Financial Awareness

Financial Awareness
Coming to terms with the cost of your new ASC

By Kris Ellis

The inception and design of a new ambulatory surgery center (ASC) is an exciting process for owners. Just as bricks and mortar form the structural framework of the facility, physicians must ensure the financial integrity of their project in order for it to succeed. As with architects and builders, a variety of choices exist with regard to lenders and financing options. Owners who do their homework will benefit from a greater understanding of this specialized market.

“Customers have never had so many options for financing their ASCs,” says Peter Myhre, president, Mar- Cap Corporation. “Because of the growth in the ASC market, there are more financing options. For example, the terms now can go anywhere from 60 months to 120 months. Projects can be done with no personal guarantees, or they can be done with full personal guarantees and lower rates. Owners can get reduced payments for as much as 12 months. There’s a lot of variability.”

Todd Tidmore, managing director of Med- Capital Group, notes that lenders are looking for quality projects that are structured in a way that mitigates risk for the lender. “There’s money out there — reasonable money for reasonable projects,” he states. “The trick sometimes is understanding, as a borrower, what it takes to put together a project that is favorably received by the lending community, and being able to go through the process. In general, the current market is pretty receptive to healthcare real estate projects.”

Tidmore says lenders need to have a complete picture of those involved in a potential project, including finances, experience in the industry, and so on. “What’s the first tipping point in a project that’s going to have success vs. one that might not have success? Generally, it’s having professional alliances to assist the healthcare provider in doing what they do best,” he asserts. “If a lender is looking at a project that involves a group of physicians who have never run a surgery center before and never built a building before, and they’re trying to do it all, that’s generally a little less favorably received than one that has either a management company managing the surgery center and/or a professional real estate developer at least providing consulting to the project to help make sure it gets done. In general I would say having professional alliances where people do what they do best is a key element in improving the access to capital. That’s not to say that a group of physicians can’t do it on their own; it’s just that it makes sense that you let other people do what they do best while the physicians practice medicine.”

“I think there’s a trend underway where more and more ASC owners are trying to own their building, either through a medical condominium situation, or a standalone building where they may add some office space to the facility and, in essence, be their own landlord,” says Jeffrey Fox, of Outpatient Finance Group. “There are many opportunities for real estate loans. You have to be somewhat careful, because not all companies provide construction finance, so you need to distinguish the difference between a construction loan and a permanent mortgage. A lot of people will provide real estate, but not everybody is going to provide construction. That tends to be more of a local bank product, which is fine, but nonetheless this is a step in the process that needs to be thought through.”

Interest rates on a loan are, of course, an important consideration. Additionally, Fox suggests that the term and amortization period be evaluated. “Typically, terms offered are much shorter than the amortization period. The advantage is to get the longest possible term and the longest possible amortization period. A 20-year amortization is pretty good — not a lot of people offer that — with a 10-year term.” Fox adds that potential owners must also figure out if the ownership structure is going to be the same for the real estate partnership as for the surgery center partnership. “A strategy out there is, since you can’t really have physicians be members of an ASC who don’t do a percentage of their cases there, some people are opening up the real estate partnership to other physicians.” For example, patients are oftentimes referred to an orthopedic surgeon by a family physician. “The surgeon can own the ASC, but the family medicine doctor can’t,” Fox continues. “But, he could own part of the real estate. He could become, in essence, a landlord. That model is out there. It’s a very legal, safe, model.”

Tidmore explains that depending on what type of loan is needed for a project, some lenders may be more suitable than others. Construction loans are for facilities that are yet to be built, while permanent loans are for structures that have already been built and are occupied. “In terms of structuring the loan, sometimes the lender who does your construction loan does not give you the best permanent loan option, and vice versa; different lenders do different things better. For instance, most construction loans are best done by banking institutions. They, because they’re close to the projects physically, can go and evaluate the construction phase of the project. This is the phase that carries the most risk for the lender, because if something happens during construction and the tenants don’t end up there, then you have problems as a lender that will require you to fall back on your recourse to the guarantors.”

Once the building is completed and occupied by a tenant who is paying rent, or who has agreed to pay rent, Tidmore notes that other lenders may become interested in financing. For example, he says, life insurance companies may provide a loan at this point, if they feel the ASC will generate sufficient revenue. While banks oftentimes use the prime interest rate as the basis of their rates, a life insurance company may be able to offer a loan at a lower rate, according to Tidmore. “Depending on if you’re in the construction phase or the permanent phase where you’ve already got the building completed, then evaluate your options — use a professional to help you secure the financing and they will give you access to more options than if you just walk into a local bank.”

