CBRE Healthcare Perspectives – November 2013
THE TRUTH BEHIND THE NUMBERS – WHY THINGS ARE NOT ALWAYS WHAT THEY SEEM
Patrick Duke, Managing Director Everything is moving in the right direction. You have put together capital budgets for a new Ambulatory Care Center and new Hospital that you believe will be approved by your Capital Allocation Committee and Board to begin in 2014. These capital projects are a focus of your organization in an effort to consolidate underutilized facilities that are geographically misplaced as a result of a recent merger with your former friendly competitor in the adjacent county. As you spend Friday afternoon thinking about your Team’s accomplishment preparing this solid approval package, you are brought back to reality with a new email that hits the inbox. The email is from your CFO who has just wrapped up a conversation with one of his old college buddies working for a health system in the southern part of the US. He claims they are constructing two similar projects for far less than the budget you have submitted when comparing on a $/SF and $/Bed comparison and about eight months earlier than your planned overall schedule. All the work you have completed with your Team is now coming into question and you need to be prepared to support your position or lose credibility with your CFO. Where do you start?
Keep Calm and Ask Questions Something just does not seem right about your CFO’s information. You know the contractor that did the work on the project the CFO referenced and immediately know that is step one to providing some insight as to how they could provide pricing that was so much lower and a schedule that was faster for this other organization. After attempting to call your contact at the contractor, you spend the weekend with no resolution. On Monday morning, you finally reach your contact and present him with the following questions:
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CBRE Healthcare Perspectives – November 2013
What is the completed construction cost for both comparable facilities? You find out from the contractor that the Ambulatory Care Center was constructed for $150/SF and the Hospital for $305/SF. This compares to your cost estimates of $225/SF for the Ambulatory Care Center $450/SF for the Hospital. At this point you see why your CFO was a bit upset, but understand there must be more to it.
What was the size and scope of both comparable facilities? You find out that both facilities are roughly the same size as the two for which you are seeking approval. However, there are some key differences that give you comfort. The Ambulatory Care Center is being developed by a third party and they are leasing to physicians. Therefore, the construction cost breakdown only includes a $45/SF tenant fit-out allowance. Also, sitework was not included in the number provided by the contractor. It was another $10/SF. Since your organization is developing the Ambulatory Care Center and paying for complete fit-out of the tenant spaces at an average of $90/SF, you quickly catch a difference that can be explained. Your site is a bit more difficult with topography and rock, so your sitework cost is $15/SF. For the Hospital, you find out that the comparable project includes two shelled floors that represent a total of 55,000 SF and in the future would add 64 Beds. These metrics were included in the $/SF and $/Bed metrics provided to your CFO. Your Hospital on the other hand includes no shell space or future bed counts. At this point you begin to feel much better.
When was the buy-out of the comparable projects and did you use Union or NonUnion labor? The comparable projects were bought out in 2013 and your projects are not scheduled to be bought out until 2015. This is another encouraging sign for your future meeting with the CFO to explain these differences as you assumed escalation of 3.5%
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CBRE Healthcare Perspectives – November 2013 per year based on 2013 cost data. In addition you find out that the contractor was able to use Non-Union labor on the comparable projects and your market will require a Project Labor Agreement (PLA) and use of Union Labor. Depending on the market, this can account for a 15%-30% variation in estimated labor costs. Surely the CFO accounted for these variations when comparing the costs he received from his friend. ď Ž
What were some of the features of the building design? The contractor quickly points out that the comparable facilities are built in a very basic manner and mechanical, electrical and plumbing systems are code minimum. The organization he is working with has a tried and true approach to capital facilities with design standards in place they have utilized for years. They focus on keeping first costs down and are in markets where competition is not as fierce. On the other hand, your planned facilities are required to be LEED Accredited. Furthermore, your organization is in a highly competitive market where patients from a preferred payer mix are looking for amenities and your donor base only want their name associated with signature buildings. This alone accounts for another difference of about 10%-12% in your estimated cost and the cost of the comparable facilities.
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Did the construction cost include things like low voltage systems or kitchen equipment for the New Hospital? The contractor says that he included low voltage systems to the extent they would rough in for nurse call and other such communication systems, but they did include cable installation or providing the packaged systems. He did say his number included kitchen equipment, while you had this included as a separate line item. This was another win for your case. In addition your preferred buy-out approach is for the contractor to provide all low voltage scope and the only cost you include outside of your construction budget is for network equipment, computers and PAGE 3
CBRE Healthcare Perspectives – November 2013 any clinical informatics systems. These are all handled by your internal IT department. Another fact that provides you with more rationale for the higher costs you have estimated. ď Ž
What about the schedule? You ask the contractor about his construction schedule and you find out that your estimate is only three months longer. Given weather patterns for your northern climate, this may even be a bit aggressive for you on second thought. As you try to figure out the additional five month discrepancy you realize that your CFO was probably looking at the overall project schedule including design and approvals and not just construction. With both facilities in CON states that have similar timetables for approval, it could not be that. The contractor then mentioned how they had a close relationship with the local Planning Board and how easy they were to deal with. After that statement you realized this probably was accounting for the remaining difference. The process for approvals in your municipality includes review by a Planning and Design Board and you are also in a special historic district. Armed with this final piece of the puzzle you then prepare to meet with your CFO.
Preparing to Deliver the Message Relieved that you now understand the difference between your projects and the comparable projects, you are still concerned that you have no solid solution as to how to present this information to your CFO at your meeting in two days. At home that evening, your wife, who is car shopping, asks you to review some online information with her. She shows you a comparison of two vehicles, side-by-side; with a list of features and a simple check box for the model that includes those features. There is also a comment column with explanations for each feature listed. It then hits you! You thank your wife and get your laptop fired up and prepare the information in this manner. In your meeting with the CFO, you use the side-by-side comparison model you had viewed the evening before. PAGE 4
CBRE Healthcare Perspectives – November 2013 Quickly, the CFO realizes the projects were not as far out of line as he once thought. In fact when the comparison was made in the proper context, he actually requested that you go back and ensure the numbers would support the organization’s vision with an adequate contingency at this stage in the process. Upon completing his request you forward him the revised package for Board Approval.
The Moral of the Story If you have not been involved in a story like the one above, directly or indirectly, you probably have not been involved in the capital project delivery process during your career. In the internet generation, vast amounts of data and information are only a search engine away. We believe this can actually be counterproductive when it is used in the wrong manner. It is important to evaluate benchmarks closely when utilizing them to develop or compare a capital project plan. We touched on only a few of the items that may impact a project. Some additional concerns are as follows:
How much new equipment and furniture is included in the budget versus reuse? Does the budget include land costs? Does the budget include financing costs? Are you capitalizing in house project management and IT staff’s labor effort to the project budget?
You begin to get the picture that it is one thing to have the data, but quite another to have the knowledge of the process and experience in setting up a capital project plan. Truly understanding all of the pieces involved in the puzzle will ensure you launch a project correctly for a successful outcome. As things are rarely what they seem, clearly defining the truth behind your numbers will alleviate stress and avoid endless frustration.
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