Construction & Development Roundtable
Our Expert Panel
George Gialamas, CEO, The Gialamas Company
Aris Gialamas, Executive Member, The Gialamas Company
Brad Binkowski, Principal, Urban Land Interests
David Beck-Engel, Executive Vice President, J.H. Findorff & Son
Todd Cegelski, Vice President, Johnson Bank
Aaron Olver, Director of Economic Development, City of Madison
Neil Stechschulte, Economic Development Director, City of Sun Prairie
In our most recent coverage of construction and development, cautious optimism was expressed about the health of the industry, and there were predictions of gradual recovery, despite some concerns that higher energy costs and inflationary effects on material and shipping costs could put some projects on hold. That was before the economy took its recent dip, including the recent unprecedented downgrading of the U.S. credit rating. With the economy still struggling, we thought it appropriate to get an up-to-date snapshot of the industry.
GLYNN PATRICK: I am going to open with a request for a "State of the Union" – a few comments from each of you on where we're at.
OLVER: I think the glass-half-full way of looking at it is to recognize we've had eight consecutive quarters of economic growth, and we saw a [July] jobs report last Friday that was stronger than expected. Not great, but decent. And if we continue to see that kind of improvement, the construction industry will follow the expansion of the economy and follow job growth.
GEORGE GIALAMAS: Those are pretty words, but I don't agree. What they're doing to us in the market with this downgrading, I'm concerned, very concerned, about where we're going. This next step is not up, it's definitely down. How far down, I don't know, but I'm very concerned. I was semi-retired at one time, and I came back on board, just to make sure we don't lose our butts. And I'm sure anybody in this industry is saying, 'I've had it.' We're working harder for maintenance, not for growth. I don't think we're going to see much positive growth the rest of this year, and I think it will be [the same] at least next year. There are exceptions, and I've still got two projects going – nothing in Madison – but I'm not happy, so I'm not having fun.
BINKOWSKI: We're in sort of a unique situation. Dane County, Madison, is probably one of the brighter spots when you look around the country. The fact that people want to live here, and that we've got very stable government and insurance company and university-related employment, has always made this market somewhat immune to what happens in the rest of the country. Obviously, we've had a bunch of unrest relating to the governmental cutbacks in compensation, but I think we're still in a relatively protected position. It takes a lot of guts to do a new project or sign a long-term lease or commit to expand your company. In uncertain times, when you really don't know what the future is going to hold, I think there's a general reluctance to commit for the future.
BECK-ENGEL: Up until a couple weeks ago, we were much more optimistic than we were a year ago. And I don't know what's going to happen now because of the last couple of weeks [of debt-ceiling debate]. But we've been busier in our pre-construction world, working with Brad and others on projects that they're trying to make happen, and that's encouraging to us. We're hearing that our architects are starting to hire back; that's encouraging to us. It means work is coming down the pipeline. It isn't bricks and mortar for us yet, but it's coming. So we were more optimistic. Now we have got to see what this last couple weeks has done and, hopefully, it hasn't shaken people's confidence too much.
CEGELSKI: I would say, in the last 60 to 90 days, we're seeing an uptick in activity. And, yes, it's related to some specific projects, which I'm sure everybody has seen in the paper, announcements of the university clinics and health care facilities. There certainly seems to be money available for apartment financing – new construction. That seems to be probably the hot spot in the market. But in terms of office buildings and things like that, I just don't see it. To George's comment, you need the optimism from the developer. It has to start there.
STECHSCHULTE: The biggest thing we've noticed is that with the players who are involved in this during the last couple of years, there has been just a dramatic shift in who is involved in development in Dane County. Guys who have been from Milwaukee, Minneapolis, or other places outside our area, and guys who, for whatever reason, have been conservative through this downturn, and have some extra funding and things available, and are looking for investments.
In Sun Prairie, we're probably in the biggest pipeline that we've seen, certainly, in the last five years. Part of that is because projects have taken 10 years to get to this point. The Woodman's groundbreaking is great. We're finally adding 225,000 square feet of commercial space, but that's been 10 years in the making, at least 10. The amount of time it's taking projects to get to fruition is just mind-boggling. On average, when I first started five years ago, it was probably one to two years from concept to breaking ground.
