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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.

Similarly, WakeMed Health and Hospitals, based in Raleigh, N.C., is in the midst of a building boom that includes a new $99 million inpatient facility on its main campus, as well as a $50 million expansion of its hospital in the town of Cary. William Atkinson, WakeMed's CEO, says all the work now under construction or still being planned will be paid for through cash reserves. However, he does say that at some point in the future, bonds may have to be used. “Given the current recession, we're cautionary.” But because the healthcare system has never had to use bonds to finance projects, Atkinson says, “We don't even have a public bond rating.”

Replacement value


Jennifer Garland

Jennifer Garland


For Middle Tennessee Medical Center, the decision to build a new hospital was obvious. The original hospital was built in 1927 and the newest buildings were constructed in the 1990s, Simpson says. Besides age, space also was a factor. The old hospital contains 350,000 square feet and is licensed for 217 beds. The new hospital will be 560,000 square feet and have 286 beds in all-private rooms.

Ground was broken for the new hospital in April and construction should be completed by August 2010, says Jennifer Garland, the project director. The first patients are expected in November 2010. “This will be a replacement hospital,” says Simpson. “So we are currently involved in determining the value of the old building.” That building will eventually be sold, he says, but adds, “We don't expect it to be used again as an acute care hospital.”

The new hospital will be 3.5 miles from the current campus and will be located on 68 acres which the hospital purchased from the city in 2003.

As city-owned land, the parcel was part of the city's master plan for commercial expansion, Garland says. But it had no road access. With the money the city received from the sale of that land, it was able to construct a new interchange which will greatly increase the new hospital's accessibility. The land cost about $5 million, Simpson says. Of that, approximately $3.5 million came from the Christy Houston Foundation, with community philanthropic efforts making up the rest.

Garland says purchasing an existing facility was not an option, but consideration was given to renovating the original building. However, expansion was limited, to say the least. “We're adjacent to a downtown historic district, a graveyard and a university,” she says.

Designed by Nashville's Gresham Smith and Partners, with Brentwood, Tenn.-based Turner Universal serving as the construction manager, the new hospital also will reflect input requested from physicians, nursing supervisors and floor nurses, Garland says.

Regional differences

The Research Triangle region of North Carolina that includes Raleigh, Durham and Chapel Hill is booming in both population and healthcare construction projects. There is currently more than $1.5 billion in projects either under construction or in the planning stage.

One of the largest health systems in the area, WakeMed has consistently added new facilities in areas of rapid population growth. In part, WakeMed is competing against both Duke University Health System and UNC Health Care System — each of which have established satellite facilities in neighboring towns. But Atkinson stresses, “We go where the market is, where the demand is.”

As a result, WakeMed has enlisted the services of Birmingham, Ala.-based Brasfield & Gorrie, a major Southeastern construction company, for many of its projects, including the 105,000-sq.-ft. WakeMed North Healthplex in Raleigh and the 85,000-sq.-ft. healthplex in the town of Apex. Three other local healthplexes also are planned.


James Connelly

James Connelly


Atkinson says the expansion of the WakeMed Cary Hospital will add 42 new beds, double the size of the parking deck and expand the women's center. Expansion of the main campus in Raleigh will include a new four-story, 168,000-sq.-ft. medical surgical building that will contain 102 medical/surgical, intensive care, rehab and pediatric beds. The project also calls for a new 2,500-car parking deck. WakeMed also received approval to add 21 new beds in the North Healthplex for OB and women's support services, Atkinson says.

Over the years, WakeMed has purchased parcels of land in areas where expansion will be needed or where there is an anticipated need for a new facility. “We try to pay close attention to the market,” he says.

But this healthcare system also is exploring third-party options. “At the Northplex, we allowed an outside investor to build a medical office building on property which they lease from us,” Atkinson says. “We like the strategy because we don't want to be in the medical office building business.”

While Raleigh's economy is still strong, Detroit continues to reel from high unemployment and years of a depressed economy. But healthcare there remains vibrant.

The Henry Ford Health System is nearing the completion of a new $350 million, 300-bed hospital in Detroit's northwest suburbs that will be called the Henry Ford West Bloomfield Hospital. “We're positioning ourselves for the next couple of decades and pushing out from the urban core,” explains James Connelly, Henry Ford's CFO. Building the new hospital was in essence an expansion project. “West Bloomfield was a major satellite, but there were no beds,” Connelly says.

Henry Ford, an integrated delivery system with revenues last year of $3.5 billion, had purchased the 160-acre site about 20 years ago with the vision of building a full-service hospital, he says.

With an A-1 rating from Moodys, Henry Ford was able to secure $300 million worth of tax-exempt bonds. “We were fortunate to have gotten the bonds when we did,” Connelly concedes.

Long before ground was broken in late 2006, a lot of planning and strategizing went into deciding to open a new hospital. “We considered all the aspects: expected cash flow, debt service, assessing the feasibility of taking on new debt,” Connelly says. But as a satellite, this site was already seeing 250,000 patients a year, he notes. When acquiring a hospital, these factors, as well as expected performance, rate of return and staffing issues also must be considered, Connelly says.

In July 2007, Henry Ford Health System acquired the remaining 50 percent of St. Joseph Health Care, a multi-site system with 435 beds, and renamed it Henry Ford Macomb Hospital. It also acquired a 153-bed hospital in Grosse Pointe that it had jointly owned with Bon Secours and renamed it Henry Ford Cottage Hospital.

All these expansions have given Henry Ford Health System a much larger footprint in the region. “Our desire is to have our operations in dozens of places in southeast Michigan,” Connelly says. “Healthcare is a regional business. You have to go where the people are.”

Richard Rogoski is a contributing writer based in Durham, N.C.

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