Commercial Development
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The Madison construction
landscape (here featured work on the now completed U.S. Bank Plaza) is
improving, but it may take awhile for the market to regain lost
traction.
photo by Mike Rebholz
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Construction & Development Inching its Way Back to "Normal"
June 1, 2010
As reported in the pages of In Business magazine.
From the lens of some area builders, the commercial building industry is
looking up, even though construction projects are not as profitable as
they were three years ago, and the competition for bid projects is more
intense.
It remains to be seen whether that's a case of people obliviously
smiling with thin ice below them, but there is little doubt the building
and construction industry has been a stressed segment of the economy.
Even with higher than usual unemployment in the trades, easing the
labor shortage at least temporarily, Dane County's built-in economic
insulation is helping to some extent. The University of
Wisconsin-Madison and various public improvements ensure there is some
level of building construction, but vacancy rates for commercial
buildings remain high and the lending environment isn't helping.
Before, if 25% of a building was pre-leased, that was enough to get
a construction loan. Now, with bank regulators demanding that financial
institutions reduce their real estate portfolios, office projects have
to be 75% pre-leased, if not more.
For the time being, interest rates are attractive, but projects
still are judged on their individual merit with factors such as
occupancy, the amount of cash in, and the strength of guarantors
weighing heavily.
Dick Brachman, market chairman for Town Bank of Madison, noted,
"The people really hurt in this economy are contractors that might have
built things on speculation and are holding property, and that property
is worth significantly less today than it was a couple of years ago."
Some ancillary businesses are faring well, primarily plumbing and
electrical suppliers who can control inventory expenses to a certain
extent, and freeze wages. But complicating matters is yet another wrench
in the credit works.
The Federal Deposit Insurance Corp. is jacking up insurance
premiums on healthy banks in order to prop up failing institutions,
which isn't helping the capacity of banks that avoided foolhardy
lending. "That's a cost of doing business," said Brachman. "We are not
happy to pay it. We're part of an industry that is really trying to help
our customers stay in business."
Build on That
In construction, timing may not be everything, but it's hardly
irrelevant. Before the recession hit with full force, some builders had
jobs lined up for the 2009 construction season, while others were
scrambling to find work.
Those companies with fortunate timing in 2009 may be doing more planning right now.
Tom Jilot, CFO of Ruedebusch Development & Construction, said
the design-build company stayed busy through most of 2009, but now it's a
little slow as future projects are being designed. "It's not so much
that there are no projects out there," he said. "There is stuff out
there. Locally, it's a matter of people who want to build getting the
financing in order to do the projects. That's the common theme."
On the flip side, Ruedebusch is starting to see an increase in
leasing over the past month or two, and that's important in the interim
because the company has been busy with planning, design, and engineering
work, Jilot explained.
In addition, projects simply are not as profitable as they were
three years ago, and to keep their workers busy, more builders are
expanding their geographic reach and more are bidding on jobs they might
not have even considered before. Others, like Ruedebusch, have made
greater use of their own crews, relying less on sub-contractors.
Even with profit margins squeezed, 2009 was the second best year in
the history of Miron Construction Co., but it took more time and effort
to find opportunities, according to Vice President and General Manager
Dennis Lynch. Whereas Miron was accustomed to bidding against five or
six other contractors, all of sudden there were 20 or even 25
contractors competitively bidding for various jobs.
"That's what we've seen, a lot more competition for fewer jobs, and
you had to work a lot harder to garner those opportunities," Lynch said.
Miron Construction, which employs 290 people in the Capital Region
and 1,200 statewide, made a corporate decision not to lay people off and
to find cuts elsewhere. Among other adjustments, it has experienced a
change in its mix of public and private projects, ending the year with
70% public money and 30% private, a trend that is holding in 2010.
"Historically, this office has been closer to 60% or even 50% public,"
Lynch indicated. "Fifty-fifty is where we'd like it to be, but it's a
little more skewed toward public right now."
The federal stimulus bill, with its funding for "shovel-ready"
projects, has had more of a public impact on Wisconsin, but it helped
Miron with public and private work. Stimulus dollars supported Miron's
role in the development of a biofuels plant in Park Falls and
improvements to various wastewater treatment plants.
Lynch said Greater Madison's commercial real estate market still
has anywhere from 17% to 20% vacancy, and until more space is occupied,
the area probably isn't going to see much in the way of new commercial
construction. However, he said tenant movement and tenant improvement
(TI) work is up dramatically, an observation confirmed by others. "Even
though we're not doing the new buildings, we are still doing a fair
amount of remodeling of existing space," he said. "That will probably
continue for awhile until the employment picture turns around."
For Todd Jindra, building consultant and project manager for
Building Systems General Corp., work is steady. He acknowledges that
Building Systems General could be running at a higher level of capacity,
but the upswing in volume is contributing to a sense of optimism in a
company that is set up for longer, sustained commercial projects. Jindra
noted that while some smaller contractors have turned to "TI" projects,
Building Systems' current project work includes the construction of a
new Woodman's store in Menomonee Falls, and work at Edgewood Campus
School.
