operating margins because they avoid high upfront investments in real estate and infrastructure. The ownership model, on the other hand, incurs much higher CapEx per bed due to owning land, buildings, and medical equipment.
RoCE & Breakeven Period:
RoCE is higher for lease models due to efficient capital usage and lower capital investments with BEP of 1-3 years. Ownership models, although more capital-intensive, tend to provide long-term gains, leading to slower but steadier returns & BEP of 5-7 years.
Ind AS 116: An Overview
Ind AS 116, which replaced the earlier lease standard Ind AS 17, is a key accounting standard in India that deals with lease accounting for both lessors and lessees. This standard, introduced by the Ministry of Corporate Affairs (MCA) in 2019, has brought significant changes to how leases are reported in financial statements.
The primary impact of Ind AS 116 is that it requires lessees to recognize most leases on the balance sheet, which was not mandatory under the previous standard. This means that hospitals, many of which lease critical assets like medical equipment, office spaces, and even entire hospital buildings, are significantly impacted by the new accounting treatment.
Key Provisions of Ind AS 116:
Right-of-Use (RoU) Assets: Under Ind AS 116, lessees must recognize a right-of-use (RoU) asset, which represents the hospital's right to use the leased asset over the lease term.
Lease Liabilities: The lease liability is recognized at the present value of the lease payments over the lease term. This liability represents the obligation to make future lease payments.
Impact on Income Statement: The expense related to leases is no longer confined to lease rentals. Instead, it is split into:
Depreciation on the RoU asset
Interest on the lease liability
Lease Term and Discount Rate: The lease term, which includes options to extend or terminate the leases that are reasonably certain to be exercised, and the discount rate applied to calculate the present value of lease payments, are critical in determining the accounting treatment. Exemptions: Short-term leases (less than 12 months) and leases for low-value assets may still be treated as operating leases.
Impact of Ind AS 116 on the Hospital Sector
Hospitals typically operate in an asset-heavy environment, which involves substantial leasing of buildings, equipment, and other assets. The adoption of Ind AS 116 fundamentally alters the way hospitals manage their leases, affecting both their financial statements and key performance indicators (KPIs).
1. Balance Sheet Implications:
Right-of-Use (RoU) Assets: Under Ind AS 116, hospitals must recognize the value of leased assets (e.g., hospital buildings, medical equipment) on their balance sheet as RoU assets. This leads to an increase in total assets, potentially impacting ratios like Return on Assets (ROA), Debt to Equity ratio, and asset turnover.
Lease Liabilities: Simultaneously, hospitals must recognize a corresponding lease liability, which will show up as a non-current and current liability on the balance sheet. This can lead to an increase in liabilities, affecting the Debt/Equity ratio, making the hospital look more leveraged than before.
2. Profit and Loss Impact:
Transition from Operating Lease Expense to Depreciation and Interest: Previously, under Ind AS 17, lease rentals for operating leases were recorded as an expense on a straight-line basis in the P&L account. With Ind AS 116, the lease expense is split into:
Depreciation on RoU assets: Depreciation will be recognized over the lease term on a straight-line basis, which will be a non-cash expense.
Interest on Lease Liabilities: Hospitals must recognize interest on the lease liability, which may initially be higher in the earlier years of the lease, and lower as the lease progresses.
This shift can lead to higher EBITDA in the early years of the lease since depreciation and interest expenses are excluded from EBITDA, but the bottom-line (PAT) may show a higher expense in the initial years due to the interest component.
3. Cash Flow Impact:
Operating vs. Financing Cash Flows: The major shift under Ind AS 116 is that lease payments are now split into principal repayments (which are classified as financing cash flows) and interest payments (which are classified as operating cash flows).
For hospitals, this means that cash outflows related to leases, which were previously shown under operating activities, will now be shown as financing activities, affecting the operating cash flow which could make operating cash flow appear stronger and improving the financing cash flow.
Impact on Free Cash Flow: The reclassification of lease payments will impact the reported free cash flow, potentially making it appear lower in the short term due to the financing cash flow outflow being higher.
Example:
Let’s consider a hypothetical example of a hospital in India with a leased property for 10 years (for simplicity). The annual lease payment is ₹10 crore.
Under Ind AS 17 (Old Standard):
Lease payment is treated as an expense in the P&L.
The hospital reports ₹10 crore as lease rental expense each year.
Under Ind AS 116 (New Standard):
Recognizing Right-of-Use Asset: The hospital now capitalizes the lease on its balance sheet. Suppose the lease is for ₹10 crore annually for 10 years, with an interest rate of 5%. The present value of lease payments would be ₹85.74 crore, which is recognized as a RoU asset.
Lease Liability: The hospital records a lease liability of ₹85.74 crore, which is reduced as lease payments are made.
Income Statement: Instead of a flat ₹10 crore lease rental expense, the hospital will now:
Depreciation: Recognize ₹8.57 crore (assuming straight-line depreciation) of depreciation on the RoU asset each year.
Interest Expense: Initially, interest will be higher due to the larger liability at the start of the lease term. Let’s assume the interest expense is ₹4.28 crore in the first year.
So, the total lease-related expense in the first year will be:
Depreciation (₹8.57 crore) + Interest (₹4.28 crore) = ₹12.85 crore
Impact on Key Metrics:
EBITDA: Under Ind AS 116, the operating lease expense is replaced by depreciation and interest expenses. So, the EBITDA will be higher than under Ind AS 17, but the net income could be lower in the initial years due to the interest expense.
EBITDA Growth: Since depreciation and interest expenses are added back when calculating EBITDA, hospitals may show better operational performance (higher EBITDA) in the early years, but PAT may be impacted due to the interest on lease liability.
Operating Cash Flow: Cash paid for interest on the lease will still be considered an operating cash flow, but the principal repayment will be reclassified as a financing cash flow.
Free Cash Flow: The principal repayments reduce free cash flow since these are now financing activities, even though the total cash outflow is the same.
Steps to Adjust Financial Statements
Identify Lease-Related Changes:
Look at the financial disclosures to extract lease-related information, such as:
Total lease liability.
Interest expense on lease liabilities.
Right-of-use (ROU) asset depreciation.
Lease payments.
Reconstruct EBITDA:
Adjust for the lease expense (interest + depreciation) to reflect pre-Ind AS 116 operational profitability.
Recompute Leverage Metrics:
Separate lease liabilities from other borrowings to avoid overestimating financial leverage.
Normalize Cash Flows:
Combine lease payments across financing and operating activities for a clearer view of cash flow sustainability.
Reported operating cash was Rs.321 Cr from which we have to deduct principal amount of Rs.72.5 cr and Interest on lease of Rs.59 cr.
After this we land on to the actual/ adjusted operating cash flow of Rs.189.5 cr. (321−72.5−59 = 189.5).
What’s next?
Ownership versus leasing isn’t just a financial debate; it’s a question of strategy, growth potential, and risk management. As we’ve explored in this article, each approach comes with its own set of advantages and challenges, making the decision highly context dependent. Ultimately, the key lies in aligning the chosen model with the hospital’s long-term vision, financial health, and market dynamics.
But the hospital sector is far from static. In the next part of this series, Understanding the Hospital Sector (Part 4): Is a New Model Emerging? & Competition? we’ll dive into how emerging trends and evolving competition are reshaping the industry. Are we witnessing the rise of a new model? And how are hospitals positioning themselves in an increasingly competitive landscape? Stay tuned for an exciting exploration of the future of healthcare.