Two years ago, Las Vegas-based general contractor, Plise Development & Construction, erected an office building at a cost of $87.50 per square foot for the core and shell. Subsequently, it completed a similar structure at $99 per square foot. In March, it was constructing the exact building at $125 a square foot. This reflects a 42.8 percent hike over a 24-month period.
“The reason for the cost differences is cost escalations in materials and labor,” said Matthew Weinman, president of construction for Plise Development & Construction, a Las Vegas-based commercial general contractor.
Plise Development’s experience is not unique in Nevada’s slowing commercial real estate market. “Construction costs continue to play a big role in the dynamics of the commercial markets, in both the shell side of the project, as well as the tenant improvement and build out,” said Rob Silecchia, vice president of business development for Las Vegas-based SR Construction, a general contractor providing design and construction services.
Steep construction and land costs, along with greater difficulty obtaining financing, are making business more challenging for commercial developers in the Silver State.
“It is so hard to make a deal come together in this environment,” said Cary Richardson, partner and vice-president of business operations for Reno-based Miles Construction, a commercial industrial general contractor.
This year DP Partners will install 6,500 tons of steel and 100,000 cubic yards of concrete in the 2.7 million square feet of industrial warehouse space it is building, said Marc Markwell, a Reno partner of DP Partners, a Reno-based company specializing in industrial commercial real estate development. At about 50 cents per pound, DP Partners will pay at least $6.5 million for steel this year. This compares to a December 2003 cost of $2.4 million, when the price was 63 percent lower, according to the U.S. Bureau of Labor statistics.
Most key materials are high in cost and increasing. “The price of steel, for example, is expected to rise further, at a rate of about 6 percent to 8 percent per month,” said Dick Rizzo, vice-chairman of Perini Building Co., a Las Vegas builder of hospitality and gaming resorts.
“For the current market, the pricing is still too high,” Richardson said. “I don’t think commercial and industrial developers have fully experienced the correction that they need.” On a tilt-up building, the predominant materials used are concrete and steel for reinforcement. The use of steel, however, extends well beyond the structure.
Unlike with steel, the price of concrete has plateaued after experiencing a 38 percent increase since December 2003, U.S. Bureau of Labor showed. Copper, another widely used material, increased 140 percent in the same time period.
“It just continues to increase each year, and we don’t see it pulling back,” Silecchia said.
The cost of lumber, on the other hand, is at a 20-year low. This material, used predominantly for a wood-frame building, now costs 30 cents a board foot, about half the price at its peak several years ago. The national residential slump primarily is to blame.
“Costs that are low are a result of lessened demand, as well as panicked suppliers and manufacturers,” Weinman said.
As of mid-March, the price of materials commonly used in commercial tenant improvements – metal studs, drywall, acoustical grid, tile, paint and carpeting – hadn’t increased in some time, said Bob Phillips, division manager for the general contracting division of Las Vegas-based Tradewinds Construction, a general contractor specializing in design-build tenant improvements and a multiple trades subcontractor. The cost of drywall, for instance, according to Perini’s Rizzo, has stabilized because of increased global capacity and consequent prevalent availability. Material costs overall, however, remain high. As a result, whereas tenant improvements once were done for about $30 to $40 per square foot, they now cost between $75 and $150 per square foot.
The cost of materials related to petroleum products, such as PVC pipe and plastics, have all increased. This is due to the continual rise in the cost of oil over the past few years. Whereas two to three years ago, oil cost $50 a barrel, it now is upwards of $95 to $108 a barrel. The cost of diesel fuel is up 185 percent from December 2003, according to U.S. Bureau of Labor data.
“Increased fuel prices will affect the cost of every material because it’s more expensive to get raw products to the plants and job sites,” Markwell said.
In some cases, Silecchia said, buyers are required to pay freight surcharges for the first time. Fuel and transportation cost increases are expected to continue to elevate materials costs. For example, Phillips expects the typical metal stud to rise from its current 20 cents per lineal foot to between 22 cents and 25 cents in the next few months.
Domestic and international supply-and-demand greatly influence materials costs. Other current factors include increased energy costs, greater demands on environmental responsibility and the internationally shrinking value of the U.S. dollar.
“If the dollar goes back to where it’s supposed to be and we have an adjustment, then materials costs will go back down,” Phillips said.