We've had, with the last three or four projects we're working on, some of the most creative assemblies of financing I've ever seen. And that could be good, and it could be bad, I'll be the first to admit. As the municipality, we've had to look at doing things that we never thought about doing before. Real estate investment trusts and the requirements they have are odd sometimes, depending on the trust that you're speaking with. There's not a standard playbook anymore. You have to make sure everybody is talking to each other, and everybody understands the project rules going forward.
GLYNN PATRICK: What about the state of Wisconsin and its attempt to resolve its fiscal situation? Are there still public monies available to approve new projects in the immediate future?
OLVER: The biggest drag on the economy right now is that there's not enough aggregate demand so that you can have an expansion of employment, and so that you can have construction. Aggregate demand – 70% of it is consumption and 20% of it is government expenditure.
So when you see people cutting back government – the city is certainly looking at its capital budgets – you're hearing about 25% cuts in discretionary spending in Washington, so that is going to be a drag.
BECK-ENGEL: I would say, though, that the state is very conscious that it needs to continue to invest. We have a world-class university right here in Madison, and to attract top researchers, top faculty, they have to invest in facilities, and they do continue to do that. The capital budget this time around is lower than it has been in the past, but it's still pretty significant. They're still invested.
OLVER: The university is a bright spot for the Madison area, in terms of the construction economy.
GEORGE GIALAMAS: The fact is that most of the cranes in the sky are for the university right now. Are there any private cranes downtown?
BINKOWSKI: The Mullins apartment project. But at the university, when you look over the downtown Madison skyline, there are at least six tower cranes. That indicates there's a lot of activity, a lot of it university-focused. Certainly, the Mullins project is in close proximity to a major demand generator that it tends to take advantage of, so I think that's a really bright spot. There are still people looking to get more student housing development in the downtown, and that's a bright spot.
GEORGE GIALAMAS: Could I say one thing? We're not negative people. None of us could be in this business and be negative. In fact, they think we're crazy most of the time, so I'm not trying to be negative, I'm just trying to be realistic. When my banker, who has been banking me for 40 years, asks me for a copy of my driver's license, I say, 'Geez.' That tells you a little bit.
GLYNN PATRICK: Are you describing a different landscape for doing business?
GEORGE GIALAMAS: Different landscape. Brad and everyone here at this table, we're treated like we're brand-new kids on the block, like we just started the game and we don't know what we're doing, and I don't like that. I don't want to go through the same BS I went through 30 years ago.
GLYNN PATRICK: Do we think that we're going to go back to the go-go days, without requirements for 40% to 60% pre-leased? Do we have a new normal, or are we just adapting to the demands and realities of today and then we'll revert back to 'before?'
BINKOWSKI: We have a new normal for a while, without a question. We'd be foolish to say it's a new normal forever because we've been doing this since 1974 through all kinds of cycles, at least six major economic downturns, and every time credit tightens, people assume it's forever, and it's not forever. Economic expansions occur and banks go back to the business of lending money, which is really a positive thing. But for the next four or five years, we're not going to see the easy credit and the ample money that created a lot of the problems that led up to an oversupply situation.
GLYNN PATRICK: Is it going to be cyclical?
BINKOWSKI: I hope it doesn't revert back. If you look at a lot of money chasing real estate, it always creates a bad situation over time. Securitization of collateralized debt obligations was a huge problem where people were shoveling money out the door. They viewed loans as fee-generating opportunities that they really didn't have to service. They'd do a deal, sell off the risk, sell off the servicing, and get ready to do the next deal. That's not good lending.
We much prefer establishing relationships with banks that understand us, that maybe won't maximize the financing that we're looking for, but continually do projects that are good. You need a different kind of relationship today than you needed five years ago, a banking relationship.
CEGELSKI: Relationships have been severely tested over the last four years. Our perception, and who we deal with, is probably going to change as a result. A lot of people have, unfortunately, fallen by the wayside in real estate-related entities. People in the banking business know who the survivors are. George mentioned it earlier – a lot of developers have said, 'We're going to maintain what we have. We're not going to build, and try to make sure that we're generating cash flow from what we have.' That's a very common thing that's going on.
On the return to the go-go days or the new normal, whenever I hear somebody ask, 'Is this the new normal?' I say, 'Just wait five years, and then we'll see what's normal.' Obviously, there's been a huge tightening of credit from various things with, frankly, the good reason of losses. But the majority of loan losses have been related to residential construction and development, the vast majority. But that's had a ripple effect.
