Health systems ‘taking a breath’ on major construction projects

Health systems have delayed their construction projects over the past year as rising interest rates crimp budgets, investment income plummets, costs skyrocket and labor shortages persist for the medical and construction industries.

While most big-ticket endeavors have continued, some systems have been forced to narrow the scope of those initiatives—opting to renovate rather than break ground and to complete developments in phases, according to participants in Modern Healthcare’s 2023 Construction and Design Survey. Health systems continue to reevaluate their priorities for major projects as they balance necessary upgrades and capacity constraints with an unstable economy.

“There seems to be a little bit more tentativeness to pull the trigger on projects, particularly with the cost escalation that has gone on,” said Robin Savage, president and chief operating officer of the construction firm Robins & Morton. “Some of it has to do with the cost of borrowing with interest rates rising. We are also hearing from some clients that building doesn’t make sense right now because the staff isn’t available to operate it.”

See the full results of Modern Healthcare's Construction and Design survey.

Grow or slow?

Some health systems, after benefiting from low interest rates, are easing off the gas pedal for ambitious construction plans.

After announcing a major inpatient expansion earlier this year, Detroit-based Henry Ford Health says it will stretch out large projects over longer periods of time and be selective with starting new ones.

“More than any other strategy, we have slowed the pacing of construction,” said Robin Damschroder, chief financial and business development officer. She cited delays between six months to a year on several in-progress projects. “We’re now taking a breath as we gear up for our next strategic planning, go through our inventory and identify the most urgent needs around security, safety and infrastructure.”

In February, Henry Ford, Michigan State University and Detroit Pistons owner Tom Gores announced plans to invest $2.5 billion in hospital expansions, a medical research center, housing developments, retail and public spaces. The undertaking includes a new $1.8 billion hospital at Henry Ford’s main campus in Detroit.

The project will be completed in phases over a 10- to 15-year period to accommodate economic volatility and any changes in demand as more services are delivered in outpatient facilities and via telehealth, Damschroder said.

The announcement follows years of construction budget tweaks from Henry Ford in response to the COVID-19 pandemic and changing interest rates.

In 2018, the system set a five-year capital budget of $2 billion to expand its inpatient and outpatient footprint. When the pandemic hit, Henry Ford leadership decided to slow down and scale back some of the projects. They lowered the budget to between $1.5 billion and $1.7 billion, Damschroder said.

The system benefited from favorable fixed interest rates between 2.5% and 3% in multiple bond offerings issued in June 2022 totaling $300 million. It primarily used the bond proceeds to fund a 160-bed inpatient tower at Henry Ford Macomb Hospital opening this month.

“We locked in that price just before the rates went crazy,” Damschroder said. In March, the most recent increase, the Federal Reserve raised the federal funds rate 25 basis points to 5%.

“We’re not anticipating the need to go back to the bond market until 2025 or 2026, and hoping the market settles by then,” Damschroder said.

Falling stocks, rising hospital construction costs

Waning investment income, coupled with rising material costs of lumber, steel and other construction supplies, is also leading some healthcare facility managers to rethink their strategies.

A March paper published in Health Affairs Forefront saw the investment income of 10 large nonprofit health systems, including Chicago-based CommonSpirit Health and St. Louis-based Ascension, decline 184% from 2021 to 2022. Investment income is often used to help fund capital expenditures. Meanwhile, steel prices neared an all-time high in June 2022, according to a report from S&P Global.

“There is no prediction on when these inflated material costs will end. Therefore, uncertainty remains more of a constant,” said Laura Stillman, principal and national director of the healthcare practice of Flad Architects.

Flad is helping design a bed tower for one of its health system clients, which Stillman didn’t identify. It was budgeted at $300 million about two years ago, and is now estimated to cost $450 million, Stillman said, citing higher material costs and construction staffing shortages.

While none of Flad’s clients have paused projects yet, providers are trying to find ways to reduce costs by “shelling out” parts, meaning building the exterior framework and leaving the interior construction for a later date. They are also designing “bare bone” projects or selling a building to a developer and leasing it back, Stillman said.

“It is unbelievable the inflated cost of supplies and bids we are getting,” she said. “Clearly the owners have major headaches trying to figure out how to absorb these costs.”

Many health systems are ordering key materials earlier to give them plenty of lead time and avoiding any unnecessary expedited shipping costs, said Peyton Robertson, quality manager at construction firm Brasfield & Gorrie.

UAB Medicine saw construction costs for renovation and expansion of its rehabilitation, inpatient and nursing facilities increase 17% in the 12 months ended Sept. 30.

The academic medical center in Birmingham, Alabama, is renovating its Spain Rehabilitation Center, slated to be completed in 2025. The $157 million project will feature 78 rehab beds and 28 acute-care beds, some of which will be reallocated from the existing facility and some will be new. The system’s renovation of a floor at its UAB Highlands inpatient facility that opened in April includes 24 acute nursing beds. It has additional plans to expand, though it would require a certificate of need to do so.

UAB is operating at maximum inpatient capacity. Although the health system does not intend to pause construction, it may have to extend timelines if demand drastically slows or if its capital budget drops significantly, said Arpan Limdi, chief facilities officer.

“We cannot just think we are going to build more and more forever, and we aren’t,” Limdi said.

One large health system in California paused all expansion and renovations other than the seismic retrofitting required to hit the state’s 2030 deadline, said Molly Wolf, a senior associate at the architecture firm NBBJ. Wolf didn’t name the system. California set a 2030 deadline for meeting a law designed to keep hospitals fully operational after earthquakes.

“It wouldn’t be a surprise if we continue to see a decline in capital budgets,” Wolf said. “We have gone from having a fixed scope of a project and the cost being a variable item, to now a fixed cost and the scope being a variable item.”

Reduce, reuse, renovate

The biggest cost savings will come from renovating versus new construction, said Tracy Hunt, senior vice president of operations at Skanska, a project development and construction group.

“A lot of systems are buying an office building and converting it to a medical office space, reducing construction costs,” Hunt said. “Some are buying smaller healthcare systems or finding partners with complementary services and building joint facilities.”

Skanska has not seen any cancellations. There may be fewer children’s hospitals or specialty clinics, but the essentials will continue, Hunt said.

“I don’t see healthcare construction stopping, because one thing about healthcare is that it is always needed,” he said.

See the full results of Modern Healthcare's Construction and Design survey.

Atrium Health—part of Charlotte, North Carolina-based Advocate Health—is prioritizing inpatient expansion and renovations while scaling down or staggering progress on ambulatory care projects where it can, said Collin Lane, senior vice president of facilities management for Atrium.

Atrium, which operates in North Carolina, South Carolina, Georgia and Alabama, is constructing about 4 million square feet of acute-care, ambulatory care, education, research and other facilities over the next five years, Lane said. The initiatives will include more than 700 new and replacement acute-care beds.

To minimize costs, project overseers are reconfiguring exam rooms and repurposing unused space rather than building new facilities where possible, Lane said. The health system is removing private offices for all clinicians, adopting more of a “hoteling” office space. It is also designing each patient room to scale up or down in acuity and prefabricating certain building elements, Lane said.

“We have been in growth mode,” he said. “But we are very conscious about reducing scope and scale, particularly in our ambulatory buildings. There is constant reprioritization based on the needs of the community and health system.”