Whenever they can, commercial developers and subcontractors strategize to get the best materials prices possible. Early in the process, developers review constructability. In other words, they weigh the materials options for the type of building they’re constructing, by comparing costs, to determine the ideal options. “We consider tilt-up versus steel buildings, when we can,” Silecchia said. “We review where the trends are headed to determine the best end result for the client’s project.”
Some companies shop around for the best price on specific items, whereas, some buy one product consistently from a few select vendors. “When we can, we’ll pay a deposit ahead of time to receive a discounted price, or agree to early payment terms, which we do whenever the opportunity is available,” Weinman said.
Several obtain materials locally when they can. Regardless of their approach, most have learned to sharpen their negotiating skills when purchasing materials, haggling over price or terms, to drive the best bargain. When they can’t negotiate, they purchase from elsewhere in the U.S. and even overseas – Asia, for example. “Although several years ago, China wasn’t active in the production of construction materials, the nation can now virtually source most products,” Silecchia said.
Some companies have learned the value of conducting detailed product research on a far-flung global scale, and in so doing, have compelled domestic producers to hone their ability to compete in a growing global market. For example, when Perini Building Co. shops the products it buys in great volume, such as drywall, plumbing fixtures, tile and fabricated millwork, it considers the cost both domestically and overseas, for the best buy possible, Rizzo said. “In many cases we’re able to get a comparable product that was initially higher in the U.S. at overseas prices after introducing the competition,” he said.
Alternative materials of adequate quality sometimes can be the best value. These can include environment-friendly options. In a project it’s constructing in Minden, Miles Construction is reusing brick from old dairy buildings formerly located on the site. “Even if an alternative may have a slightly higher price initially, payback on that product from a life cycle perspective makes sense,” Richardson said.
When Miles Construction expects to place a large order of a specific material and anticipates a price spike, it sometimes locks in an order and a price ahead of time, Richardson said. This maneuver, however, isn’t always optimal. Project design can change, for example, or owners may have trouble obtaining the necessary financing. “You have to be careful not to get too far ahead,” he added.
Similarly, Perini Building Co. sometimes buys materials in advance, warehousing them until they’re needed. This method isn’t common, however, due to expense of storage and opportunity for theft. Materials theft from job sites and completed buildings is a costly problem, as are preventive measures, insurance and
materials replacement. Plise Development employs round-the-clock armed roving security and cameras at all of its projects. “It’s an expense we’re willing to bear because the loss in theft of a significant piece of equipment could have far greater impact on a project than the cost of security,” Weinman said.
There have even been cases where thieves have cut copper, a big ticket item, right off an existing building’s decorative metal roof. “This is not a cheap date,” Phillips said. “It’s $20,000 to $30,000 to replace copper that they probably get $300 or $400 for in salvage value.”
On its CityCenter project, Perini Building Co. has about 5,500 craftspeople and estimates that number to reach about 7,000 at construction’s peak next year, according to Rizzo. To support its workers in the field, the company has 900 administrative employees nationally (650 in Nevada). Perini occasionally hires engineering consultants, as well.
Labor, the total cost of which equals that of the materials on a project, has ticked upward in the past few years, and is expected to continue to do so. Non-residential wages likely will rise 4.5 percent to 5.5 percent in 2008 and 5 to 6 percent in subsequent years, with heavy industrial projects likely to experience the largest increases, according to data published by the Associated General Contractors (AGC) of America. “Most companies associated with the construction/development industry, including ourselves, are aggressively cutting back on payroll or have already done so,” said Weinman, whose firm, Plise Development, is down 10 employees on its construction side from last spring.
At the same time, because of the slowing economy and changing market, it is now easier to find qualified workers than it was in the past few years. “The availability of talent has increased, and the ability to bring better people on board with better qualifications has improved on the contractors’ side,” Silecchia said. “We have a better pool to pull from.”
Workers typically involved in a commercial development project consist of administrative personnel, consultants and subcontractors. The administrative team often ncludes some or all of the following: project managers, assistant project managers, conceptual estimators, superintendents, assistant superintendents, foremen, accounting and clerical personnel.
Three-quarters of Miles Construction’s 40 employees are administrative, working in the production and accounting departments, Richardson said. They include project managers, superintendents, assistant superintendents, foremen, a contract administrator, purchasing agent, design coordinator, controller, human resources/payroll individual, safety officer, plus accounting and clerical workers.
