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To Buy Or To Build?

May 29, 2008
by Richard Rogoski
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Hospitals are facing tough choices when planning to expand.

Despite the current recession and a meltdown in the credit markets, hospitals are continuing to expand. In fact, although overall commercial construction has been slowing, healthcare construction remains relatively robust throughout all regions of the country.

Robert Levine

Robert Levine

Robert Levine, senior vice president of Turner Construction's healthcare division based in Nashville, Tenn., says that while healthcare construction starts were down 3.6 percent between January 2007 and January 2008, construction starts in all other industries were down 13 percent.

Levine says the current building boom in healthcare is being driven largely by four factors: obsolescence, demand, technology and demographics.

Many hospitals were built in the 1950s, or before, and now need to be replaced, he says. As the tsunami of aging baby boomers requires more healthcare, the demand of inpatient and outpatient services will dramatically increase. Newer technologies also demand modern and larger spaces. “You can't put new technology in a 50-year-old building,” he notes.

And finally, since most of these older hospitals are located in urban centers, continued development of suburban communities has forced many large healthcare systems to establish outpatient clinics where the majority of their patients live.

But this strategy may also increase the need for new construction because these outpatient clinics serve as feeders for the home-based hospital. “And that has led to home-based hospitals needing to expand or to build a new home-based hospital closer to the people,” Levine says.

With so much emphasis on new construction, how viable is it to acquire existing facilities through purchase or a merger? “I think the bulk of merger activity is over,” says Levine, adding that M&A activity appears to have peaked in the early part of the decade.

Financial planning

John Sweet

John Sweet

Building a new hospital costs money, says John Sweet, managing director of healthcare real estate for Milwaukee, Wis.-based Ziegler Healthcare Finance, which assists healthcare organizations in developing capital and strategic plans. “It costs $1 million a bed to build a hospital today,” he says. Given rising construction costs, the land costs involved are minimal, he adds.

Sweet acknowledges that hospitals are constantly trying to tap new markets, but notes, “They may be precluded from building in a certain market because the state may not let them.” As an example of these types of restrictions, Sweet says that a new hospital recently built in Bolling Brook, Ill., was the first hospital built in that state in 24 years. On the other hand, hospital construction in Texas has been booming because that state does not restrict new hospitals based solely on a certificate of need.

Hospital administrators also are getting more inventive when it comes to financing large projects or recouping their expenses. A hospital may build a new medical office building, for example, and lease space in it to physicians, Sweet says. But because this makes the hospital the doctors' landlord, “It can create an uncomfortable relationship because the hospital can't charge docs too little for rent,” he says, noting that this would appear to be favoritism.

Another strategy that is now becoming common is for hospitals to hire a third-party contractor who will not only build, but also own the building. The hospital then leases the building from the contractor/builder/owner.

Ryan Simpson

Ryan Simpson

Using a third party also provides relief from normal financing. “With a strategy that says, ‘Let's go to a third party,’ the hospital doesn't have to worry about financing the project — the builder does,” Sweet says.

In other instances, a hospital that owns an ancillary building can sell it to someone who will then lease out the space. The money made from this sale can then be invested in the latest technologies, Sweet says.

And as for the tightening credit and bond markets which offer more traditional financing, Sweet believes this will prove to be only a temporary setback.

William Atkinson

William Atkinson

Interestingly, not all healthcare systems are relying on bonds to fund their major construction projects. Ryan Simpson, vice president of operations for Middle Tennessee Medical Center in Murfreesboro, Tenn., a member of Saint Thomas Health Services and Ascension Health, says the new $268 million hospital now under construction is being paid for by Ascension Health through cash reserves.