Builders Face Tough Balancing Act

Despite rising land, labor and materials costs, construction firms are finding ways to stay on budget while maintaining quality.

By Lynn Peisner

Commercial real estate developers and builders active in seniors housing face the same problems squeezing other property sectors. Permitted land is more expensive and harder to find. The cost of capital is rising. Fewer skilled laborers are available. And materials costs are steadily increasing. Meanwhile, construction firms put in many hours on the job site to ensure projects are completed on time and on budget.

The total cost for a seniors housing development increased by 5.3 percent on a year-over-year basis in the third quarter of 2018 to an average of $298 per square foot, or $270,200 per unit. That’s according to CBRE’s U.S. Seniors Housing Development Costs Report released in December.

Data was drawn from valuations of 330 seniors housing developments that were scheduled for delivery in 2018 and 2019. The properties in the data set included either standalone facilities or a combination of independent living, assisted living and memory care communities.

The report determines that hard costs represent the majority of a development project, followed by soft costs then site acquisition costs.

Site acquisition costs increased the most — 16.2 percent per square foot on average — between the third quarter of 2017 and third quarter of 2018, according to CBRE. Hard costs rose 7.1 percent, and furniture, fixtures and equipment (FF&E) expenses climbed 7.9 percent.

Associated General Contractors of America (AGC of America) released its own Construction Trends & Outlook report on Dec. 12, 2018. Authored by Chief Economist Ken Simonson, the report further analyzes key areas affecting rising costs. The report states that those factors include the impact of trade policies on materials costs and demand for construction; a widening labor shortage aggravated by U.S. immigration positions that have curbed the supply of foreign-born workers; and rising interest rates that may reduce affordability of income-
producing projects.

An AGC Workforce Survey revealed that, as of August 2018, the most difficult positions to fill were pipe layers, sheet metal workers, carpenters, concrete workers, pipefitters and welders.

Worker shortages affect costs and completion times. Nearly half of respondents to the AGC Workforce Survey reported that their firms’ new bids contain higher prices, while one-quarter indicated that they are quoting longer completion times to reflect labor scarcity and cost increases.

President Donald Trump’s tariffs on steel, aluminum and timber are also affecting construction costs, according to AGC. In March, the Trump administration announced a 25 percent tariff on steel imports and a 10 percent tariff on aluminum imports.

The producer price index (PPI) for steel mill products rose 19 percent from August 2017 to August 2018, and the index for aluminum mill shapes rose 14 percent, according to the Bureau of Labor Statistics (BLS). The increases, AGC says, have resulted in delays in receiving orders and quotes from mills, which means firms are likely to raise bids to account for higher costs and uncertainties.

“Increasing demand from some segments of construction, such as oil and gas pipelines, may have contributed to the steel price increase,” says Simonson. “But reports from contractors of price increases and delays in fabrication largely coincided with the announcement and imposition of tariffs.”

Simonson’s PPI commodity data for metals and metal products shows a steady climb after March 2018, with a 12-month percentage change in cost rising from 4.9 percent in March to a preliminary figure of 18.5 percent in December.

Those are national figures. Individually, construction firms report their own cost increases. Meyer-Najem Construction, which has completed approximately 40 senior living projects in the past 40 years, reports that the price of wood for its projects has risen 10 to 15 percent in the past year, while the cost of steel has risen about 10 percent.

“Wood and steel tariffs have affected the cost of construction over the past 12 months,” says Kevin McGovern, executive vice president of senior living for Meyer-Najem Construction based in Fishers, Indiana. “Estimates have been adjusted to accommodate cost increases, but the biggest hurdle is educating owners that costs are going up and budgets and proformas need to be adjusted accordingly.”

Tariffs on various Chinese goods include construction-related items — which AGC says are products needed for manufacturing construction equipment or directly for construction — are also raising costs of supplies and materials. This is causing contractors to increase their bid prices. Those who watch and measure the construction industry regularly evaluate the PPI, which measures the average change over time in the selling prices received by domestic producers for their output.

“BLS generates the office building and health care building indexes by asking the same set of contractors each month what they would charge to put up a fixed group of buildings,” says Simonson. “The year-over-year change in that price was less than 3 percent throughout 2017 for both types of buildings.”

