Five Steps to Smoother Financing

Facility Construction and Design

By: Judith Lee

Published: 10/10/2007

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In the early stages of building a new surgical facility, your success may hinge more on finding the right financing than on any other single factor. Here's what you need to know.


Three mistakes experts see investors in surgery centers repeat time and again: Rushing into financing without learning about alternative ways to structure a deal, failing to research the different lending products available to them and focusing solely on finding the lowest interest rate they can.

Financing a concern for many
Thirteen percent of your colleagues who participated in our reader survey rated financing as the No. 1 obstacle they had to overcome to get their facilities built and operational (see "The Biggest Obstacle"). One reason financing is such a stumbling block in the new surgical construction industry might be because the cost of construction itself is going up. The $1 to $2 million it may have cost to build a small surgery center just a few years ago will run you $3 to $4 million today. Nearly half (48) of the respondents to our reader survey say it cost between $2 and $5 million to construct or expand their surgical facilities (see "The Total Tab"). Building a surgical hospital? You may need $10 million or more in financing.

Five steps you can take
We asked several experts to share what you can do to help make the financing aspect of your project go more smoothly.

Give yourself plenty of time.
Nine months, most experts agree. Six months to select a lender. And another three months until funds are available (four to six weeks for the financing approval process and four weeks to document the transaction, says Bob Goodman, a financing consultant in Westampton, NJ). The lender will often want to meet the investors personally, visit the site and take its time crunching the numbers.

Typically, bricks and mortar are financed over 15 to 30 years, and equipment and leasehold improvements are financed for five to seven years. Lenders look for varying types of guarantees from the investors, and this can be tricky.

Most lenders want a 'joint and several' guarantee, where all the investors are on the hook for the entire amount of the loan, no matter how much they've invested, says Steve Dobias, CPA, principal in the health care group at Somerset Accountants and Advisors in Indianapolis. The drawbacks to the deep-pocketed physicians are obvious. "We look for a 'limited guarantee,' which means the investor is on the hook just for the amount he or she invested," says Mr. Dobias.

Because physicians have high incomes and good credit, they may think they can secure financing quickly. But financing large, single-use buildings filled with expensive equipment will always take time. A tip to keep the project moving along: Begin seeking financing at the same time you're selecting a developer, says Jeff Fox, vice president of Citicapital Ambulatory Care Group.

Do your part.
As soon as you decide to build a surgery center, experts urge you to gather the financial information you'll be required to disclose. An experienced management company will help with the process. Begin by collecting these items, says Steve Jasiukiewicz, vice president of marketing for DVI in Jamison, Pa.:

  • a complete financial statement from each investor
  • a list of the surgeries the physicians performed over the last year to support the assumptions of case volume
  • and a pro forma on month-to-month basis and a five-year projection from your accountant.

Lenders will be looking for a feasibility study (see "Conducting a Feasibility Study" on page 116). If you've selected a management company or developer to partner with you, this entity may be able to perform the study for you. However, you might want to think about hiring a consultant who has no financial interest in the project. "If you hire an independent professional to do this for you," says Mr. Fox, "it might be more objective than one done by a development company."

Don't overlook a key intangible lenders will be interested in: how much commitment the physician-investors bring to the project.

Build a nest egg for the first six months.
Lenders will want to see a financial commitment from investors, as well as funds to tide the surgery center over in the first six months of operation. "Typically, when a center opens, it may or may not have contracts. The center starts doing patients, but won't get reimbursed for 90 to120 days. The lenders want the investors to have enough working capital for six months," says Mr. Jasiukiewicz.

Here's an example from Mr. Jasiukiewicz. Let's say you're planning a two-OR surgery center with eight investors contributing $100,000 each. You'd originally intended to apply the $800,000 toward the construction price of the center, but the lender advises you to use $200,000 toward the acquisition and keep $600,000 for working capital. The lender finances the shortfall, and the physicians guarantee it.

In another project Mr. Jasiukiewicz worked on, 22 physician-investors initially put up $5,000 each for ownership interest. The investor group guaranteed $1.6 million in leasehold costs, and provided a $500,000 working capital line (total financing was for $3.2 million in equipment and leasehold improvements).

