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To build or not?

By Mike Hrickiewicz, Health Facilities Management
December 2009

As hospital building activity spent the year under the shadows of Wall Street’s financial meltdown and Capitol Hill’s health reform debate, industry planning, design, and construction professionals found themselves riding out an extended down market.

Indeed, project-start data from New York-based McGraw-Hill Construction’s Construction Outlook 2010 show hospital construction dollar volume down 32 percent from 2008 and square footage down a remarkable 38 percent.

While many challenges have yet to be resolved at the time of this writing, enough light has been shed on the activities of the past year to provide a clearer view of where the hospital construction industry has been and a somewhat more diffuse view of where it is going.

Mounting signs
“There were mounting signs in late 2008 that the weak economy and tight lending were having a negative impact, causing capital expansion plans to be deferred, and this situation grew more pronounced in 2009,” Robert Murray, vice president of economic affairs for McGraw-Hill Construction, writes in Construction Outlook 2010.

The first confirmation of this came in January 2009 when the American Hospital Association (AHA) published its survey of 639 CEOs titled, “Report on the Capital Crisis: Impact on Hospitals.”

With about 90 percent reporting it harder or nearly impossible to access tax exempt bonds or attract charitable contributions - and other important sources of debt such as banks and other financial institutions becoming more difficult to access as well - it became clear that the 2008 financial crisis was going to affect healthcare construction throughout 2009. In fact, according to the AHA survey, nearly half of hospitals had put capital projects on hold and many had stopped projects already in progress.

Richard Galling, president and COO of consulting and development company Hammes Company, Brookfield, Wis., saw this phenomenon firsthand. “I know we had three hospital projects that were under construction with the structure almost complete, and the clients put them on hold in the fourth quarter of last year,” he says. “We had four other hospital projects where clients paused while we went through their options with them.”

Among the options typically explored in such situations are value engineering some of the costs out, shelling empty space for future use and slowing the project down to flatten the cost curve, says Todd Freed, LEED AP, vice president of operations - healthcare, at McCarthy Building Companies Inc., St. Louis, which also saw a number of its projects stopped or stalled.

“Even after we were contracted and bid the work out, we began working very aggressively with our clients to figure out how we could take out some of the costs,” Freed says. “We had some projects with accelerated schedules that we decelerated to slow down the cash burn.” Obtaining third-party financing is also an option to restart some stalled projects, Freed adds.

Work in the pipeline
Indeed, the year could have been much worse for many hospital construction professionals had the industry not developed such a high level of activity over the previous several years, keeping many projects in the pipeline.

One sign of this may be discerned from the American Institute of Architect’s (AIA’s) recently released survey on the “Business of Architecture: AIA Survey Report on Firm Characteristics,” which found that healthcare was the top sector served by architects in 2008.

“I think that’s probably right,” says AIA Chief Economist Kermit Baker. “Those have gone through the design phase and in a lot of cases financing was secured before the downturn really hit.”

“Our backlog was very strong entering 2009 and, thus, 2009 was still a very strong year for us,” agrees James Brownrigg, vice president and director of healthcare at Turner Construction Co., New York. “Construction typically lags the rest of the economy 12 to 18 months.” McCarthy’s Freed comments: “I think we were very lucky in that we had a good backlog of projects that were started and continued.”

In fact, the pipeline has been so full that Jim Haughey, chief economist for Reed Construction Data, Norcross, Ga., believes hospital construction activity on the job sites this year is up by a percent or so over last year, despite this year’s drastic drop in project starts.

Both Galling and Brownrigg add that medical office building construction stayed relatively strong throughout the year, with Galling noting that ambulatory care facilities also provided work for some construction crews.

Where from here?
Though they are hardly jubilant, experts offer varying degrees of cautious optimism for the market in 2010, though a couple are quick to note that the larger hospitals and health systems seem to be having an easier time rounding up financing than the smaller players.

“Given the steepness of the 2009 downturn, it’s believed that much of the correction for healthcare facilities has occurred in one year, which sets the stage for at least low-level stability in 2010,” writes Murray. “The greater downside risk that occurred during the early months of 2009 appears to be easing.”

Anecdotally, Galling says all three of his firm’s stalled projects have restarted, the last of which went back on line in November. Freed tells a similar, though more speculative, tale. “Those projects that have stopped are starting to rekindle,” he says. “The steering committees are starting to meet and the intents are to restart next year.”

Much of the hope for early 2010 seems to rest on a spate of large-scale Department of Defense and Department of Veterans Affairs projects that are in the early startup or bidding stages. “There are a ton of architects and contractors chasing that work,” Galling says.

Beyond any other factor, though, experts tagged healthcare reform as the No. 1 issue affecting healthcare construction moving forward.

“It’s a nervous time to make a decision that’s delayable and I suspect there’s some of that going on,” Reed’s Haughey says. Brownrigg adds: “Our investment-grade-rated clients are able to sell bonds today but most of them are hesitant to take on a 30-year debt service until they fully understand the ramifications of healthcare reform.”

For its part, McGraw-Hill forecasts a small increase in 2010, with hospital starts edging up 4 percent in square footage and 6 percent in dollar volume over 2009.

Vision of growth
While long-term demographic, design, and technology trends continue to provide a vision of strong growth for the hospital construction market, the darkness of the past year may take a bit longer to fade.

Health Facilities Management can be located on the Web at www.hfmmagazine.com.