Still, the jobs are harder to get now. "I'm seeing contractors of
much, much larger size than us, such as the [J.H.] Findorffs of the
world, going after jobs that, three or four years ago, they never would
have thought of going after," Jindra said.
One year out from the recession and the federal stimulus bill, Joe
Alexander, president of the Alexander Co., a developer and property
holder, agreed the biggest construction players in Greater Madison
continue to be the state, UW-Madison, and health care providers, and
that it's difficult to get financing in the commercial market unless the
building is 100% pre-leased.
Alexander Co., developer of the Novation Campus in Madison, is
diversified by geography and product type. With the help of stimulus
dollars, the company has closed a $36 million development deal in Kansas
City for the adaptive reuse of a former federal courthouse into 174
housing units. Alexander has not seen a huge impact with stimulus funds
on private sector development in Wisconsin, but that doesn't mean the
stimulus lacked economic value.
"Certainly, there is plenty of impact regarding capital projects by
the university in particular," he said. "That's an important function by
helping to provide work, particularly for design, engineering, and
general contracting firms. Those kinds of businesses, architectural and
general contracting, were hit hard by the recession."
Investor Relations
Rose-colored glasses are not necessarily sported by Kurt Welton,
president and treasurer of Welton Enterprises. As an investor who owns
buildings and pays the bills with management fees — development fees are
mere gravy, he notes — Welton has run smack dab into new banking rules
that limit the percentage of a bank's net assets that can be consumed by
loans to real estate investors.
At first, the limit was placed at 300% of a bank's net assets.
Since most banks had a lot more than that in their portfolios, they
immediately told customers they weren't doing any more, Welton said.
Not long after that limitation was established, the Feds handed
down a more stringent requirement: a new limit of 200%, meaning banks
would have to knock another 33% of these loans off their books. "A lot
of this will get sold in fire sales and foreclosed on and that type of
thing," Welton predicted. "When they say the shoe hasn't dropped yet in
commercial real estate, I think that's what they mean."
As a result, people can more easily buy a property and move their
business because the loan limits are placed on the investors, not users,
Welton said.
Adding to the lending uncertainty is the higher FDIC insurance
premiums banks are required to pay, in some cases many times higher than
before. While this may be an extreme example in terms of the ratio,
Welton said one bank saw its FDIC insurance increase 16-fold, and was
powerless to stop it. At various levels, "That is what's happening to
every single bank in the country," he noted, adding that well-run banks
are being punished to favor the "high-flyers."
Welton, who said deals are being negotiated despite the difficult
lending environment, is working with eight different banks to refinance
21 loans. Admittedly, he's never had to deal with anything this
complicated before.
In one project, Welton Enterprises will remodel office space for a
tenant that just signed a new lease; as part of another, it would build a
new 90,000-square-foot building that will become the headquarters of a
long-standing area company. "So there are deals getting done, but all of
these deals have been a year or two in the works," he said. "I just had
a closing on a deal where we started talking two years ago, so there
has been a lot of sitting around and waiting, and now deals are finally
starting to pop."
Another thing that's happening is that commercial tenants have been
led to believe that they should be able to get a better arrangement,
but banks want more cash, higher debt-coverage ratios, and higher
loan-to-value ratios in real estate deals. "That means I have got to
charge more for rent, yet tenants think they are going to get half-off
when they come back to the plate," Welton remarked.
Another sign of industry change is what Welton now requires of
builders. With past building projects, he rarely got a bond or letter of
credit from a builder. Now, he tells builders that not only does he
want a bond, he wants a letter of credit from each of their
subcontractors and a layer down from that — the sub of a subcontractor,
or a supplier.
Some residue from the recession will make that more difficult. In
the late 1980s, when Madison became a Top 100 market, more Fortune 500
companies established a presence here. Now, Welton said, some of those
organizations have left, believing they can serve Madison from
Milwaukee, Chicago, or Minneapolis.
The "New Normal"
Whenever the economy emerges from a recessionary period marked by low
pricing for construction services, and the economy begins to scale back
up, the expectation of would-be building owners is that favorable
pricing will continue, according to Lynch. "In fact, their costs
typically begin to rise faster than owners think they should," Lynch
said, noting that it takes some skill for builders to manage this
situation. "That's the risk we're heading into."
Welton doubts the industry will ever return to the "go-go" days
because some very hard lessons have been learned. Nevertheless, he
predicted that a stronger foundation will be built. "There is not going
to be a normal like there was," he said. "The new normal is going to be,
I think, a more cautious, a more coherent, and a stronger normal."
Alexander believes normalcy will return when liquidity and lending
standards return to a point where there is an opportunity to develop
with some speculation, which will require a relaxing of today's
stringent pre-leasing requirements. "That's good for developers," he
said, "and that's good for builders."
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