The economic implications of developing your medical office

In prior articles on facilities, I focused on planning and design issues that make for good, productive ophthalmology offices. Once you have all that under your belt, it is necessary to find a “home” where you can practice. This may involve renting or owning. Many doctors have called our office and asked us: “What will it cost me to build a new medical office?” In developing a new office, it is important to prepare an economic pro forma of the development implications inherent in your undertaking. This far exceeds just the construction cost of your building.

An economic pro forma for your office generally consists of understanding the interrelationships between total project costs, total project financing, annual costs, cash flow assessment and, potentially, return on investment. This article is going to address just the total project costs.

The project costs of a medical office development comprise a number of components, which are discussed below. For the purposes of this article, we will assume you are building a 1 ft² medical office building.

Land acquisition

In an earlier article, Medical Design International (MDI) explained that a good rule of thumb for land acquisition is 6 ft² of land for every square foot of each building. That was used in this case, and the land was arbitrarily priced at $5 per square foot, or about $250,000 per acre.

Acquisition cost	$30
Area	6 feet
Cost per square foot of land	$5

There are a lot of elements that go into land selection and acquisition for a medical office project. Zoning, environmental studies, suitability of soils and cost are certainly important considerations, as is the slope of the land. If you consider a very hilly site, your land-to-building ratio may well exceed the 6:1 ratio. Likewise, if you are in an urban area or are planning a multi-story building, the ratio may be well below that.

Building construction

This is a 100% owner-occupied building. Therefore, the shell area and the tenant improvement area are the same. If you were going into a multi-suite medical building, the tenant improvement area would be smaller than the shell area, but then you would also have expenses to improve the common areas.

Building shell
Area	1 foot
Cost per square foot of land	$100
Tennant improvements
Area	1 foot
Cost per square foot of building	$100
Covered entry
Quantity	1
Allowance	$1

For this example, the building shell and the tenant improvements are about evenly priced. They will vary from community to community. In addition to these costs are any appurtenances that you add to the building, such as a covered entry, covered drop-off or covered physician parking.

Tenant improvement (TI) costs are often hotly discussed. MDI has found that when TIs are done well, they tend to approximate the cost of the building shell. These are not TIs that utilize expensive interior design finishes, but ones that impart the necessary infrastructure for a high-quality office. This includes such things as highly differentiated mechanical systems for quality temperature control, sound attenuation systems to make sure conversations in a room stay there and durable materials so the suite can stand up to long-term heavy use.

Land development

Part of the cost of developing a project includes the work done on the site outside of the building. This includes such things as grading the land, bringing the utilities from the street to the building, and putting in the parking lots and sidewalks.

Development cost	$15
Area	5 feet
Cost per square foot of land	$3

Contingency

The contingency is a reserve fund to provide dollars for unanticipated expenses. Projects always have unanticipated expenses. It could be something found under the surface of the land that was not identified earlier, or it could be inconsistencies in the architect’s drawings. Regardless of the source, you need funds to pay these additional expenses.

Contingency cost	$11
Percentage of building and land development costs	5%

Designers’ professional fees

The professional fees are allocated among the three professionals most likely to be involved in your project: your medical planner, your architect and his/her engineers, and your interior designer.

Medical space planner fee
Area	1 foot
Cost per square foot	$4
Architect/engineer fees
Total construction costs	$216
Percentage fee	6.5%
Interior design fee
Area	1 foot
Cost per square foot	$2

The professional design fees can vary greatly. The more experience your team has in designing a clinical practice space, the more aware they will be of the complexities of the undertaking and the higher the fees will be. Likewise, some projects are just inherently complex, which also increases professional fees.

Accountant and attorney fees

Your accountant and attorney will generate professional fees associated just with this project. These fees will surely be expended. You might as well budget for them so that it is an anticipated expense, not a surprise.

Total fees	$1
Lump sum budget	$1

Interest during construction

Your building will be built with a construction loan from the bank, which is a loan separate from your mortgage (sometimes referred to as a take-out loan). In this case, it is assumed it will take 6 months to build the building. It is also assumed you will pay your bank 1.5 points to originate the loan with a 5% interest rate.

Interest	$6
Interest rate	5%
Time in months	6
Points	1.5

You pay for this loan as you draw funds from it to pay your contractor and others. For budgeting purposes, figure you will use the entire loan (it will generally be as much as your mortgage loan but not more) for half of the construction period.

Typically, you get the mortgage loan first. However, most of the time the bank will not release the mortgage loan proceeds until the building is complete. So, go to your bank and with a mortgage loan behind you, the bank will issue you a construction loan.

Inflation

This covers the expected rise in prices due to inflation from the time you develop your pro forma to the time you actually get your contractor’s price firmly fixed and your project financing in place.

Inflation costs	$4
Months to contruction start	6
Percentage of inflation	3%

Project manager/development fee

If you have a project manager or developer, you need to budget those professional fees. For this assessment it is assumed the project manager/developer is paid 3.5% of all the costs incurred in developing the project prior to this budget category.

At times, when the professional has control of the development of the numbers noted above, his/her fee will be buried. It is preferable to know those fees and list them as a line item in your budget.

Fees	$10
Project costs	$288
Percentage of professional fees	3.5%
Total project costs	$298

Sometimes these fees are based on all of the expenses associated with your project, and other times they are based just on the construction costs. A lot has to do with the breadth of responsibility and control that the project manager/developer assumes.

Going through a pro forma budgeting process like this helps you understand the complexity of the undertaking and all of the various areas in which you will be expending dollars. It is especially interesting to note that the initial question, “What will it cost me to build a new medical office?” only really addresses about 68% of your total project costs.

The development of your own practice space can be not only important, giving you a place to practice medicine that optimizes your practice ability and opportunity, but also a good investment. You need to practice somewhere; doing so in a building you own will be less costly than practicing in identical space developed and owned by a third party.       

Richard C. Haines Jr. can be reached at Medical Design International, 2526 Mount Vernon Rd., Suite B-405, Atlanta, GA 30338; 770-409-8123; fax: 770-409-8662; email: haines@mdiatlanta.com.