We've also had the CDOs [collateralized debt obligations] and the collapse of Lehman, and that started everything down. But I'm somewhat encouraged over the last 60 to 90 days, where we are seeing some activity and, frankly, other banks are. We're hearing about a lot more aggressiveness, pricing, and looking for deals out in the marketplace.
GEORGE GIALAMAS: We have to always plan ahead for the new projects, and be prepared. It's not coming to fruition yet. I think it's going to be another year, I really do. Again, I'm not negative, I'm positive, in the mere fact that I'm here [laughs]. But I wish it were more pleasant, that's all. Getting back to the banks you were talking about, what is this new [Dodd-Frank] law, the new papers that you have to work under? ÃÂ¦ I read part of it, believe it or not.
GLYNN PATRICK: Two thousand, three hundred pages?
GEORGE GIALAMAS: Part of it, I said. That is absurd, obscene, and every other word I could think of. How the hell can you operate under a thing like that?
CEGELSKI: Keep in mind, the regulatory pendulum has swung over, all the way over, and it's going to take time for it to come back. And that's where we talk about the new normal. Where's the balance? We were way over here, and now we're way over here. And the normal is going to be when we get back toÃÂ¦. We'll know it when we just feel that things are better or we'll feel like, 'okay, this is at least tolerable and we can do business.'
GEORGE GIALAMAS: Why don't they tell government to keep their hands out of it, and leave us alone in this kind of stuff?
CEGELSKI: Look at the government guys.
OLVER: We don't count right here [laughs]. It's all those higher-up guys that cause the problems.
GEORGE GIALAMAS: I'm talking feds. We've got to talk to our senators and congressmen and say, keep this stuff away. All you're doing is complicating and compounding the issues on the table now. And they get appraisals; now the appraisers, every appraiser I know, is trying to cover their behinds. If I paid – this is an absolute fact – $1.7 million for a piece of land in Milwaukee, and it was a distressed sale, and I bought it from one of the banks I won't mention. He came back and appraised it afterward, a week later, at like $700,000, $800,000. I said, 'I just bought it. It was assessed at $3 million, I paid for half of it, and you cut me in half again.' I said, 'I can't make the project work.'
BINKOWSKI: It's an unfortunate feeding frenzy. We run into the same kind of mark-to-market situation that a lot of the banks and security houses run into, where 'what's something worth right now?' Well, who knows? If you had to sell right now, are there willing buyers? Maybe not. But if you have the capacity to hold onto a project over time, that value just doesn't go away, your leases don't disappear and, hopefully, your tenants don't disappear. There's an intrinsic value that, unfortunately, isn't recognized today with some of the constraints the banks and appraisers are working under.
But Jody, you asked a question about survival. How do you steer your way through these turbulent times? It's really by focusing on fundamental value. We operate in the downtown market, primarily. The downtown market has held up very, very well. It's always been supply constrained, so it's extraordinarily difficult to do a new project of scale because it involves acquisition of land, which sometimes requires city assistance, which is potentially going to be a big problem in the future, depending on some pending legislation. It involves financial assistance to make parking affordable because the cost of parking is always a horrific drag on the economics of a downtown project.
But once you get a project built and once you get it up, and if you can satisfy your tenants and meet their expectations, you've got a pretty stable occupancy.
We've got six or seven lease transactions where tenants are actually under construction with tenant improvements, or are about to be, so the downtown is a relative bright spot. But even in a relative bright spot, the only way you become a survivor in this business is to pay off debt. You have to be able to have a project that can stand the test of challenging economic conditions, if you're going to live for the long term. Managing debt, paying it off, and having borrowing capacity in tough times has been the key to our survival.
CEGELSKI: To follow up on that, when I talk about the surviving companies and the large, nationwide homebuilders and their ability to survive, it starts with strong balance sheet liquidity, low leverage, and just being able to, when they're making money, hoard cash and be ready for the tough times. And as you've run into trouble, it's always the companies that are over-extended or over-leveraged or took too much speculative risk on whatever project.
GLYNN PATRICK: I'd like to know where we are in the cycle of 'extend and pretend.' Are we coming out of that? Did we have good relationships with bankers so that we could move through a tough period?
CEGELSKI: The best way to say it is that it's been an evolution. If you've had a vacant piece of dirt on the books for five years, you just can't renew it at interest only for another year or two.