Myhre notes that a risk factor in financing that he has begun to see is ownership of multiple centers by individual physicians. “Some physicians have invested in multiple centers, but the developers of those centers don’t always know about the other investments.” In response to this, some developers are extending non-compete terms. “The non-compete period might stay in place for one, two, or three years after a physician divests ownership of the center. It’s more of a non-investment than a non-compete; the physician can’t invest and own another surgery center.”

Overall, Fox states that there is an abundance of capital available in the marketplace. “This makes it very competitive, thus it makes it very inexpensive for physicians. Yes, interest rates are rising, but the margin between the cost of the money and what the lender puts it out for is thin. That’s good for physicians.” Potential owners should be cautious when it comes to fees, however. “You can see this great rate and then just get hammered with fees, so you have to be aware of that,” Fox continues. “Especially when you’re dealing with banks; they have made kind of a shift to where fees make up a large percentage of their income. There are all kinds of fees. You really have to understand that and map it out.”

Timing

The financial component of a project is one that should be looked at as soon as possible, according to Myhre. “You’re going to want to decide on a finance company no later than 30 days before funding is required. A better timeframe would be 90 days. The more time you have to look at financing, the more options you’ll be able to consider. If you start later, you’re not going to have as many options. Before you do that, however, you need to take a step back and consider the overall capital structure of the project. How much equity are you going to need to finance? Another consideration to tie into the capital structure is the leaseholds; how much the landlord will finance on the leaseholds. There’s significant variation, and obtaining leaseholds from real estate financing or the owner of the building is another way to affect the capital structure; basically to raise the money to start a center. You really have to start thinking about where you’re going to raise your money early in the process.

Getting a jump on the financing process may also allow owners to consider other construction options as well. “One thing I tell people who are doing a surgery center, is to seriously consider not just building a surgery center, but if you’re going to finance real estate and own a piece of real estate, consider trying to do a medical office building and a surgery center together,” Tidmore offers. “That way you have even greater access to capital that can be less expensive and that can be non-recourse. It’s easier to have access to capital with a building that has multiple tenants. It’s important to explore your options relative to what it is you really want at the end of the day — what exactly are you trying to achieve?”

Fox agrees that allowing plenty of time to go through and understand the different financing options can be advantageous. Once an organization is formed and owners begin looking at construction sites or existing structures to purchase, he suggests that they should be talking to lenders simultaneously. He adds that the architectural direction a facility takes in terms of form, function, and aesthetic considerations plays into the financial side of things as well. “That can affect the cost for a long time; it’s easy to create a very expensive project in real estate. I think it’s very important to find an architect who the physicians can check the references on.”

Alternative Approaches

Lon Rochester, vice president of Medibuild Group, a development and construction management firm, notes that his organization offers financing options as well. He explains that Medibuild may purchase land and build a new facility, or retrofit an existing structure that the company owns, and then lease the building back to its clients. “The advantage for the client in doing that is they’re able to deduct the full capital lease as a business expense, as opposed to depreciating it out over a 39-year period of time,” he asserts. While Rochester does not claim to offer tax advice, this is an option that may hold interest for potential ASC investors. This can also save clients money in terms of capital expenses compared to a project in which the clients own the facility.

Rochester also points out that the location of a facility may dictate which financial route may be most expedient. “Depending on where you are in the country, there might not be inventory to purchase; maybe the only inventory available is to lease from somebody else,” he says. “If that’s the case, we’ll actually go out and help you to find lease space and negotiate the best possible lease on your behalf. Every location is different -- it’s going to be more difficult in big cities, where much of the land is generally already purchased, to find something to buy. When you go into the medium and smaller sized communities, it’s usually a lot more feasible to purchase.”

Future Trends

A variety of issues and developments may impact the financial outlook for ASC projects in the upcoming year. On the legislative side, Myhre mentions the Deficit Reduction Act, which was signed into law by President Bush in February of 2006. “This was unlike any legislation that I’ve seen. It snuck through, and there was no opportunity to lobby or even understand the bill,” Myhre says. “Interested parties didn’t have time to educate their congressmen on advantages and disadvantages of the bill, and it passed with very little review and discussion.”

