Question

I am a labor law attorney who has been recently appointed as a board member at a healthcare facility. I must help to determine whether the Hospital should consider a bond to finance major hospital renovations. I need to prepare a position on this critical financial determination for an upcoming Board meeting where all sides will be discussed. What are the issues associated with the bond issue; and how will I support the facilities' financial drivers and what those drivers might be?

Answer 1

The mentioned case can be answered in by example of Community Memorial Health System.

When it comes to the culture of a hospital, nothing is as important as the employees who work for it and aim to provide excellent patient care. When it comes to a hospital's balance sheet, particularly the physical assets, nothing is as important as the actual hospital and other ancillary buildings.

Renovating and building new hospitals are expensive ventures, and in most instances, they are necessary. Hospitals, like other forms of property, age and need the occasional tune-up or a full-scale reconstruction to stay competitive within their market and state.

For Community Memorial Hospital in Ventura, Calif., there were two reasons the administration moved forward with the construction of a new hospital: California's mandated seismic guidelines for buildings and a desire to keep their facility "modern and competitive," says Gary Wilde, president and CEO of CMH's parent organization Community Memorial Health System.

In September, CMH broke ground on its six-story hospital, which is being built next to its current facility. The 250-bed hospital — expected to open in 2015 — will feature all private rooms and will meet California's seismic standards. Mr. Wilde and CMHS CFO Dave Glyer say the process of building a new hospital has been rewarding, but there are five main challenges and financial barriers every hospital management team must overcome before it moves forward with its own renovation or construction project.

1. Accessing affordable capital. Before hospitals can tackle a project as big as a new facility construction, executives must know the capital and financing options that are available to them. Mr. Wilde says CMHS had three financing options when it looked to build the new Community Memorial Hospital: It could go through a government agency, such as the Federal Housing Administration or the more local Cal-Mortgage; it could go through a bank or consortium of banks; or it could through the traditional method of bond financing.

There were pros and cons with each option. The governmental agencies provided security but would not have supported an endeavor as large as the $350 million CMH project. The banks similarly would have worked better for smaller projects. CMHS ultimately chose to go to the bond market on its own and issued $350 million in tax-exempt bonds. Mr. Glyer says what made the health system's situation so bizarre was the executive team was mapping this out during 2008 — one of the worst financial crises the country has seen since the Great Depression. It ironically turned out to be the best time to fund a new hospital project.

"The most interesting part of whole story was we were trying to borrow money at the worst point in at least a generation," Mr. Glyer says. "We realized after the stock market crashed at the end of 2008 that as we got into 2009, construction had absolutely stopped. This was a unique opportunity to do [our project] at a reasonable price if we could get it done in the next couple years before construction costs started escalating."

Going to the bond market on its own worked well for CMHS. In addition, the health system was in the heart of a bond market when other national and state fiscal affairs were stealing the spotlight. "We sold our bonds the day after the debt ceiling crisis was solved [last summer] and the day before California was going to sell $3 billion in bonds," Mr. Glyer says. "There was a big demand for California bonds because no one was issuing them. It gave us an advantage in the interest rates, and [the bonds] sold out in a couple hours."

While CMHS was able to strike a unique deal at a low cost because of the timing of the situation, not every hospital will have the same opportunity to take advantage of historic low interest rates on tax-exempt bonds, Mr. Glyer adds. However, hospitals can work together within their management team and other financial consultants to know what type of capital is required and when the best time to build may be. "We were able to hit the market when very little construction was going on, and we benefited from that," he says.

2. Selecting an approach and facility design that optimizes costs. Picking an architect for a hospital renovation or new construction is like making a selection at an ice cream shop — there are a vast array of options, and choosing only one flavor (or architect) that suits your tastes is pretty darn hard.

Mr. Wilde says CMHS worked with and looked at several different architects, and there were several factors to consider. Hospitals that are renovating or constructing new facilities have to weigh the overall design of the building against the outlined budget. CMHS eventually went with HBE, a St. Louis-based firm that has built more than 1,000 hospitals throughout the United States.

