Bringing your project into alignment with your financial goals
With healthcare demand on the rise nationwide, many hospitals are feeling the pinch for expanded medical office space to accommodate growing outpatient needs. As the U.S. has entered into a seeming economic downturn it is increasingly important for hospitals to preserve good credit standing and minimize risk. For many, this means utilizing an off-balance sheet financing approach for certain projects in order to maintain borrowing capacity.
Off-balance sheet financing is an attractive solution for a number of reasons. First, an off-balance sheet status for a new project minimizes project risk for the hospital as all risk and liability stays with the project itself. Additionally, off-balance sheet financing may provide an opportunity to utilize more flexible financing methods since the project can establish its own line of credit rather than relying on the hospitals credit rating.
Attaining off-balance sheet status is a complex and delicate process. For many hospitals, it requires the experience and insight of an experienced developer to navigate the maze of accounting rules to accomplish their real estate development objectives. Following are some of the principle concerns for a hospital when utilizing an off-balance sheet approach for an outpatient development.
The Basics
The primary accounting guidance in the construction of a medical office building (MOB) is the Financial Accounting Standards Boards Emerging Issues Task Force (EITF) 97-10, which relates to The Effect of Lessee Involvement in Construction Development Transactions. This guidance applies to MOB projects when a hospital or a related party is a lessee that leases more than 10% of the MOB.
Fundamentally, EITF 97-10 establishes an “ownership” test. The deemed owner of a project must record the asset on their books. It is important to be aware of these rules early in the projects development. Agreements need to be structured to address first dollar needs such as engineering, architectural and legal fees, cost accounting, and direct construction costs in a manner to comply with EITF 97-10.
Avoidable Pitfalls
Shared resources are a detriment to off-balance sheet financing. During the feasibility stage, costs and investments that benefit both the hospital and the proposed medical office building (for example- a parking garage) need to be evaluated.
Owner/tenant guarantees, financings, cash advances, reimbursements, early lease payments, tenant provided land and pre-construction costs are just a few of the many risk transfer and financing techniques utilized by developers.
Alternatively, a well-capitalized developer may assume construction risks of a project and accordingly be the owner of the project from the early feasibility stages through completion. In this case, the developer may not require equity investments or guarantees from tenants or a hospital in the construction of a medical office building.
Award of Development (Pre-Construction):
The construction period, as defined by accounting guidance, begins with the earlier of the date of inception of the lease, the date of the construction arrangement is agreed to, or when hard costs are incurred or ground is broken. At the award of development, if the developer has assumed the construction risk, the hospital will not provide any construction indemnities including pre-existing environmental indemnities, and the hospital will not have the right or obligation to take title of the project.
During Construction:
If the hospital incurs costs greater than 10% of the total construction costs incurred to date and is not reimbursed under normal terms, the hospital could be deemed the owner of the project. In addition, the hospital could be considered the owner of a project if it is responsible for paying costs other than normal tenant improvements, which, as defined by accounting literature, exclude structural elements of a project.
Project Leasing:
In addition to the EITF 97-10 considerations discussed above, leases are also subject to review in the off-balance sheet process. The Financial Accounting Standards Board Statement No. 13 (SFAS 13) has established standards for financial accounting and reporting for leases which must be evaluated during the lease structuring process. The goal for an off-balance sheet structure is to compose the lease in such a way that, by SFAS 13 standards, it is considered an operating lease rather than a capital lease, which will allow the hospital to maintain off-balance sheet status. Many factors are considered in this process including lease term, buy-back options, property value and residual guarantees by the lessee.
In Conclusion
According to FMI Corp., a management consulting and investment banking firm, by decade’s end annual U.S. healthcare construction spending could surpass $60 billion. As construction spending grows, so will the demand for intelligent financing solutions to maximize the hospitals financial viability. While off-balance sheet financing can often be a tedious process with many moving parts, an experienced partner can help guide you to the financial status you desire to achieve your financial and real estate goals.
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