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Coming Up for Air

Building owners and developers are struggling to keep their heads above water in most construction sectors

July 01, 2003 |

It's been a heckuva year for building owners and developers. Even giants are faltering in markets such as hotels, industrial facilities, and office buildings. Healthcare, multifamily housing, and retail are bumping along, but no single sector is doing fabulously.

Our report begins with one of the more troubled sectors, the industrial market.

Industry — Streamlined for growth

FMI, a consulting firm specializing in the construction industry, says spending on industrial buildings and warehouses fell by $10 billion between 2001 and 2002. The changes owners are making to save money now could change the market in the future.

Warehouses and factories are being built with more flexible space, computerization, and sustainable energy sources, says Thomas Bisacquino, president of the National Association of Industrial and Office Properties. Bisacquino says that the focus on efficiency will speed up distribution.

One such project is Windgate Distribution Center, a 658,060-sq.-ft. warehouse in development near Chicago. Jim Purinton, president of Chicago-based Orix Real Estate Equities, says the distribution center will consolidate several smaller facilities into a more efficient site on a major interstate.

Other recent projects, notably Ford Motor Company's renovation of its Rouge Plant in Dearborn, Mich., focus on sustainability.

A predicted upswing in the economy has encouraged mildly cautious optimism about construction in the industrial sector. "We're trying to build in a prudent manner," says Tom McCormick, COO of Panattoni Development, Sacramento, Calif.

Hotels — Switching gears

Hotel construction has dropped dramatically following post-9/11 declines in business travel and tourism. While nearly $11 billion was spent on new construction in 2000, FMI estimates that just under $6 billion will be spent this year. Hard times are forcing hotel owners to diversify.

Investing in condominiums has become a lucrative option for hotel chains like Irving, Texas-based FelCor Lodging Trust, says president and CEO Tom Corcoran. FelCor is spending $100 million on a condo project at Kingston Plantation in Myrtle Beach, S.C. Corcoran says 90% of the units were sold before construction began. "I think condo development will continue to grow as there is increased demand from the baby boomer population," he says.

Laurence Geller, CEO of Chicago-based Strategic Hotel Capital, says branded condos, popular since the '90s, can help preserve a hotel's reputation until economic growth returns.

Renovation is another way hotel owners are preparing for the future. Low occupancy rates provide an opportunity to remodel without disturbing guests. Corcoran says his company spent about $65 million on renovations last year.

Offices — Tailored for tenants

Private-sector office space has taken the brunt of the current recession. With a national vacancy rate of 18%, owners are making tenant retention their top priority.

Improving efficiency of both space and building systems is one way to keep tenants from straying. Owners agree buildings that provide flexible space, money-saving energy and HVAC systems, and convenient "plug-and-go" offices have a better chance of competing.

Amenities are another factor. Widespread vacancies mean tenants that would have had to settle for Class B offices five years ago now expect more for the same price. Owners are offering larger suites, luxury furnishings, and technology upgrades, such as Internet pre-wiring and improved data and voice infrastructures to tenants.

Some owners are dangling improved security features in front of tenants. Fingerprint and voice identity technologies, lock-off gates, and personal identity codes are all popular. Two years ago, Grubb & Ellis, a Northbrook, Ill.-based real estate advisory firm, created a Web-based emergency preparedness tool. The new program allows building managers to customize plans for 24 different emergency scenarios, including bioterrorism.

According to FMI, the worst may be over for the office market. A recent decline in construction may slow vacancy rates by reducing the glut of buildings. Lowered sublease inventories are another sign of recovery. However, most owners say a rebound won't come anytime soon if job growth doesn't improve.

"I have no doubt that the cycle will return to a more robust phase," says Burt Follman, chairman and CEO of St. Louis-based Follman Properties-ONCOR International. "But I think it's going to be slower and more deliberate."

Government — Reaching out

Federal construction spending has remained fairly stable. The General Services Administration, the government's landlord, spent more than $660 million on new construction and another $600 million on renovation last year.

Bill Guerin, deputy assistant commissioner in the Office of the Chief Architect, says the GSA is focused on improving construction delivery.

Gone are the days of the sealed bid and reliance on internal contractor teams. The agency is now evaluating which contractors provide the best value.

They are also going to the private sector for advice. Guerin says the agency consults industry experts throughout the course of construction. This helps ensure efficient and effective work. The agency is also experimenting with new delivery methods, such as design-build, design-build with bridging, and construction manager as constructor.

Since the 1995 bombing of the Murrah Federal Building in Oklahoma City, all new GSA projects have been designed with enhanced security features, such as access controls, glazing, and support systems.

