By Andrew Volz

Hospitals and healthcare systems face a construction conundrum. More outpatient facilities are needed to meet patient expectations for convenient care close to home. Yet budgets are stretched thin. Costs are increasing, reimbursements are decreasing, and the labor shortage persists. Despite these challenges, healthcare providers are applying smart real estate strategies and continuing to renovate their facilities or build new ones to stay competitive. 

The pandemic, its aftermath and current macroeconomic conditions have created a perfect storm of challenges for the healthcare industry. It is no secret that U.S. hospitals and health systems are experiencing some of the worst margins since the beginning of the pandemic, according to Kaufman Hall’s August 2022 National Hospital Flash Report. 

The healthcare industry’s early 2022 financial gains were reversed by July as lagging outpatient volumes shrunk revenues and expenses. No wonder Fitch Ratings on August 16 revised its outlook for U.S. not-for-profit hospitals and health systems to “deteriorating.” 

Continuing to build 

Despite margin pressures, construction in the healthcare industry continues to show strong momentum. In fact, the year-over-year annualized value of healthcare construction was up by 7.1 percent in 2021, despite a moderate month-over-month pullback of 2.6 percent from August to September. 

Construction project value in 2022 is already above expectations, and similar growth is expected in 2023. Medical office and hospital construction starts tend to follow divergent paths, with significant variations from month to month. In fourth quarter 2021 through the second quarter of 2022, hospital starts outpaced medical office starts, but that is not always the case. 

Healthcare construction has continued to show strong momentum despite rising costs and other challenges arising from inflation and supply chain difficulties. For instance, medical offices nationwide recovered from pandemic-related delays and have since surpassed historical levels. But completions have not reached their pre-pandemic rates and likely will continue to lag because of cost challenges, macroeconomic concerns and supply chain delays. 

Now in its sixth month, the Russian invasion of Ukraine remains a major source of uncertainty and economic impact. While the petroleum shock was immediate, the effect on production of semiconductors and other items is becoming clear. The conflict is generally slowing growth in the construction market globally, given that Russia and Ukraine are major exporters for a variety of critical industrial materials. 

Labor has been another complication. Just as the healthcare industry suffers from staffing shortages, construction staffing also has been affected by high turnover. Labor availability remains a deep-set structural challenge for the construction industry and will be a larger issue as construction demand persists. 

Because of the unique materials and specialized equipment required for medical facilities, construction costs have escalated more dramatically in healthcare than in other industries. Costs for hospital construction have risen by roughly 15 percent, while costs of medical office building construction have risen by 20 percent or more. 

Steel and lumber, which saw the most aggressive price increases in 2021, are stabilizing. Fuels, plastic and services related to construction are responsible for price increases in the first half of 2022 and are unlikely to stabilize over the second half of 2022. Since the start of the pandemic, a variety of material divisions have seen astonishing price growth and volatility. 

Once the worst offenders, umber and steel have stabilized due to a combination of supply chain management and onshoring. These and other construction materials with significant declines in volatility generally have seen corresponding decreases or stabilization of prices in the first half of 2022. 

Price volatility remains a major challenge for construction materials. Volatility has not gone down uniformly across construction materials. Some items are charting rapid price and volatility escalations as new geopolitical and other factors disrupt previously secure supply chains. The whack-a-mole pattern of growth has created conditions for continuous overall escalation and a combination of persistent demand and stubborn inflation has largely stopped prices from decreasing. 

In particular, prices have risen for HVAC components, creating unique concerns for healthcare projects. The high-performance HVAC systems required to help prevent hospital-acquired infections can constitute 35-45 percent of healthcare construction costs per square foot. 

From the start of the COVID-19 pandemic, manufacturing costs for HVAC have risen by 37.4 percent, outpacing the cost increases for materials overall by a significant margin. Domestic production also has struggled to keep up, with the total value of shipments rising 26 percent from pre-pandemic levels to $4.8 billion. Unfilled orders in HVAC manufacturing reached $11.9 billion in September 2022—almost double the historical average. 

Outpatient services and construction 

Growth in outpatient services demand is driving activity and competition among healthcare systems, creating relentless demand for medical office buildings. As of September 2022, year-over-year outpatient revenues grew 30 percent since 2020, according to Kaufman Hall, while inpatient revenues only grew 8.5 percent in the same period. 

Outpatient volume in the United States is forecasted to grow 20.7 percent over the next 10 years. Innovative new medical technologies and approaches have made the outpatient setting increasingly feasible for many types of procedures. Outpatient care also is less costly for insurers and more convenient for patients who would prefer not to be hospital-bound. 

As a result, medical office buildings benefit from strong profitability and leasing activity, supporting demand for space despite rising interest rates. An aging population, the increased availability of procedures in outpatient settings and the fundamental need for healthcare services—even in times of economic uncertainty—translate into steady demand for healthcare construction, particularly medical office buildings. 

With margin pressures at the forefront, established healthcare systems with scale are turning to creative real estate solutions to boost revenue and reduce costs. For example, investing in expansion, relocating and reprogramming sites and building new outpatient locations are important strategies for improving patient access to services. In turn, increasing access can lead to greater increasing market share and revenues. 

For many hospitals and healthcare networks, investing in facility renovations or new sites can be a profitable solution to margin challenges. Coupled with smart project management to keep projects on track and on budget, construction projects can help ease the pressures of financial and competitive challenges. 

Andrew Volz is construction research manager, project and development services, with JLL.