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Cautious optimism blankets commercial construction

Market reports for 2001 and views expressed by the executive officers of leading construction companies point to slowdowns across geographic markets and product types. While all of the players interviewed acknowledged the near-term slowdowns, nearly all see an upturn in conditions for the remainder of 2001 and into 2002.

Perception of the state of the commercial construction market depends on the perspective taken. While national statistics and economic reports paint a dismal picture of a market in correction, regional analyses of markets and submarkets often portray healthy levels of activity and even strong growth.

The May construction activity report published by F.W. Dodge shows the April reading for the Dodge Index slightly ahead of the 142 average for all of 2000.

“April's rebound is consistent with the sense that the construction industry is leveling off close to last year's volume, as opposed to being in the early stages of a sustained decline,” said Robert Murray, vice president of economic affairs for F. W. Dodge. “The general economic slowdown has raised concern about construction's near term prospects, but so far in 2001 the construction industry has been able to hold up reasonably well. At the same time, it's also true that the full impact of slower employment growth and tighter bank lending standards have yet to be felt by commercial building and housing.”

Some Wall Street analysts and industry leaders see a different scenario in which the activity buoying the market stems from projects left over from 2000. Declines in employment growth, corporate downsizing, and the failures of dot-coms as well as Competitive Local Exchange Carriers (CLECs), not to mention an influx of sublet space flooding the market, are all factors that can depress the market. Yet, those conditions have yet to diffuse the commercial market.

Sigrid Fennemore, a senior commercial markets analyst with the National Association of Realtors, issued a study on commercial trends in May that shows overall absorption of commercial space still remaining at healthy levels while construction activity was disciplined in the majority of the 54 markets tracked. Vacancy remained at near historic lows while average rent increases, although slowing, continued to stay ahead of inflation in most office, warehouse, retail, lodging and multifamily markets through the fourth quarter of 2000.

The Dodge report shows commercial building categories featured a 51% rebound for hotel construction after a lackluster March, a 6% gain for retail, and a 1% rise for warehouses. Office construction retreated 1%, indicating this category is beginning to pull back from its strong performance at the end of 2000. Manufacturing plant construction plunged 57% in April on the heels of an unusually strong March.

“Manufacturing plant construction has been generally depressed for the past three years, and despite brief upturns, April's data indicates that this category continues to be very weak,” Murray said.

“Everyone is indicating a general slowdown and in Chicago we're feeling the effects of a significant downturn, particularly in the office market,” according to Jeffrey Raday, president of McShane Construction Corp., a division of the McShane Cos., based in Rosemont, Ill., a suburb of Chicago.

According to Raday, the trepidation and uncertainty that exists in the current economy has demonstrated its impact on the commercial construction market since late 2000. “The availability of existing office and industrial space that has been constructed on a speculative basis in mid-to-late 2000 has yet to be absorbed, thereby slowing the commencement of new construction,” Raday said. “Caution is being exercised by purchasers of real estate and construction services due in part to the sluggish economy and the availability of ready capital to begin new projects.”

In addition, the availability of existing space is slowing the volume of new speculative construction that drove the construction industry to unprecedented levels of activity over the last three years. The key to survival in this economic climate is diversification, Raday said.

“The companies that survive weak markets are the ones that planned ahead for foreseeable downturns,” he said. “The best strategy is one of diversification in product type and geographic presence as a hedge against slowdowns.”

McShane, which earlier focused on industrial then moved into office, has expanded into education, multifamily and seniors housing. In May, McShane announced a co-development project for a new 117-unit senior living residence in Westmont, Ill., for Cordia Senior Living, a member of the Lend Lease Group. In Texas, McShane also has been active in the education market.

“We've done more schools in Texas than any other construction company,” Raday said. “In the past eight to 10 years we've built more than 70 schools there. Texas has a huge education program and commitment to expanding its education infrastructure.”


Despite negative outlooks for the industrial sector, CenterPoint Properties of Oakbrook, Ill., continues to focus entirely on the industrial market, although the company did expand its geographic focus in 1995 north into Milwaukee, Wis., and east to South Bend, Ind.

According to Mike Mullen, COO of CenterPoint, the company focuses on industrial properties because the market tends to be less volatile and has generated higher risk-adjusted returns than any other property type. The company's belief is that industrial construction holds up well under recessionary conditions and is more consistently resistant to cyclical changes.

“Our market in the greater Chicago region has been relatively solid,” Mullen said. “Occupancy rates have been running about 95%. As a whole, our economy has been importing more and we've also seen a move toward improving distribution logistics, centralizing facilities. And there is a growing desire to locate near major transportation hubs, which is the Chicago area's strongest asset. As a result, reliance on railroads for distribution is seeing a resurgence.”