Mold problems are being handled through changes to HVAC systems and the Envelope Design Guide, which the GSA is developing with other government agencies and the National Institute of Building Sciences, Washington, D.C.

Multifamily — Marching on

Spending on multifamily construction has been growing steadily for 10 years. FMI reports that nearly $39 billion was spent on multifamily construction in 2002, up from $32 billion in 2000.

"I think the baby boom is a big part of this, but I think the so-called baby boom echo generation is a bigger part," says Bill Albert, president of multifamily development for Irvine, Calif.-based Sares*Regis Group. "They're transitioning from being apartment renters to condo owners."

Albert says his company is focusing on condos because the apartment market has hit a soft patch. But he says he expects that to change in a couple of years. His company is converting apartments to condos now, but is buying land where it can develop more apartments in the future.

Brian Dapper, SVP of Oakwood Property Services, a Cranberry Township, Pa.-based owner/developer, says his company has been converting luxury corporate housing into condos and apartments and is also installing wireless high-speed Internet in its buildings. "We think wireless Internet is the wave of the future, like cable TV was in the '80s," Dapper says.

Retail — Seeking new horizons

The retail market is also experiencing moderate growth despite the recession. Malachy Kavanagh, VP of communications for the International Council of Shopping Centers (ICSC), says both malls and strip centers have occupancy rates above 90%. Big-box stores are also doing well. Discount giant Wal-Mart owns 4,087 stores worldwide, opens a new one every day, and plans to add roughly 48 million sq. ft. to its U.S. holdings by next February.

Despite a fairly stable market, owners are adapting to meet new customer demands. The biggest transformation is the alteration of massive, enclosed malls into pedestrian-friendly "lifestyle" or "main street" complexes.

Simon Property Group, an Indianapolis-based investment trust, is a leader in this kind of conversion. "There are whole generations that don't have experience with Main Streets and downtowns," says Jim Goggan, VP of architecture and engineering for Simon. "This is changing the way people are experiencing shopping."

The new centers re-create the pre-mall American shopping experience. Stores, housing, and restaurants are arranged around tree-lined streets and landscaped public squares.

An ICSC survey showed that most shoppers used both types of facilities on a regular basis. John Bergstrom, SVP of Chicago-based General Growth Properties, says his company is trying to incorporate some aspects of lifestyle centers into mall renovations.

For now, upgrades and changes are keeping shoppers coming back to retail outlets. But the ICSC's Kavanagh worries about the market's future. "The consumer has really kept the U.S. out of double-dip recession," he says. "The question is, how long can that go on?"

Healthcare — Onward and upward

Healthcare is one of the few markets that is experiencing relatively strong growth. FMI reports spending on new health facilities jumped from about $6 billion in 2001 to nearly $8.5 billion in 2002. The obvious reason behind the boom is an aging population. The Baby Boomers are demanding amenities that are changing the healthcare system.

For example, HCA Health Inc., Nashville, Tenn., spent $2 billion last year on new construction and improvements, according to Tom Gormley, VP for design and construction. Other chains are rolling out new facilities where private rooms are the norm and hospitality is part of the service. "Our patients are asking why a stay at the hospital shouldn't be as nice as a stay at the Hampton Inn," Gormley says.

FMI predicts that the healthcare sector will remain strong in the short term and will see even more growth in the long term.

All in all, things may be looking up.

Low interest rates and a fairly stable past growth rate have drawn investors tired of stock market fluctuations. Owners are also benefiting from low rates, especially in the office construction market. Robert Bach of Grubb & Ellis says owners in that market have been able to recoup some of their costs by refinancing.

Certain regions are doing better than others. The hotel market is still strong in Las Vegas, for instance. Even the office buildings market has a few bright spots, notably recession-proof Washington D.C., with a vacancy rate as low as 7%.

FMI is predicting most markets to start recovering by 2004. The Federal Reserve announced on June 11 that economic activity is increasing in four of its 12 districts. If the Fed lowers interest rates, as it is expected to, the economy could get an even bigger boost in the coming months.

For owners, that would be a breath of fresh air.

U.S. construction put in place, 2001-2003

(in millions of current dollars)

Sector 2001 2002 2003 (est.)
Multifamily $35,951 $38,837 $37,817
Healthcare facilities 6,285 8,415 8,346
Hotels/motels 9,854 6,527 5,945
Industrial/warehouses 31,456 20,273 19,498
Private office 44,236 31,016 28,065
Retail 27,822 26,386 28,679
Source: FMI Construction Outlook, Q2/2003

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