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No Consensus on Capital Spending

Karen Minich-Pourshadi, for HealthLeaders Magazine, January 8, 2010
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"There's still as much demand for capital development projects as before [the recession], but getting access to capital to move forward with them is challenging," adds Kennedy. "For those hospitals that are able to effectively access capital, it's a very appealing time to finance."

What are the financing alternatives? Kennedy says there are two options:

  1. Unenhanced funding that includes issuing debt on the hospital's own credit profile and financial strength
  2. Enhanced financing, when a hospital borrows on the strength of an investment grade-rated institution.

The cost of delay
Though capital expenditure financing options are available, many hospitals remain undecided on whether the time is right to proceed. One concern is the potential for hyper-escalation, such as was experienced in 2002-2008. "Those six years saw pretty steep escalations in the healthcare market that it wasn't used to seeing. One of the biggest contributors to the state of the market then was that tradesmen were busy and not available," Brownrigg says. Hesitation may prove costly for several reasons.

First, the motivation for the initial construction boom, which includes aging facilities, advances in technology, seismic code changes, and the large influx of aging patients, remain in place. "You have to ask what waiting is going to do to your infrastructure," says Brownrigg.

Second, capital improvements are crucial for hospitals to recruit physicians, to provide quality care and to attract patients—the last of which, helps hospitals maintain market share.

Third, the materials cost and some labor costs are lower than in the past. The construction materials price index showed a 9.5% drop from September 2008 to May 2009. However that will change in 2010, according to Jim Haughey, PhD, chief economist at the Atlanta-based Reed Construction Data, a leading provider of construction information.

"If hospitals wait until the spring to build, they'll pay 3%–5% more for materials," he notes. Given the amount of time it takes to put a hospital capital construction project into motion, facilities that are further along in the planning process in early 2010 may be able to beat the rising cost of materials by breaking ground before another projected 6% increase in materials occurs in 2011.

As the economy reboots, it would seem be right time for capital construction to resume; still, hospitals remain divided. For those facilities that do decide to proceed, Van Gorder offers some words of caution: "Projects still need to make sense in the strategic plan of the hospital, and the project has to be financially feasible from a debt service coverage perspective, and from an overall financial project prospective."


Karen Minich-Pourshadi is senior finance editor for HealthLeaders Media. She may be contacted at kminich-pourshadi@healthleadersmedia.com.
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