In 2018, the year-over-year change was 5 percent for office buildings and 4 percent for health care buildings.

Preconstruction phase critical

Construction companies are changing how they operate in order to complete projects on time and without overspending. Under the current conditions, some firms, such as McShane Construction, do not follow the traditional procurement model for new business, where a developer/owner would employ architects and engineers to design their community, then put the project out to bid in search of the lowest cost through competition among contractors. Instead, McShane favors an alternative approach called design-build or design-assist

“The traditional model only works as long as the plans and specifications don’t miss any scope, and the final ‘low bid’ falls in line with a value the project’s proforma can support,” says Mathew Dougherty, executive vice president and regional manager with Rosemont, Illinois-based McShane Construction Co. McShane has constructed more than 2,000 senior living units, including memory care, assisted living, independent living and active adult.

“Otherwise, in the case of uncovered scope or inaccurate plans, the owner and design team are exposed to unforeseen change orders, and in the case where the bids are over what the project can support, there is an exhaustive redesign process, which adds cost, redesign time, rebid time and frustration to the process,” adds Dougherty.

A developer’s success leads to a construction firm’s success. Therefore, many firms are learning how to be flexible in order to execute on deals. “It’s hard enough when the costs are going up, but it’s exceptionally painful if the costs are going up and the schedule is longer and they pay more for the site,” says Dougherty. “So we’re doing everything we can to help mitigate as much of those costs as possible.”

To jointly accomplish this goal, contractors advocate for inclusion during the preconstruction phase. The design-build, or design-assist approach, supports preconstruction by placing the contractor at the table earlier in the development process. Preconstruction can be thought of as the phase when a developer knows the project location and parameters. It’s likely, at this point, that the developer has had precursory talks with a designer and may even have a rough site layout and building massing plan for the project, including concept renderings

“Preconstruction speeds up the timeline of the project, and time is money,” says Randy Kibsgaard, project manager with Clear Lake, Iowa-based Dean Snyder Construction, which has been in business since 1958. To date, the company has constructed more than 400 units of seniors housing, 50 percent of which are assisted living, 17 percent memory care, and 33 percent active adult. “There might be something we can do in preconstruction to get that cost under control before the architects even finish the drawings.”

Dougherty concurs that developers benefit from a contractor weighing in during early development talks. “Engaging a contractor that is versed in a product type — and that has current project information relatable to the client’s vision — allows us to work side by side with the owner and design team to vet building structural systems, mechanical systems and aesthetic options based on cost, constructability and availability.”

A project that McShane recently broke ground on in Naperville, Illinois, exemplifies the cost savings found in preconstruction talks. Once general building requirements were established, such as unit counts and amenity areas, McShane worked with the owner and design team to vet three different structural options for the project: below-grade garage parking with units above; podium amenity and parking with units above; and slab-on-grade building structure with some tuck-under parking and some on-grade parking.

“McShane developed a concept budget for each of the three options, allowing the client to establish a good understanding of the cost impact of each option,” explains Dougherty. The analyses were done with some assistance from the architect to understand general building layout, but detailed drawings were not completed.

“It was just a few hours of the architect’s time to ensure the design met the development requirements and operational demands of the facility,” recalls Dougherty. “The McShane procurement model, through partnering with our clients in preconstruction, allows us to leverage our vast experience in the senior living product type and put real data in the clients’ hands in order to help them make informed, fact-based decisions.”

Labor shortage drags on

Builders have to ensure a return on cost amid not only increasing materials and site costs, but also rising labor wages. The construction industry is charged with being more proactive and diligent when it comes to hiring great subcontractors. Supply and demand is not working in contractors’ favor today. The dearth of skilled workers, coupled with the demands to produce quality work, is driving up wages.

It also means there are fewer skilled workers to assign to jobs. Some construction companies are getting out in front of this issue by implementing a number of strategies.

The Weitz Company, which has built more than 365 senior living facilities nationally in the past 50 years totaling 31,000 units valued at more than $3 billion, believes intimate market knowledge is the foundation of its game plan.

“We’re putting boots on the ground,” says Chris Harrison, executive vice president of The Weitz Company based in Des Moines, Iowa. “We try to put our front-end preconstruction people into the cities we’ll be working in a year or two before we put a shovel in the ground.”

