Rising material and labor costs have had a major impact on the healthcare industry. Construction costs have doubled in some cases, driving a shift away from new projects and toward the renovation of existing facilities. Does redevelopment offer a faster and more cost-effective solution for health systems trying to grow in today's challenging landscape?
The economic V5
Inflation, supply chain constraints, labor shortages, material shortages, and rising interest rates. These risks are the volatile five, or V5 for short. The healthcare industry arguably feels the strain of these economic conditions more acutely than any other business or trade.
In a good year, the complexity of hospital operations and health system economics present inherently challenging decision metrics. Now, with the V5 forces at play, the healthcare decision matrix, especially as it relates to construction of new facilities, is notably more complex and nuanced. As a result, healthcare facility planners are increasingly considering renovation of existing facilities as a potential alternative to now projects, but is renovation the answer?
While it is true that renovating existing facilities often mitigates the risks associated with certain project variables, such as land availability and unidentified conditions, the fact remains that the design and construction of modern healthcare and life science facilities is highly specialized. They require an amplified core and shell and customized interior specifications and functionality, regardless of whether it is a new facility or a retrofit project.
The V5 forces often affect renovation projects and new projects equally. Given these factors, renovating an existing facility can be just as costly as building a new facility, and in many cases result in an end product that is less productive in the long term. Renovation can be the most appropriate solution under certain circumstances, but managers should not view it as a standalone solution for rising project costs or V5 pressures.
Given that the V5 forces impact renovation and new construction projects, effective strategies are those that focus on mitigating economic pressures to the greatest extent possible, whether it be in the context of a renovation or a new project. Several recommended strategies emerged from a recent survey of firms active in healthcare development and construction:
Early alignment of design and construction teams. Select project team professionals carefully to ensure effective alignment of design and construction approaches and philosophies. Value engineering starts on the first day, and to succeed, it requires early, ongoing and consistent alignment of the project design and construction teams in every aspect of the project.
Overcommunication. Now more than ever, healthcare clients and project partners must be in nearly constant communication about every aspect of a project’s development to ease the emotional and economic strains of managing a project. The V5 forces can change daily, which requires seamless knowledge across all project partners.
“Our clients and trade partners always expect and are given transparency in pricing guidance, but the openness of this communication is more important than ever, given the shifts in material pricing and labor availability,” says Ben Cox, executive vice president with Meyer Najem, a Midwest regional general contractor. “Open communication requires that both the client and the design and construction teams not only have standing calls (normal protocol), but that certain team members are equipped be a ready voice for the project advancement every-day.”
Although project teams cannot control the macro V5 forces, they can manage expectations and mitigate overall risk by overcommunicating challenges and opportunities in the interest of maintaining both the schedule and the budget.
Decision readiness. Given the necessity for quick decisions, transparency and fluidity in communication are more important than ever. Healthcare clients and project partners must be prepared and empowered to make decisions daily to avoid project delays and unnecessary cost increases.
Pre-order materials. “Certain materials might have a one-year lead time, and given the forces on material supplies, it could even be longer,” says Lee Watkins, chief operating officer with Snyder Langston, a West Coast general contractor. “Clients simply are not afforded the luxury to wait on every final detail and expect to hit a target budget time-line.”
In some markets, trade contractors are struggling to hold pricing for more than two weeks. Since prices are not expected to come down in the short term, waiting for a series of decisions to line up could be detrimental to the schedule, which is detrimental to the budget.
In some cases, “we are asking the design process to keep up, which might be a challenge for the long-term operational efficiency of the building,” Watkins says. “But in some of our California markets where approvals have particularly long lead times, we have no choice but to buy materials while they are available, and design might need to flex in order to accommodate critical material allocation.”
In other words, design and construction must make certain structural and material decisions before final design approvals, requiring a constant high level of coordination at every stage.
Schedule and budget conservatively with input from clinical operations. Hospitals can further manage expectations by softening revenue projections for new clinical spaces while also working with conservative budgets.
“If we project revenues to commence in July but we learn along the construction process that a facility might not open until December, we’ve just lost five months of revenue,” says Michael Owen, vice president of facility design construction and development for Community Health Network in Central Indiana, referring to managing revenue and schedule expectations. “On a single project, this might not be terribly consequential. But when you are dealing with a few $20 million projects or a $100 million project, this revenue hit is felt.”
Revenue budget targets translate directly to the scheduled opening of a new facility, so ongoing communication with clinical operations teams is also an essential element of managing a successful project completion.
Alignment of economic interests and shared risk. Ensure that the economic interests of the healthcare client and the project team members are appropriately aligned. In some cases, a shared risk and shared upside strategy might be appropriate to incentivize design and construction partners to proactively seek the most efficient, cost-effective solutions possible.
While there is no uniform solution to the V5 forces affecting healthcare project development, healthcare facility planners can employ these strategies to mitigate the potential impact of such forces on a project. In some cases, renovation of an existing facility might be the best choice. But in many cases, an effective solution requires a combination of strategies.
John Marshall is a principal advisor with Hall Render Advisory Services. Marshall has more than 23 years of experience in commercial real estate and 17 years of experience dedicated to healthcare real estate.
Danielle Bergner is an attorney with Hall Render Killian Health & Ryman. She focuses her practice in real estate transactions and counsels healthcare clients on transactions throughout the asset life cycle, including acquisition, construction, financing, leasing, refinancing and disposition.