Construction and Development Roundtable: Facilitating a Facelift
Our expert panel: Ron Becher, president, JP Cullen; Brad Hutter, president and CEO, MIG Commercial Real Estate; Joe Alexander, president, The Alexander Co.; Verne Jesse, attorney, Murphy Desmond; and Eric Schwartz, president, Sara Investment Real Estate.
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In Business magazine convened an expert panel to discuss the latest trends in the industry that is changing the face of Madison — construction and development. If the Constellation and the newly renovated Edgewater Hotel are any indication, there is immense public curiosity about the looming cranes and rising buildings that are giving Madison’s skyline a new silhouette.
Since our last Construction & Development Roundtable, much has happened, including the addition of more stunning structures, the adoption of a new tax incremental finance (TIF) policy for the City of Madison, and the beginning of a phased rewrite of the Madison Landmarks Ordinance. These developments all hold long-term promise, but there are more immediate trends that will influence whether we can maintain the current pace of commercial construction, and whether new office construction will make a comeback.
Addressing the possibilities are moderator Joe Vanden Plas, IB editorial director, and an expert panel that includes industry executives Ron Becher, president, JP Cullen; Brad Hutter, president and CEO, MIG Commercial Real Estate; Joe Alexander, president, The Alexander Co.; Verne Jesse, attorney, Murphy Desmond; and Eric Schwartz, president, Sara Investment Real Estate.
Maintaining the pace
VANDEN PLAS: What do you envision for the level of construction activity in the next year, and then looking over the horizon, for the next three years?
BECHER: The way I look at it, and definitely from the construction side, I would see it increasing. We’ll pretty much follow what the economy is doing. It’s projected to increase, still grow, through maybe 2016. Some of the things I look at are the state, mainly the [UW-Madison] work. There’s going to be about $150 million of work bid and starting within the next 12 months, if they stick to their schedule. That’s fairly significant. It would replace all the work on the buildings that are going up in town and all the tall cranes you’re seeing. It would include Memorial Union phase 2, in addition to the UW Hospital parking ramp, Meat/Muscle Science [biology laboratory], and Babcock Dairy. Some of it is new, and some of it is just modernizing and upgrades.
JESSE: The things that have made growth so consistent in Madison remain the seat of government, the university, the number of good-paying white collar jobs, and the fact the economy here seems to be less prone to the bigger dips that you see in other parts of the country. On that basis, I would expect some continued growth both on the one-year and the three-year horizons. One thing that always causes me to pause in this economy is that surveys seem to show, whether it’s business owners or consumer confidence surveys, the perception that this quote-unquote recovery is fragile. So something that on a purely logical basis shouldn’t have a negative impact could in fact have a negative impact, and that concerns me.
SCHWARTZ: If you look at the history, the short-term history from the decline [when] Lehman fell in October of 2008, if you look at the private-sector development and how many times we called JP Cullen for work in 2010, 2011, 2012, we’ve been filling space. Our corporate occupancy is at 91%, 92%, so we’re out of space. We’re going to start having to construct buildings for tenants, or expand. So as the occupancy grows, as our tenants run out of space, we have to start calling JP Cullen to build buildings, and that is going to occur in 2015, 2016, and beyond.
The thing that is slowing the economy, the thing that’s puzzling me, is why we’re not growing a little bit more, a little bit stronger. Part of that is leverage. There’s so much leverage in the market. The QE2 [quantitative easing], QE3 programs, there were a lot of benefits to it and a lot of negatives to it. If you look at other [economic] rebounds, we have rebounded faster, and we all thought it would happen a little quicker than it has, and it really hasn’t.
Just debt in general. The average consumer, the average company, the government, we’re all more debt-laden than in any other recovery in the last 80 years, percentage-wise. The wonderful thing about QE is that it pushed down interest rates, got everybody thinking a little bit more positive. The bad thing is, we got a lot of debt, and it’s slowing our growth. That’s not allowing us to grow as quickly as you would think with 91% occupancy.
HUTTER: There are developers, still commercial real estate owners, that are still trying to dig out of 2008 to 2012 by filling spaces or selling off. Now that some valuations have come back and capitalization rates have dropped, and some of the values of some of their buildings are coming back up, they’re able to finally sell them and maybe get something out of them.
We’ve been able, over the last number of years, to fill some of those areas where tenants have contracted or maybe tenants went out of business after Lehman. We’ve been able to build those occupancy rates back up into the 90s. Money is flowing into real estate, more as an investment vehicle now than before, from large institutions.
That then pushes capitalization rates down, which pushes values up. Owners are now able to refinance their buildings and potentially take some equity out, or have some more flexibility financially.
Tenants have been relocated to different buildings and are allowing us to move their occupancy rate up. There hasn’t been a lot of speculative office building at all, which of course assists the developers and landlords in leasing out their spaces. That builds a general foundational stability in the overall market.
As we get into the 90s with our occupancy rates and we are running out of space, larger tenants, or tenants that need to expand, or tenants that are coming to us with opportunities, we may not have that. You’ve got to have that space available. One option is then to go out and purchase something existing and renovate it, which again helps the industry in that there might be other developers out there who need to unload something.
Then we have the capacity to refinance and create liquid capital to renovate an existing building, or to go out and sign a lease in order to underwrite the construction of a new office. And then there would be some speculative portion typically attached to some of those projects, which would add some square footage, whether it’s 20,000 or 30,000 or 50,000 square feet of additional opportunity in the market for future leasing.
Right now, other than a little bit of a bump, interest rates continue to be historically low. Well-run businesses continue to stockpile money, large ones especially, and build capital. Some larger businesses — I’ve seen more than ever — are now in a position to make some pretty significant moves, take advantage of the market, and do large projects.
We’re seeing residential because the timing on a residential plan is much shorter. When Eric or Joe and I work with a larger corporation, their planning for a building goes out sometimes almost two years. It’s not something you throw together in six to nine months. So you may see the apartments going up now, but there’s a lot of [office] planning happening.