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Bucks for Bricks View PDF

Whether you remodel or build your practice’s facilities, it’s not cheap, and unless you’re rolling in dough, you’ll need to finance at least part of the project. A how-to guide for landing the best deal and avoiding common pitfalls.

By christine a. hinz Unique Opportunities, May/June 2007

When Peter Dayton, MD, and his three partners set out to construct a satellite office in St. Lucie West, Florida, they knew they’d face some lean times.

After all, they didn’t want outside investors, even though each of them had to kick in $75,000 plus the $1.8 million loan.

But no one could have predicted how a force of nature would turn this group’s building plan on its head. When a spate of hurricanes—Frances, Jean, and Wilma—swept over Florida in 2004 and ‘05, their ob/gyn practice took a financial hit, though not a physical one. The partners had already signed their construction loan, but the hurricane caused innumerable delays. In the meantime, the clock kept ticking on loan payments, which meant the practice had to carry the debt.

The physicians took smaller paychecks to carry the project during the 18-month delay, which meant actually increasing their investments another $15,000. Moreover, the doctors encountered numerous cost overruns and hurdles, including redrawing the designs to meet new building codes.

But Dayton, who had learned a thing or two about constructing buildings since he’d done it in the past, kept focused on the prize—a functional 15,666 square-foot facility that would meet their space needs now and their investment goals for the future.

“I’m not a super land investor kind of guy,” Dayton says. “But I know it’s better to own your property and lease [to other tenants] than it is to rent from somebody else. That might not be true in other situations, but I think it’s certainly true for us.”

The basics of borrowing

Few decisions pose bigger challenges for a medical practice than financing and constructing an office building. On the plus side, there’s the lure of building equity as your structure appreciates. On the down side, committing millions of dollars to your own bricks, steel, and mortar is an entrepreneurial risk.

With a few make-or-break basics, you can sail smoothly through the process. In general, you want to:

• Make sure you’re a high quality borrower.

• Shop around with your proposal to multiple lenders.

• Plan upfront to get accurate project estimates.

• Consider tenants for your building.

• Think twice about outside investors.

• Bring your accountant and attorney to the table to strategize your tax and legal options before you spend one dollar.

“One of the biggest mistakes physicians can make is entering into a financial transaction, especially constructing a medical office building, without talking to a CPA first,” says Joe Scutellaro, a CPA with Jump Scutellaro and Company in Toms River, NewJersey. “There’s always so much more we can do to help structure the deal up front to maximize potential tax benefits. But those benefits can be lost if we’re brought in too late,” he says

Your advisers, for instance, will no doubt suggest spinning the building into its own Limited Liability Company, or LLC, so it’s separate from the practice. Obviously, state law will govern your options (you may see Limited Liability Partnerships instead), but the idea is that you don’t commingle the two entities for tax and liability reasons.

“If you can get your attorneys involved in the beginning, they can save you a lot of headaches down the road,” says Aasia Mustakeem, an attorney and real estate partner for the law firm of Powell Goldstein in Atlanta. “Sometimes people will say, ‘I’ve negotiated this and I just need you to do X, Y and Z.’ But when you look at what they’ve done, your hands are tied because they did A, B, and C.”

Banks…mortgage brokers…corporate financing groups…institutional investors…even the Small Business Administration. With a plethora of lenders in the market, there’s never been a better time to finance a medical office building. But what’s the best way to do it? And how do you create the kind of leverage that will earn you the most favorable terms?

First, you want to come into the marketplace with capital (usually 20 percent of the total amount needed). While the goal is to spend as little of your own money as possible, in order to compete, you must show that you’re willing and able to invest.

Second, you want to court lenders. Even before you’re ready to make your pitch, it’s smart to know what the local bankers want from you. Usually eager for such business, they’ll work with you on the kind of financing that you’ll need. This financing typically includes a short-term adjustable-rate construction loan to cover the creation of the building and a longer fixed-rate mortgage to pay it off.

Obviously, there are many nuances to this process—you may have to involve a regional institution or even Wall Street if your project is big. But in every case, you’ll want to comparison shop things like interest rates, down payments, and “recourse” or the debt level you or the group must guarantee.