Mr. Wilde says he and the executive team worked with HBE on the design concepts, the desired efficiencies and the seismic requirements. CMHS also worked with HBE to lock in a fixed rate on the construction costs. The fixed price gave the health system the peace of mind that even if the project went over budget, their price-per-square footage estimates with their architect wouldn't fluctuate. "The risk of cost escalation was huge to us, so we went for price per square footage — mid $500 per square foot — which was very favorable compared with other hospitals that are $700 per square foot," Mr. Wilde says.

3. Forecasting future needs. One of the most highly criticized aspects of renovating or building new hospital facilities comes in the form of this question from the public: "How do we know you won't need to do more construction in the future?"

Whether you frequently drive on an expressway or live next to a neighbor who is undertaking a six-month long project, construction can be both annoying and costly. Mr. Wilde says when CMHS planned for the new hospital, the team didn't just plan for the short term — it planned ahead so the executive team would not have to go through the tiresome construction process anytime soon.

This was accomplished by using forecasting modeling and by analyzing the demand of the future with financial consultants and other stakeholders. For example, Mr. Wilde and Mr. Glyer say they looked at surging specialties (such as cardiology and orthopedics), the aging population of the area, what competitors may do in the future and predictions of demand for every one of the hospital's provided services, ranging from the operating room to the emergency department. This portion of the construction outline was timely, but hospitals have to make sure what they are building now will be relevant in the immediate and long-term future. "It's both an art and a science," Mr. Wilde says. "You can study this as close to 'right' as possible, but you may never possibly get it completely right."

4. Adopting green building strategies. For hospitals that are still living in the 1970s, "green" is the new gold standard. The U.S. Green Building Council has been at the forefront of environmentally friendly hospital design, awarding highly-sought LEED certification to hospitals that show efficient design, construction and operation of green buildings and hospitals. Renovating or building a hospital with green standards in mind, however, should not just be lip service, as green design has immediate and long-term benefits.

For example, CMH is in a coastal California community, where there is a high priority on environmentally friendly projects. Mr. Wilde says when they planned the design of the new CMH, they factored all green elements into the blueprint. High efficiency air conditioning systems, areas for ambient light, double- and triple-paned windows — Mr. Wilde says the new hospital will even have mostly recycled or natural materials instead of manmade materials, as it shoots for LEED Gold certification, the second-highest certification possible.

These types of green building strategies will cost more upfront, but if healthcare executives can get over the short-term fiscal hurdle, the dividends for both the hospital and environment could be huge later on. "We estimate spending between 5 to 7 percent more on the project to fully embrace environmental aspects, but the return on investment over time in energy consumption and the durability of products will exceed those [initial costs]," Mr. Wilde says.

5. Engaging and gaining support from medical staff, civic leaders and the public early on. When a hospital is renovating or building a new structure, especially a non-profit organization, it becomes an issue for the entire community.

Mr. Wilde says he and the executive team invited the city architect, neighbors, businesses and all other necessary stakeholders in the community to attend meetings over a two-week span and critique the outlined plans. Although the idea seemed overwhelming at first, it gave a sense of transparency and genuine care for the public's thoughts. "The community came and looked at the plans, took red pencils, marked up the plans and recommended what we could do to improve," Mr. Wilde says. "That was a very successful process."

In addition, CMHS had many meetings with physicians, clinical staff and all other employees to keep them involved. The administrative staff even presented a "mock room" of what a patient room would like, and the hospital employees and community members were able to see, physically, what they would be built.

"We did not have a single voice of opposition, even though it's a tall, imposing building," Mr. Wilde says. "When it was finally improved, the meeting was packed with all kinds of people, and there was a standing ovation. Along the way, there was a naysayer here or a neighbor who doesn't like this. But [the process we took] speaks to early engagement."

The above mentioned most important points to be keep in mind.