GLYNN PATRICK: But you don't want it.
CEGELSKI: Right, but there has been a lot of tough conversations. Are we going to do step-downs starting on an annual basis or semi-annual, or we were going to amortize the debt? Tell us how we're going to get out of this, or tell us how we're going to get back to being properly margined?
I think the extend and pretend, there probably was some of that at the beginning of this, but it seems like we've been at it forever. No one is putting new land on their bank books, so all those development projects that have stalled, all have a bright focus on them, and they're being dealt with as best they can be. As Brad said when he talked about mark to market, is there even a buyer? Well, we have to re-appraise then. And as George said, 'I just bought this land at a distressed sale, and it was appraised at 50% of what I just paid for it.' So you have all of those kinds of issues, and how do you deal with that?
GLYNN PATRICK: How much longer will interest rates remain low, and how does that impact your business and economic development for communities because you're always looking at different funding?
STECHSCHULTE: We've had, with the last three or four projects we're working on right now, some of the most creative assemblies of financing I've ever seen. And that could be good, and it could be bad, I'll be the first to admit. As the municipality, we've had to look at doing things that we never thought about doing before. When we have a low-interest-loan financing program, it's usually because the private sector is a little bit higher. We can get a little bit more affordable rates, and use our tax-exempt status to get that. We've actually had a couple of projects come forward, even though the bank has actually been competitive or even lower, but the bank has still instructed them to get additional financing because they want the additional leverage. So they like the project and they're willing to put it up to a certain point, even though it's just strange in terms of metrics. It's upside down from what it's supposed to be.
GEORGE GIALAMAS: If they raise those rates at all, we're going to go into the double dip [recession] because it is that fragile right now, with our downgrade. There's enough pressure to raise it, but they can't. Who's going to pay? They're not getting any money now. They have to keep them low.
OLVER: I think they're going to stay low for a while. We know they'll rise over time.
GEORGE GIALAMAS: It bothers me that we can't use this money now. I want to get my hands on it. I'm not going to see this [low rate] again.
BINKOWSKI: On one hand, it's the best of times, and one hand, the worst of times. The uncertainty, obviously, makes it the worst of times. For new construction or new development, new initiatives, it is very challenging. But these low interest rates are a real windfall. We're looking at financing three projects in the next seven months, all of which have loans that were long term that just happened to come due. There's a lot of bank interest in it, and the interest rates that we're seeing, my dad wouldn't believe them because they're lower than what he paid on his first home mortgage when he came home from World War II and bought a house. He always told me, 'You'll never see those rates again.' Well, in fact, we are. Unfortunately, it's not possible to lock them in as long as you would like. We're seeing banks have a real reluctance for five years or less. I'd like to lock in some of these rates for as long as we possibly could, but there's a general unwillingness for banks to commit that long.
BECK-ENGEL: But you add to that the fact that construction costs are lower now than they were probably six, seven years ago, and they're maintaining that. That can't stay forever, either, but people are so hungry, they're just turning dollars over, which is unhealthy. So it adds risk, but right now construction pricing is very attractive. So if there's any optimism at all to build something, now is the time to do it.
GLYNN PATRICK: And we didn't expect that. We actually predicted hyper-inflation. But how long can you lock in materials prices?
BECK-ENGEL: Right now, it varies. It depends on the pressure internationally, quite honestly. I think commodities, like steel and things like that, it's hard to lock in more than four or five months. But if we have a project and we're able to commit to somebody, they'll lock in and we're in pretty good shape. Just a few years ago, it was 30 days at best.
BINKOWSKI: There is the prospect of significant inflation, not because the construction trades are doing so wonderfully here in a period of weak demand, but because of what happens in China, in India, and a lot of other places that are far away from Madison, Wis.
GLYNN PATRICK: What about labor? Again, when we were doing these roundtables five years ago, people were raiding one another, we were trying to figure out how to get high schoolers involved in the trades. Now, after 45% unemployment in the trades, what are your projections for labor in your industry for the next year?