“We typically tell our clients, ‘All money is green,’” says Hugh DuBose, Jr., a principal with HealthCare Facilities Associates in Columbia, South Carolina. “We recommend that they pick three to four commercial banks in the area with good relationships and then basically bid it.”

When Helen Torok, MD, and Leonard Torok, MD, decided to merge her dermatology office and his holistic medicine practice into one integrated Medina, Ohio campus, their daughter and CEO, Heather Funk, wanted to keep things local.

After crafting a business plan proving that the market indeed could support the 23,000 square-foot venture—a two-building facility called Trillium Creek—she took her package to several banks that had worked with her parents or simply knew them and their solid reputations.

Funk secured the money at rates—the fixed, just above six percent, and the variable, often floating between three and five percent—she still considers “phenomenal.” What’s more, since the total was under $5 million, First Merit Bank didn’t have to farm anything out to branch or regional lenders, which saved on costs.

“Because we used a local bank, they could be flexible,” says Funk. “To this day our lender still works with our attorneys and accountants to make sure that our loan and our tax obligations all mesh. That’s pretty important.”

Create a winning business plan

Like Funk, you’ll have to demonstrate that you’re a serious suitor to woo any financial institution, much less attract several to compete for your business. Lenders will want to know as much as possible about you, your partners, your practice, and the project to determine whether you can support a new level of debt. That means showing that you’re not only credit worthy and business savvy, but that you’re also proposing a building that will succeed in the market.

Your practice business plan will be an important element of any package. By putting details to your vision and showing how you will make your business dreams a reality, you show lenders that you’re committed to and have a roadmap for achieving your goals.

In terms of a new office, a business plan begets a building plan, which is simply the where, when, why, and how you intend to turn your designs into a real street address. By laying out in great detail the specifics of your project, such a document can help you—and your lender—understand the potential return on investment as well as the financial resources necessary to make this work. Most importantly, it shows that you’re a serious, disciplined, player in the real estate market and probably a good risk.

“Lenders are looking for stability, preparation, and substance,” says Christopher Bowen, the senior vice president and managing director of Marshall Erdman Development in Madison, Wisconsin. “The worst thing you can do is to give them information that’s not well-prepared. That sends a message that maybe you’re not a good risk.”

Jack Boudler, a vice president of Key Bank Real Estate Capital Healthcare in Cleveland, agrees. “First and foremost, we want to see the historical strength of a practice. We want to know that it’s clearly a strong player in the market and that it has the ability to sustain revenues and grow. That’s how we gauge a practice’s capability to pay the rent, which eventually will pay the mortgage.”

With a 60-year reputation as a successful medical practice, Pinehurst Surgical hardly needed an introduction to North Carolina’s banking community. In fact, when it came to financing the group’s three-story, $26 million facility, administrators parlayed their good reputation—and a decade’s worth of annual reports and business plans demonstrating solid growth—into a bidding competition on their terms.

In the end, a “feisty” local bank put together a deal the group couldn’t refuse. In exchange for Pinehurst Surgical’s overall business, the bank offered a 3.7 percent fixed-rate loan (including a two-year construction phase) to be refinanced at five years. There’s also limited liability for each doctor: The total physician guarantee is restricted to 25 percent of the outstanding note balance, prorated for each doctor and reduced as the principal amortizes and new physicians are added to the group.

“If you are a good lending risk, people with money will loan you the money,” says William Edsel, Pinehurst Surgical’s CEO. “We didn’t have a problem getting financing. In fact, lenders were competing for the privilege. The fact that our practice is a community standard and a highly successful business stood us well for our prospects.”

The construction plan

Your advisers may use other analyses to demonstrate your venture’s prospects for success. But the most important numbers to the lender will likely be what this is going to cost.

Bidding a construction project is an intricate process—many variables come into play. But the way you get estimates on your project will be dictated by the way it’s designed and built. You’ll have to decide whether you want:

• Design-bid-build. You retain an architect who develops the building schematics and, based on those drawings, also solicits and ranks general contractor bids for you to compare and contrast.

• Design-build. You forge an alliance with an integrated entity to provide complete architectural, engineering, and construction services for a guaranteed maximum price or a fee plus the cost of the work. You choose the firm based on a request-for-proposal (RFP), rather than individual bids.

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