(Reprinted from Health Care Strategic Management, December 1999)

By Ed Egger

The Balanced Budget Act of 1997 (BBA) is creating a sticky dilemma for many hospitals and health systems: managed care, new technology and enhanced consumer expectations are demanding fast changes in health care delivery at a time when hospitals and health systems can least afford capital outlays to accommodate those needed changes.

Medical technology and consumer preference are requiring many hospitals to establish outpatient surgery centers and clinics away from main hospital campuses, and managed care is forcing more care to be delivered in less costly settings. At the same time, many hospitals are trying to produce added revenues and meet consumer demands by developing complementary medicine clinics, wellness centers and other retail facilities.

Hospitals in California face an added burden: recent state legislation requires them to perform "seismic retrofitting" of their facilities by no later than 2008, adding an estimated $10 billion in construction costs.

Hospitals are finding themselves very short on capital and in less favorable borrowing positions as the BBA and tough managed care contracts continue to cut severely into their margins.

But a California development firm, Pacific Medical Buildings, believes it has a "win-win" solution to the dilemma. The firm negotiates a ground lease with a hospital or health system which allows his company to construct new facilities on the hospital's campus. Pacific Medical Buildings then obtains funding from investors, often insurance companies, as well as investing in projects itself. It then constructs, arranges, leases and maintains the facility - all without any capital investment from the hospital.

The approach works well for both hospitals and for his firm, according to Robert Rosenthal, president and managing partner. Because of his firm's track record and skill in identifying viable projects and getting them built and leased, Rosenthal said his firm and its investors are assured of a high rate of profitability. The hospitals, on the other hand, have no risk in the venture and can use their limited capital for other initiatives.

Rosenthal's firm has been developing outpatient facilities and physician office buildings using this approach since 1988. To date, it has constructed 61 facilities in 39 cities in seven western states - Hawaii, California, Washington, Oregon, Arizona and Nevada. "We think we were ahead of the curve," Rosenthal said. "We think this is now an idea whose time has come."

Pacific Medical Buildings looks for hospitals with over 100 beds that have substantial market share or a promising future - organizations that are likely to be around for the long term. The firm does its own feasibility studies. Although the company has constructed mainly in the West, Rosenthal said the company is willing to develop facilities wherever the climate is favorable.

Rosenthal said the ground lease his form negotiates with hospitals gives the hospital control over who will occupy the new building, what activities can take place there, and under what conditions. While other developers are now taking a similar approach, Rosenthal said his firm differs in that it never requires a master lease which obliges the hospital to maintain a certain level of leased space. Instead, Pacific Medical Buildings does the negotiating for all of the leased space and even maintains the building once it is built and leased, relieving the hospital of this responsibility.

In addition to the hospital's advantage of not having to take financial risk or be burdened with leasing and maintenance responsibilities, Rosenthal said there are some less obvious benefits as well. "It's very risky for a hospital to be the landlord for its medical staff in several ways," he said. "First, there are compliance issues. The hospital has to make sure it doesn't do anything more favorable to one doctor than to another. If the hospital has a specialist that it prefers to have in its facility, we can offer that physician an incentive to come there, such as a few months free rent, without violating any fraud and abuse regulations. A hospital can't do that without running into compliance problems."

Another risk a hospital faces in dealing with its medical staff, Rosenthal said, is that doctors who are large admitters may try to use their clout to get special services. While his firm strives to provide excellent tenant service, it can keep relations with tenants on a much more business-like basis, Rosenthal said.

For more information call 800-472-1005.