WEDNESDAY, MAY 20, 2009
by Mark ThomtonChicagoAs new construction declines and office vacancy rates rise, the short term outlook for the construction industry is not a positive one, but as property owners struggle to retain and attract tenants, many construction firms are finding niche work by creating value in older buildings with build-outs and renovations.
"The theme is value today," says James Brucato, president for
Principle Construction Corp. "Construction firms must figure out how to deliver value to property owners and tenants."
Recently, that may have been in the form of a brand new Class-A office facility with all the bells and whistles, but as recent reports show, this work is down and will probably continue to decrease in the foreseeable future.
According to Grubb & Ellis, new office space under construction at the end of the first quarter retracted to 66 million square feet nationwide. That's the worst performance that a quarterly report has displayed in two-and-a-half years. Perhaps more alarming is the increase in vacancy rates and negative net absorption the market is currently recording. Nationwide vacancy is at 15.6 percent and net absorption plunged to recessionary levels with the first quarter reporting negative 18.4 million square feet absorbed.
With demand decidedly down, all of this equates to the best tenant market in years.
Rental rates will continue to dip as property owners struggle to retain and attract tenants. Each area will go through different patterns and some landlords will concede more than others, depending on individual financial positions. But one thing is for certain, many tenants will find that they can upgrade their office space at no extra cost.
"Because there is so much nice space on the market, firms won't reuse older space," says Scott Kurinsky, vice president of
Bear Construction in Rolling Meadows. "If the property is 8-10 years old, people don't want it. Firms can upgrade for the same cost."
While newer, Class-A space becomes much more affordable for prospective tenants, older space is struggling to compete. Landlords and property managers with available cash are finding that it is well worth the investment to upgrade and renovate older space to compete in the current market.
Leopardo Cos. has won numerous awards for its interiors work. The firm recently completed a $60 million renovation of the CNA building at
333 S. Wabash, where it took a single-tenant building and redeveloped it to be a multi-tenant property. To attract prospective firms, Leopardo redesigned the lobby and installed a state-of-the-art health club and conference center on the building's third floor. The nearly 40-year-old property now competes with newer space.
Rick DuPraw, vice president of the Interiors Group for Leopardo, says that adding amenities like communal conference space and fitness centers are a popular way for owners of older properties to retain and attract tenants. In today's market, landlords with the cash are making these moves.
"It is a more prevalent trend today," says DuPraw. "It's all about retention. Landlords don't want to lose key tenants and firms in Class-B and C-space can now move into A-space. A way to keep those tenants is to upgrade amenities."
This process may be necessary for existing owners of vintage property, but in a bottom-line driven market, this kind of work can also be seen as an opportunity and not just an obstacle.
"I think it is the way of the future in today's market," says Adam Miller, president of
Summit Design Build. "A lot of smart developers are buying older properties, doing renovation work and looking at stabilizing these properties. They are buying them on a discounted price and repositioning these things."
Miller highlights an example that Summit delivered in Niles for AFN. The firm bought an existing 38,932-square-foot facility, and Summit performed the renovation and a 10,000-square-foot build-out.
"AFN bought the property for a great price and renovated it for less money than it would have been to build new," says Miller. "The firm owns the land, too, which gives it more room to grow."
Baer Construction recently completed a renovation and expansion for Careerbuilder at
200 N. LaSalle. The 148,000-square-foot project was LEED-certified and included energy efficient lighting and HVAC systems. The project was a build-out of six floors in the existing building.
"The general trend right now is that firms are doing whatever is most economical," says Kurinsky. "Some people are taking raw space to build out, which can be as inexpensive as renovating existing space."
While some property owners are investing in upgrades to remain competitive, others are simply doing it because there has been no better time to reinvest in property. Owner-users with cash can pay for upgrades now at a much more affordable price than they could have a few years or even a few months ago.
"A lot of people are sitting on their hands, but in the interim they are doing alright," says Principle's Brucato. "Many of them are investing in additions or upgrades, because they couldn't buy them for any less than they are right now. The prices for commodities have dropped. It's a supply and demand issue."
Commodity prices are not the only cost that has decreased. Increased competition among construction firms has brought down labor costs as well.
Leopardo's DuPraw estimates that construction costs could be down as much as 10 percent.
"Firms are getting aggressive pricing right now," says Bryan Kreuger, vice president and senior project manager for
Reed Construction. "Contractors are hungry for work and there is excellent pricing."
Reed recently finished two floors of spec suites at 125 S. Wacker for Tishman Speyer. The 31-story office building was constructed in 1974. To attract potential new tenants, Reed also installed a fitness center, locker rooms, a conference center, and upgraded the lobby and common areas.
Eight of the spec suites that the firm constructed were leased by the project's completion, says Kreuger.
But while pricing has been a boon to property owners, firms are finding it more difficult to land deals that were once plentiful. To make matters more complicated, smaller firms are now being pitted against large firms that stayed out of the renovation/rehab market the past few years.
"Competition is fierce right now," says Bear's Kurinsky. "There are so few large projects out there. Large contractors are coming into the mid-size and smaller general contractor arena and trying to get what they can. We are now competing against the larger GCs that we haven't had to the last eight years. They are chasing 10,000-15,000-square-foot deals right now."
This recent trend in construction activity reflects the cautious market that has seeped across the entire economy. Yet in the foreseeable future, many industry professionals believe that this trend will persist even after the economy turns around.
"Saving money is always en vogue. People will get a taste of this and see that they can operate at efficiency," says Principle's Brucato. "I think this will outlast the economic downturn."
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