“Right from the top down, virtually every company involved on a commercial project requires administrative staff,” said Rich Farkas, president of Dynamic Commissioning Solutions Inc., a Las Vegas-based building commissioning firm that specialzes in the U.S. Building Council’s Leadership in Energy and Environmental Design standards.
Consultants often include: design and landscape architects; geotechnical, civil and structural engineers; and other professionals. Some developers have their own architects and engineers on staff. A slew of subcontractors, either employed or contracted, are involved in every job. SR Construction, for example, typically bids 70 to 90 subcontractors for a potential project, sometimes more or less, depending on the size and scope, Silecchia said. The work subcontractors provide includes: grading; paving; concrete finishing; framing; roofing; mechanical; plumbing; electrical; heating, ventilating and air conditioning; insulation; drywall; flooring; door hardware; painting; millwork; fire protection; security systems; glazing; windows; storefronts; landscaping; cleanup; signage; and more. Specialty contractors may be needed to install restroom accessories, bath partitions, paper towel holders and the like. If the building is to contain elevators, an elevator subcontractor is needed. If the project is to be rail served, a railroad subcontractor is needed.
When acting as a general contractor, Tradewinds Construction self-performs most of the required subcontractor work except for mechanical, plumbing, electrical and fire protection, typically running between 200 and 300 workers in the field, Phillips said. “I’m able to save 10 percent to 15 percent by doing subcontractor work in-house, but my overhead costs go up about 5 percent,” he said. “So usually it’s about a 10 percent gain.”
Some firms utilize unskilled day laborers for jobs such as digging, materials removal, light carpentry and daily cleanup. Unskilled laborers are paid about $8 to $12 an hour, skilled laborers, $12 to $20 an hour.
An often-overlooked cost involved in commercial development is the array of mandatory fees paid to various municipalities and agencies, by either the contractor or property owner. “Fees have substantial impacts on projects,” Markwell said. “If your impact fee for, say, a convenient store is $25,000, it’s a huge number and can make or break the deal.”
Fees are paid for plans review, building permits, inspections, zoning fees, traffic impact fees, utility (water, sewer and power) hookups, state health and even dust control. If a zone change is required, additional planning fees for a special-use permit are paid. “You can very quickly get entangled in multiple government agencies that are due fees that you may not be aware of,” Richardson said.
Further complicating the issue, a similar fee can vary from jurisdiction to jurisdiction. Some fees, such as the Southern Nevada tortoise mitigation fee (between $250 and $550 per disturbed acre), are required only in certain zones.
Some fees vary depending upon use, such as with sanitation fees. These are charged for every installed sink, toilet, drain and drinking fountain to connect to the sewer. Depending upon the planned use of each hook-up, for example, medical purposes versus general office – cost varies from $400 to $1,600 a piece, Phillips said.
Many of the required fees, for example, development fees, building permit fees, and water and sewer fees, have risen over the past three to five years whereas other permit fees have remained constant. Last June, in Northern Nevada, the Regional Transportation Commission approved a 50 percent increase in road impact fees to help pay for new roads, Markwell said. “With the market slowing down and less projects to pool from, we’re seeing the municipalities having problems keeping their budgets in the black,” Markwell said. “So they’re looking at a combination of increasing fees and lowering costs.”
On The Horizon
Over the next year or so, the commercial real estate market is expected to slow even further.
Rizzo expects a hiatus in the overall volume of work until the financial situation works itself out, he said. “I think that ’09 could be a very difficult year for commercial and industrial development,” Richardson of Miles Construction said. “I don’t think we’ve reached bottom yet.”
In terms of construction costs, the commercial developers can expect more of the same, experts say. Construction input prices likely will rise 6 to 8 percent per year for the next several years, according to the AGC, due to global competition for materials and the ongoing dependence on limited supplies of fuel and transport capacity.
Some in the industry remain uncertain, but encouraged, about the future of construction costs. “Hopefully things will start swinging up in ’10 and ’11,” Richardson said. “As things swing up, then the pricing will follow.” Others are downright optimistic. “I have a lot of faith in the opportunities [in Southern Nevada],” said Weinman of Plise Development and Construction. “I think we will rebound a lot quicker than people are expecting.”