Rising Construction Costs

Panelists agreed that rapidly rising constructions costs were the primary obstacle to making deals financially feasible. As energy prices continue to increase, petroleum products and transportation costs drive building material prices ever higher. Panelists cited global political and economic conditions which indicate no improvement in stabilizing the supply of oil or reducing the demand for oil. Rampant inflation has affected items from carpet to concrete so that interior and base building construction budgets have become difficult to rely on even during the preconstruction phase. For example, a typical Tenant Improvement Allowance that was $40 per rentable square foot last year is now $50. With supervision costs fixed, small office build outs can be more like $60/rsf. Continued increases in construction costs were projected to range from 7 to 9 percent.

Capital Chasing Deals

The flood of capital representing the demand for deals in the market continues as the supply of sites declines. Those sites that remain are complex to redevelop and even more complex to project costs. Developers/sponsors must act quickly to win competitive bids. The fast pace of these decisions puts pressure on acquisition due diligence activities. Developers are using more of this period to define the challenges to the project, such as zoning and environmental obstacles, and devoting less time to arranging financing. At this earliest stage, they are bringing in their design and construction professionals to add the best available input to their analyses. Later, architects make use of three dimensional models which integrate elements so that rapid changes can be made as the project evolves.

Balancing Risk and Reward

Equity partners and insurance carriers are trying to uphold underwriting standards while struggling to balance development and business risks with lower, unleveraged returns caused by higher costs. In assessing projects, investors focus on the people behind the project's sponsor; the global credit of the sponsor; and the fundamentals of the property's value. Risk management issues are addressed earlier than ever as carriers allocate risk among members of the project team. More attention is paid to project versus separate insurance policies to manage risk of loss. Insurance companies are avoiding residential and office condominium projects because of litigation risks arising from defects and geographic areas subject to wind and flood exposure.

Labor Shortages

At every level, panelists reported the lack of human capital available to meet the demands of the region's robust economic activity. The supply of construction labor is especially low with many subcontractors declining to bid on risky downtown projects in favor of suburban projects. Cultivating young people fresh out of college is one alternative to the lack of experienced hires. Panelists are more selective in seeking work and concentrating on larger projects to spread the high fixed costs of supervision. Technology continues to offer speedier and more accurate responses to ever increasing demands for answers.

The panel concluded with optimistic views of a robust economy in the absence of another asset class offering more favorable returns than real estate. They reiterated their concerns that the capital flow may be stronger than adherence to sound investment fundamentals.