The High Cost of Building

Oil prices and material shortages can turn many a construction site into a money pit.

One Arts Plaza is yet another high-profile project under way in downtown Dallas, its cranes not unlike the dozens of others that have sprouted all over the Dallas-Fort Worth area. When those cranes in the Dallas Arts District are through, 7-Eleven will have its corporate headquarters on the 10-acre, four-building, multi-use site that boasts 425,000 square feet of office space, 60 luxury condominiums, restaurants, galleries, shops, and boutiques. The impressive addition to downtown will be another notch in the belt of developer Lucy Billingsley, albeit an expensive one. The total cost of the project—set to be completed next spring—is about $125 million.

Had construction not started until this year, the cost may have been tens of millions more.

“Construction prices are rising and rising fast,” Billingsley says. “We simply had the good fortune of good timing. We locked in our leasing in March 2005 and made a commitment on construction material purchasing as quickly as we could.”

For most people outside the industry, commercial construction appears to proceed at a maddeningly slow pace. But from the word go, when the bottom line on a deal is signed, contractors are up against tight deadlines and long lead times in acquiring materials they need. And for developers, the time to start buying those materials is as soon as the last lease on their pro forma is signed, because part of what goes into calculating that lease rate is construction costs. If the past couple of years—months even—are any indication, those costs rise daily.

“You’re already committed to your tenants with the lease rates. So your revenue stream is effectively set unless you’re building on spec,” Billingsley says. “So as soon as you can, you need to lock in your construction expenses at the best price you can.”

At a glance it’s hard to tell there’s any kind of shortage of construction materials. Cranes frame the downtown, North Dallas, and Uptown skylines, where more than $6 billion in new construction is under way. It’s this way throughout Texas, which has something like $26 billion in commercial construction working, according to David Snyder, executive vice president of Dallas-based Con­structors & Assoc­iates. Their projects include Coun­try­wide Home Loans, the Rent-A-Center corporate headquarters in Legacy Park, and Lincoln Prop­erties’ eight-story spec office tower at Tennyson and the Dallas North Tollway. Over lunch, Snyder rattles off the cost increases he’s personally seen, firing out percentage increases for raw materials with machine gun speed and sniper accuracy.

“The real spikes are in copper, steel, and cement. There’s a big shortage there. And sheetrock. And you wouldn’t believe the lead times for high-performance glass,” Snyder says. “I expect costs to continue rising between 2 and 4 percent per quarter going forward. And then there’s anything that uses petroleum in its manufacture. With oil at $70 a barrel, that’s having a big impact on petroleum-based construction products.”

The Bureau of Labor Statistics, which tracks prices at the national level, reports that between April 2005 and April 2006 (the latest numbers available at press time), the overall cost of materials and components for construction rose 6.3 percent. Cement rose 14.9 percent, while asphalt ticked up 11.7 percent. Gypsum—the material for drywall—rose 23.8 percent in just 12 months, while copper and brass rose a whopping 52.7 percent.

Locally, real estate professionals say it’s been much higher.

“Copper and steel, which are dominant in our industry, have been most susceptible to this,” says Mike Wyatt, executive director at Cushman & Wakefield of Texas, Inc., a full-service commercial real estate firm with offices worldwide. “The cost of copper has increased 100 percent since last December, going up almost 70 percent in the last two months alone. In June 2005, copper was being sold at $1.62 a pound. Now copper is being quoted at $3.87 a pound. This directly affects costs associated with electrical, HVAC, plumbing—not to mention what the increases in ferrous metals have done to miscellaneous material costs. Steel has gone up 100 percent since last December, and gypsum board might soon be allocated due to shortages.”

Most of the credit for these shortages goes to the domestic construction boom.

“China is sucking up some of the materials, but overall it’s more a function of the fact there’s so much construction going on domestically,” Snyder says. “And the real warning is that we haven’t even seen the effect of what the Gulf Coast rebuilding will do. These increases started well before Katrina, and right now they’re still doing clean up and reclamation on the coast. Rebuilding won’t start for another year, and when that hits, it’s going to be a strain on the industry.

“If prices don’t stop rising at this rate, you may start seeing a slowdown in construction,” he adds. “Projects will be put on hold.”

Dave Karcher, president of Precept Builders, says his company hasn’t lost any significant deals because of the volatility of construction material prices, but his firm did redefine their strategy in recent years.

“In 2004 and 2005, we spread ourselves nationwide, because then the North Texas economy hadn’t picked up the same way the economy had in other markets,” Karcher says. “In 2006, about half our work has been out of state. North Texas is once again growing at a pace as fast as the rest of the country, and our market share here is growing with it.”

As for whether the higher prices now and on the horizon will slow down construction, Karcher is doubtful. He’s only seen a few projects in a few submarkets in Dallas put on hold. Despite the costs, the growth in the general economy is making it possible for construction to chug along.

“If we were in a down economy where the rental rates were soft and developers couldn’t absorb the cost of these materials, we’d be in trouble,” Karcher says. “But we’re fortunate to be in an economy that allows the income side of a pro forma to compensate for higher construction pricing.”

It’s true that numbers continue to bode well on the real estate barometer. According to research by Grubb & Ellis, in the first quarter of 2006 alone, about 1 million square feet of office space was absorbed—something that hasn’t been seen since 2000. Compare that to the previous 12 months ending December 2005, which saw 3 million square feet of absorption and was considered a banner recovery year. Class A office space is going for upwards of $22 per square foot citywide. Job growth is consistent and strong. The unemployment rate in Texas hit a four-year low of 5.2 percent in 2005; this year should see as much as a 3 percent increase in job growth in Dallas—the most since 2000.

“If things slow down, it’s a whole other story. But until then, we’re riding a wave,” Karcher says.

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