A publicly traded REIT, CenterPoint currently owns and operates approximately 32 million sq. ft. and an additional 1,700 acres of land of which 22 million sq. ft. is developable. Its total market capitalization is roughly $1.7 billion.

With three large-scale projects already in the works, CenterPoint shows no signs of a slowdown in its activities. Its project in Joliet, Ill., will be one of the largest brownfield redevelopments in the nation involving the conversion of the Joliet Arsenal to a massive 17 million sq. ft. industrial park. Known as the Deer Run Industrial Park, this sprawling complex will provide distribution and manufacturing space in a location adjacent to a major multi-modal rail facility to be operated by The Burlington Northern and Santa Fe Railway (BNSF) Co.

The arsenal property, set aside for industrial development by Illinois' Joliet Arsenal Development Authority (JADA), includes a 375-acre parcel adjacent to the arsenal acquired by CenterPoint, totaling 2,242 acres for development.

“The opportunity to locate close to a major multi-modal distribution complex will be a powerful incentive for manufacturers, warehousers, food processors and other customers of freight transportation services to be within the Deer Run Industrial Park,” Mullen said. Other uses on the site will include a water treatment and sewage plant to serve the park and nearby Village of Elwood, hotels, restaurants and a possible power generating plant, he said.

Mullen said that deregulation and zoning requirements have made it more difficult to obtain reliable, clean sources of power and that power companies are more reluctant to undergo the costs to construct new plants. Mullen proposes additional construction of onsite generating facilities as a solution to potential power supply shortages.

The Joliet project is expected to create 8,000 to 12,000 permanent jobs, more than 20,000 union construction jobs, and as much as $27 million in annual property tax revenue upon completion of the 12-year build-out period.

Another major project for CenterPoint is the construction of the new Chicago International Produce Market in Chicago, a 500 million sq. ft. development occupying 26 acres. The new produce market will be one of the largest wholesale produce markets in the nation serving restaurants, retail stores, institutions, and other customers. The $58.4 million urban redevelopment project has been pre-sold to future occupants.

The third massive project for CenterPoint is a new 2 million sq. ft. manufacturing facility for Ford Motor Co. in the Chicago area. The company expects to break ground on the development this year.

Incentives and changes in legislation to support brownfield redevelopments have had a positive impact for CenterPoint. All three of its major new projects are on brownfields, and the Joliet Arsenal is a Superfund site. In fact, Mullen said as much as one-third of CenterPoint's portfolio is composed of rehabbed brownfields.

Mullen said that while December activity had slowed down, March through May were strong months with lots of lease activity, and the company sees healthy activity ahead.

As a major national corporate real estate development firm spanning office, industrial, lodging, health care and Telco hotel markets, The Alter Group is well positioned through diversification to ride out any short-term swings in the commercial market.

“We've definitely seen a pullback in the speculative market driven by lack of demand and limited access to capital,” said Russell Posey, senior vice president of development for Alter. “There's also been a noticeable softening in the Southeast and Florida markets.”

Posey said that the market underestimated the impact of the dot-com shakeout on demand for office space. The weak economy and uncertainty about growth prospects has led a lot of corporations to put expansion plans on hold or seek more economical alternatives to their space needs. Some options include a greater reliance on new workstation designs, pre-manufactured wall systems and flexible configurations.

“Overall, we're cautiously optimistic,” Posey said. “There's been an upturn in the Atlanta market in the past 60 days and we've signed a number of build-to-suit opportunities recently. South Florida is holding its own. Our Ft. Lauderdale property has been 100% leased to BellSouth and we just finished a 225,000 sq. ft. build-to-suit, four-story Class-A building for Siemens Westinghouse Power Corp. in Orlando.”

The Alter Group is developing a 60,200 sq. ft., state-of-the-art single-story customer support center for Nextel Communications Inc. in Bremerton, Wash. In addition, the company has built a 100,000 sq. ft. facility for Agilent Technologies Inc. and a 30,000 sq. ft. facility for State Farm Insurance Cos.

“We don't have a lot of inventory on the shelf,” Posey said. “There are significant challenges in markets where there are moratoriums on infrastructure development and stringent environmental requirements. In general, office correlates to job growth and the health of job markets varies from region to region. Atlanta, Charlotte and Phoenix all forecast significant growth.”

On the materials end, Posey said that many of the suppliers still have decent backlogs and prices have stabilized and have not been increasing as they have in the past. “Overall there are isolated spot conditions and weaknesses, but the markets are clearly taking a cautious approach to speculative development with a wait-and-see attitude toward the economy,” Posey said. “It looks as if there will be a soft landing at the end of this year or the start of 2002.”