During that preconstruction period, Weitz meets with local subcontractors and local authorities in the jurisdiction, including chambers of commerce, economic development groups and chapters of the AGC.

“We need to find out what they’re seeing in their crystal ball,” says Harrison. “What big builds are coming and how many cranes are we going to see around town? This way we can help our customers make sure they have the right proforma for their entire project with the right escalation values built in.”

Escalation is the anticipated rise in labor and equipment costs that occurs between the time a project proforma is assembled and the groundbreaking, according to Harrison. The escalation figure that Weitz, or any construction partner, provides has to be accurate and tailored to the project’s market in order to prevent a problem down the road.

For example, if a developer planned for a 3 percent escalation in a market or region where labor shortages were driving up escalation 5 or 6 percent, that would be a problem.

Harrison adds that Weitz likes to encourage its clients to hire a trusted general contractor as well as some key subcontractors early on. “Mechanical, electrical, framing — some of the big ones that are going to make or break your budget. If you let some of these subs know they have a project, they will work with you to help lock in materials prices as soon as they can and won’t overextend themselves in taking on too many projects.”

The labor squeeze has construction companies taking on more mentorship roles. Kibsgaard of Dean Snyder Construction says his team regularly visits local high schools and community colleges to generate enthusiasm among the younger generation about pursuing a career in a field that offers plenty of opportunities.

“We are always talking to the kids,” says Kibsgaard. “The teachers don’t appreciate it when I say this, but I tell them there are options other than a four-year college degree. You can go to trade school and come out with a guaranteed job where you can make a lot of money without being $60,000 in loan debt when you start working.”

Kibsgaard says that in rural Iowa, tradesmen can earn as much as $40 per hour or more if they have specialized skills and become plumbers, electricians or welders.

Vertically integrated advantage

Some owner-operators achieve efficiencies by leaning on their own in-house construction division. The LaSalle Group, based in Irving, Texas, specializes in a standalone memory care product called Autumn Leaves that is built by Lake Superior Contracting, LaSalle Group’s own contracting division.

The company currently owns and operates 47 communities and is wrapping up a 48th in Sarasota, Florida. Lake Superior Contracting also is in the midst of building a facility in Naples, Florida. John Barbee, president of the LaSalle Group, says that the company is able to quickly and affordably incorporate the latest evidenced-based research on caring for people with dementia into a construction project at any time.

“We try to stay completely on top of the latest and greatest information. And as we gather that information, it becomes inserted into the latest and greatest physical designs,” says Barbee.

“Being vertically integrated allows us to narrow our focus in matching our construction design with our operational programming design. It’s an easy call to make an adjustment here or add something there that is good for the operations side. So, there is no down time in getting answers and moving forward with the construction project,” adds Barbee.

Scale and volume also come in handy for some firms when it comes to reining in costs. Minneapolis based Ryan Cos., for example, co-invests in senior living projects with four different operators as well as select capital partners.

Operating partners include Grand Living Management; Cadence Senior Living; Great Lakes Management; and LCS, which develops an independent living, assisted living and memory care product called Clarendale.

“From a standpoint of what we do, it’s soup to nuts,” says Eric Anderson, vice president of real estate management. Ryan Companies locates development sites and completes design and construction. The company also is involved with its capital partners on asset management, while operating partners run the communities.

Such bandwidth helps keep costs down. For example, Ryan Companies has partnerships with national subcontractors and vendors, such as a light steel supplier that’s engaged on all the company’s projects throughout the country.

“Based on that larger volume and larger workbook, they’re able to provide us lower pricing than we can get in a primary, secondary or tertiary market,” says Matt Sayre, director of operations for senior living.

Ryan Companies also employs a procurement agent who sources the best contracts on items such as flooring, wallpaper, light fixtures and many other line items. “The agent can look across a national spectrum and get better pricing than just looking in one region of the country,” explains Anderson.

In addition to relying on a deep bench of suppliers, Ryan Companies also advocates for standardizing designs.

“What we’ve learned in the senior housing space is that we really need to develop
construction-design brand standards, much like hotels do,” says Anderson.

“We don’t want to have to redesign every time we build. We’ve done this with two of our partners, and it creates a better development process.”