While the Deficit Reduction Act wasn’t significant for the surgery center market, Myhre speculates that similar legislation could pass that would affect ASCs. “The expectation is that they’re going to change ASC reimbursement to some percentage of hospital outpatient rates, and regulators are stating that this is going to be revenue-neutral. The reimbursement per procedure will change for a number of procedures — some will go up, some will go down, but across the board it’s supposed to be revenue-neutral. After seeing the Deficit Reduction Act, I hope it is in fact revenue neutral, because there’s tremendous pressure to reduce the budget. I think there’s a clear connection here that people need to understand.”

Tidmore comments that because costs will continue to increase, he would advise embarking on a construction project sooner rather than later, if possible. In order to combat rising expenses, he suggests shopping around for the best financing. “If your bank doesn’t want to present you with more options, talk to another bank or a mortgage broker, or people in the finance community, and try to determine what those options are,” he says. “The lending process is one that people need to understand has a certain culture. It’s a complex process that has many moving parts to it. Just as physicians have certain specialties and sub-specialties, medical financing of any type is similarly a sub-specialty of the overall financing world, to the extent that groups can tap into people who are involved in that sub-set and they will be better served. People are very willing to give out advice.”

Equipment

Before a new surgery center can begin operations, the proper mix of equipment must be in place and functioning properly. There are a number of tactics that owners can use in terms of procuring equipment, according to Wade Byerly, corporate accounts, Med-XS Solutions, each of which may involve different financial strategies. “Wherever that particular facility needs help, whether it’s operational, capital, or what have you, there’s a myriad of different ways to solve issues. They need X amount of equipment in order to be operational; some of the ways to handle that certainly have to do with refurbished equipment.”

John Daniel, director of non-acute sales, Med-XS Solutions, suggests that buying certain refurbished items, such as OR tables and lights, may allow a facility to put the money saved therein toward a piece of equipment that may be billable for use, such as a C-arm. In terms of the durability of refurbished equipment, Daniel recommends that customers carefully evaluate the supplier. “When someone is considering buying equipment, if you go the refurbished route, you have to know who you’re dealing with. You have to deal with reputable companies that have quality control in place in their manufacturing. You have to know that you’re buying a truly refurbished piece of equipment and not something that’s just been wiped down and cleaned,” he says. “It needs to come with a bio-medical record, it needs to have a preventive maintenance sticker on it, and then it needs to have a warranty attached to it.”

Byerly also mentions the possibility of renting equipment. “Clearly, I think one of the other intelligent things owners can do is identify categories of equipment or certain devices that they may only need infrequently,” he says. “Because they’re surgery centers, they can usually predict that usage, and many times it makes sense to rent those items. That way they never have to take ownership of the items or take responsibility for their maintenance, and only have them in their possession for the time that they’re needed, as opposed to owning it and letting it sit and collect dust. I’ve seen that happen with more advanced respiratory equipment, and with surgical generators of a certain variety — that type of situation where a device can be rented to meet a periodic need.”

Leasing may be a viable option for surgery centers as well, Byerly adds. “It’s very circumstantial in terms of what makes sense to lease; if you find yourself in a position to generate revenues, and you can afford to pay the lease on a piece of equipment, then that might make sense until such time as you can afford to buy it outright. If you hold the device for a long period of time, you’ll end up paying more on the lease than what it would have cost you if you’d bought it outright, however. But, because of cash flow circumstances, it’s a very viable option and it allows the operation to get up and running before making a purchase. There are derivatives of that as well. Some leasing companies can have as many as 20 different leasing and rent-to-own options that they can provide.”

As with real estate, there may be significant variation in the terms involved with equipment deals. “This falls back to having a good equipment planner, because it behooves the organization, when they make any purchase, to negotiate the optimal terms and conditions on behalf of the ASC,” Byerly continues. “You could negotiate partial deliveries; if it’s a surgical suite where you’re going to have gases and endoscopy equipment on a boom, for example, you may want to take an early delivery on that, but you might also negotiate your payment structure so it doesn’t necessarily coincide with all of the pieces arriving at once. It has to do with how willing the manufacturer is to work with you and how astute of a negotiator you are to get optimal terms for the organization. Virtually everything is negotiable.”