BECK-ENGEL: Right now, there's a lot of capacity out there, not surprisingly. But some people are starting to leave the trades. It's something that you have to be aware of, and we've talked about it a couple times. Dane County has been fairly blessed with a fair amount of construction. There are a lot of cranes in the city. But statewide, that's not necessarily the case, so there are a lot of people coming and chasing the same pie here, and so the slices are getting smaller. The talented people in the trades have kept working, for the most part, but I think everybody, including Findorff Â¦ we've reduced our field force. It's significant. We've started to rebound because we picked up a little work in the last six months, but it's been challenging for people who have made their living doing construction, and they're good at it, and they want to work, and you don't have a job for them. It's very difficult.
GEORGE GIALAMAS: Can I interject, just to ask a question? I'm making an assumption that half the people in your industry, builders and contractors, are either in Chapter 11 or have closed the doors.
BECK-ENGEL: I wouldn't say I've seen anything nearly that high. There are a lot of people at risk, George. We have had our share of subcontractors, trade contractors, go out of business. I haven't seen it in this market at all. I've seen a couple statewide, but not too many general contractors go out of business, and we're worried about it. They rely on lines of credit from the bank, and those are starting to dry up, so how are they cash-flowing their payrolls? The longer this drags on, the more challenging it's going to be for them to stay in business.
GEORGE GIALAMAS: I feel for them, I do. We're fortunate. We've been around a long time, we have a few dollars put away, so we can maybe ride through this. But the newer contractors and newer subs, they're having major problems. And a lot that I've seen, not all of them, but they're being picked on by the banks. The banks aren't working with them, I know that, to come through this. And I know why – they can't. The feds are telling them a different story. They're telling you to push down, aren't they?
CEGELSKI: You're right, George, in terms of how long people have been in business and their ability to weather this current downturn. The two are absolutely related. As you look around this table, the survivors are the long-established companies that have had, as I said before, a strong balance sheet, and less leverage, and liquidity to draw on during these times. I've talked to a lot of developers that said, 'If you had started in business 10 years ago versus 30, you would have been in big trouble in taking the same types of risks.'
GLYNN PATRICK: I'd like, in these last few minutes, to give everybody a chance to make a point that hasn't yet been made.
BINKOWSKI: One of the topics related to sustainability. Stronger projects – projects that operate more efficiently – create value. We see it as just a critically important trend because we're focused on long-term ownership. U.S. Bank is a good example. When we did the modifications to the U.S. Bank, we took a building that was highly problematic and had a very uncomfortable environment for office tenants, and consumed extraordinary amounts of energy, and we made it into a building that now is going to get, we think, a LEED gold certification and has an ENERGY STAR rating of 93. In the process, we saved over $800,000 in annual operating costs. That's the kind of thing that you have to do.
OLVER: Sustainability is not only great for the tenants and the owners of the building, in terms of reducing their operating costs, but it's a great way to put some of these construction workers in the trades back to work retrofitting buildings. So that's a great thing for us to be focusing on. In the short term and in the long term, they're going to see consumers demanding sustainability, you're going to see companies managing their bottom line. That's not a trend that's going away anytime soon.
BINKOWSKI: The federal government really missed the boat, you know, when it created its stimulus spending by not really focusing on creating some more incentives, so they could partner with people that were going to make their buildings more efficient. The city and the state have to look at those initiatives very seriously.
BECK-ENGEL: It is not a passing fad, it's growing, and every project we work on now has some level of sustainability. They may choose not to chase LEED certification because of the cost of doing that, but they're going to do the steps that go into making a LEED quality-like building because they see the long-term value. So it is really becoming the norm of how we do business.
GEORGE GIALAMAS: We've always been LEED certified type of quality, but we didn't want to spend the money on the Marshall Erdman building. It cost me $300,000 just for paperwork. Big deal. We had a grant just for paperwork, to make sure that we're covered on the LEED certification. That's a gold LEED certified building. And I won't spend that again. I know we know how to build buildings. We've been doing it for many years, like you all have, but I don't want to spend that. I don't want to blow money away just to try and get somebody to say it is gold LEED.
ARIS GIALAMAS: In my opinion, it's not approaching fast enough with the money that we put in for that Marshall Erdman building. The market just doesn't satisfy the rents you need to put that kind of green into a building and make the project work. So, yeah, we have been doing LEED certified buildings or green builds the last 15, 20 years. But right now, with the markets the way they are, it's tough. And there is a demand, but it's not where we'd like it to be.
GEORGE GIALAMAS: They're not willing to pay more for it.
ARIS GIALAMAS: Everyone talks about green, but when they have to give you some green, they say, well, it's too much green out of my pocket.
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