The South rises again

Batson-Cook, a fixture in the Southeast market for more than 80 years, maintains offices in Atlanta; West Point, Ga.; Tampa, Fla., and Jacksonville, Fla.

“We haven't seen a measurable slowdown in construction with the exception of office products,” said George Adornato, senior vice president and general manager of the Georgia Group of Batson-Cook. “The market for us remains extremely active. In fact, we've seen more opportunities than in the previous year or two.”

Adornato says his company has fielded a lot of interest in high-rise apartments and condos, and right now the company has five high-rise residential projects in the works. He also says that there is a growing trend of partnering with developers for residential.

“I think there is a serious misconception among developers about a slowdown in construction,” Adornato said. “Much of the hesitancy in the market has to do with a misreading of the economy. Also, the impact of the dot-com failures has been blown out of proportion. There is a growing desire for design/build office projects and speed to market has become paramount.”

Offsetting the office slowdown has been Batson-Cook's active work in education construction. The company's university activity includes Georgia Tech, Georgia State University, Clemson University, Vanderbilt University and the University of Alabama.

“We have about 15 to 20 residential and university projects in the pipeline,” Adornato added. “There are so many different submarkets where activity is high that it's difficult to attribute a slowdown to any markets across the board. Orlando is slowing down, but Atlanta, Charlotte, Jacksonville and Tampa markets are really strong.”

Hoar Construction, based in Birmingham, Ala., also is active in the Southeast in the office and hotel markets and nationwide in retail. “The Houston market has shown steady growth, coming back from low levels in the late '80s,” said Michael Lanier, vice president of preconstruction services for Hoar. “Now Houston is really strong in office and retail. Orlando is hot, especially in the downtown area with retail and office.”

In Miami, Hoar recently constructed Dolphin Mall, a 1.6 million sq. ft. mall with 17 anchors. The company is working on other mall projects in Aspen, Colo., and Raleigh, N.C.

“A new trend in retail that we're seeing is the emergence of more lifestyle centers with mall-type tenants and situated between two malls and offering higher-quality specialty stores than strip centers,” Lanier said.

Other trends Lanier sees are an increasing demand for design/build and greater use of renewable materials in a “green” approach. “The balance of 2001 looks great and 2002 looks stable,” Lanier said.

In New Jersey

Despite a growing softening in the New Jersey office market, Jeffrey Siegel, senior vice president of Murray Construction, does not see a major slowdown being sustained. “New Jersey has a diverse economy with a lot of pharmaceutical companies and corporate headquarters that shield it from a lot of economic cycles,” Siegel said. “The office end has slowed and there's a lot of sublet space available, but we're forging ahead with a number of projects.”

Among those projects is Branchburg II, the second building at Murray Corporate Center in Branchburg, N.J., with summer occupancy planned for the 81,400 sq. ft. speculative building.

“We're basically optimistic and see strong growth potential for the New Jersey market, particularly along the Hudson waterfront, in central New Jersey and Morris County,” Siegel said. “Things should pick up in the latter half of 2001.”

A market in transition

Whether it is just uncertainty about the economy or our changing culture, commercial real estate construction is in a state of transition. Corporate players are looking to space solutions, design/build methods and energy solutions to meet their rapidly changing needs. Inventory technology also is changing the warehousing and manufacturing market with more demand for centralized complexes and multi-modal transportation access. A rash of bankruptcies and concerns about overbuilding have put the retail industry on the alert.

“There has definitely been a slowdown, with office hit harder than industrial,” said Jim Miller, senior vice president of the Pizzuti Cos., based in Columbus, Ohio. “From our perspective, we've remained stable and have been active with build-to-suits and speculative projects. We're diversifying geographically — we moved into Indianapolis two years ago and we're doing a project for IBM in Lexington, Ky., and a 600,000 sq. ft. facility for McGraw-Hill in Akron, Ohio. There's definitely a trend toward consolidating distribution centers with the buildings getting bigger, deeper, with more parking and more employees. We see things picking up for the rest of this year and into 2002 when the economy will right itself.”

The cuts in interest rates by the Fed are expected to stimulate the economy and begin moving the market toward a more stable position. As conditions improve along with perceptions, corporate and consumer spending will rise and the spiral will begin to turn upward again. However, commercial real estate should continue to exercise the discipline it has held the past few years to remain profitable and successful.

Barry Kipnis is a Warminster, Pa.-based writer and frequent contributor to NREI.

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