"From the lender's point of view, the more equity by as many physicians as possible, the better," says Mr. Goodman.

Shop around.
Physician-investors should start shopping early for financing, because it pays to shop around.

Approach the lenders early on and find out what kind of deals they're making. Ask each lender to give you a non-binding letter of intent to describe the rate they're offering and the guarantees they require, says Mr. Dobias.

Also know which type of institution would be appropriate to finance a project of your size says, Mr. Dobias. For example, a surgery center with two ORs and two procedure rooms looking for $3 million in financing should approach a large bank instead of companies like Citicorp, Bank of America and Wells Fargo, which are looking for projects in the $5- to $10-million range.

It's also quite common to have more than one lender involved. You can look to one source for construction financing, and another source for equipment and leasehold improvements. As a guide, you'll need $300,000 to $400,000 to equip each OR, says Mr. Dobias.

Mr. Goodman lists other desirable loan features:

  • a 'skip period,' where the facility doesn't have to make loan payments during those first few, lean months of start-up
  • an 'interest-only' period of three to six months
  • and the lender pays for equipment deposits and contractor progress payments prior to the facility opening and charges interest only.

A tighter economy and a maturing ambulatory surgery industry have affected the way new projects are financed.

"Ambulatory surgery has been around long enough that we are reaching new levels of complexities. Nowadays, doctors must put more cash equity into the deal," says Mr. Fox.

Perform your own due diligence.
Just as lenders will perform due diligence when considering your application, you should do the same when considering a financing package. Nowadays, it may be in your interest to take some risk, says Mr. Fox. A 6 percent rate with some recourse might be better than a nonrecourse loan at 9 percent interest. Nonrecourse financing means there is no personal risk to the physician-investors.

Are Leasebacks Right for You?

In a leaseback (or "build-to-suit") arrangement, a real estate developer buys the land intended for the facility and then leases it back to the facility owners. You then sign a long-term lease with the developer. In a similar arrangement called a sale leaseback, the developer buys and leases back an existing facility from the group.

If you're content being a tenant on the property, the leaseback arrangement can save you a lot of much-needed money for other start-up costs. Depending on your location, a typical four-OR facility might cost $2.5 to $4 million for design and construction, says Chris Franklin, president of Medevelop, a healthcare real estate development firm. If you pursue traditional bank financing, you'll need to put down 20 to 25 percent of the total building cost. On a $3 million surgical facility, that amounts to $600,000 and up, before a penny of your operational costs are raised.

In contrast, the leaseback frees you from having to come up with the initial cash to build the facility. Even more importantly, the arrangement lets you control the design, location and building specifications of the project as though you were the owner. Additionally, the terms of your lease may present you an option to buy back the property after two or three years. That might be very attractive if you're sitting on substantial positive cash flow after a few years of operation.

Leasebacks are often attractive to first-time builders. In many cases, the developer handles all the details of the design, construction and financing of the project. Instead of the facility owners having to deal with many separate businesses, the developer coordinates everything on your behalf. This greatly expedites the process, especially if you are inexperienced with these types of arrangements.

A final benefit, says Mr. Franklin, is that your initial equity yield will be higher if you opt for a leaseback. For example, you might get a 20 to 30 percent return on equity if you put your capital into the surgical center operation itself. That compares with an average 9 to 11 percent return for facilities that own the real estate as well as the center. The lease expenses are fully deductible as operating expenses on your income tax statement. You can deduct the interest, but not the principal, portion of mortgage payments.

Of course, leasebacks come at a price. For one, you'll need to tie your facility into a long-term lease, which may extend from 15 to 20 years. Secondly, unless you have a buy-back clause, you could stand to make less overall in the long term if the property values increase. Lastly, compared to a traditional mortgage, you'll pay $3 to $4 more per square foot on your facility. With the exception of urban areas such as Manhattan or Los Angeles, lease rates for the surgery center will run from $24 to $32 per square foot, estimates Mr. Franklin.

If you decide that a leaseback is the best way to get your new center built quickly and economically, you can speed the process even further by getting your financial documents in good order so you can transfer the information quickly to the developer. Other than the actual construction of the facility, the transfer of financial information represents the longest part of the process, according to Mr. Franklin.

- Louis Pilla, Contributing Editor

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