Mark Oberholzer
Mark Oberholzer
AIA, LEED AP, Associate Principal, KTGY Architecture + Planning (Irvine)

Roundtable: How is the Southern California CRE development sector dealing with rising construction costs?

Carrie Rossenfeld Roundtable

From SoCal Real Estate’s July 2018 issue

Just when you think development in Southern California couldn't get more complicated, rising construction costs have come to the rescue. The unprecedented escalation of costs has become the new top agenda item in every development project meeting, replacing even regulatory approval time as the most pertinent issue in SoCal development.

For projects to move forward, there is a growing awareness that the right people with the right level of expertise need a seat at the table at the right time. At this moment, it's critical that any development endeavor includes effective preconstruction services. Although preconstruction services can add cost to the "front end" of a project, there is no substitute for the specific costing guidance that keeps a project on track. I'm all for wishful thinking, but a dose of realistic budgeting will help make a project (and its proforma) real.

As an architect, I must mention how important it is to have the right architect to keep a project on track. Designers can't control the cost of construction, but they can work to maximize the value of a budget. How can design create more value with less cost?

In addition to having the right expertise, it's critical that the development team works as a team, in spirit as well as name. The best teams have talent, expertise, and ambition, but they also need an understanding that the intense pressure of cost escalation is a pressure that needs to be shared by all team members in order to keep costs under control.

Many of the specific cost-control strategies we're seeing in the current market, such as prefabrication, modular construction, and project fast-tracking, are critically dependent on a talented team of experts that can function together at a high level. Cost escalation isn't someone else's problem — it's currently the most important factor that warrants creative collaboration among all of us.

Marty PottsMarty Potts
SVP, JLL's Project and Development Services Group (Irvine)

Rising construction costs are not a new challenge plaguing the Southern California CRE development sector; costs have been on the rise since construction began. Although now it's more widespread and sharp.

These days, not only are material costs escalating, the shrinking labor force is causing upward pressure on labor costs. This is compounded by the added challenge of material shortages, which present a risk of schedule slippage, with increased direct general-contractor costs.

To offset the escalating costs to build in today's marketplace, developers are accelerating their construction starts and executing construction contracts early to minimize their longer-term exposure to rising costs. JLL has been seeing an increase in development activity as a result of this urgency. Information is value. On the tenant side, most office tenants have a high-level understanding of the construction industry, but few have a granular view into the costs, putting them at a disadvantage when decision time arrives. JLL recently decided firms considering a change need more precise information and recently released its 2018 U.S. and Canada Office Fit Out Guide, a report that compares buildout costs across multiple office styles in multiple markets. One goal is to give tenants a sense of how seemingly small choices can affect a fit-out budget in a big way.

The best value engineering is done before bid documents are prepared. There is no longer a one-size-fits-all office design concept. Designers work to find the most economical office layouts combining the tenant's culture with efficient use of minimizing materials.

When it comes to construction, maintaining a high level of competitiveness in the bid process will help reduce the costs exposure. But before exposing your plans to the bidding circle, it is best they be thorough and complete, avoiding the need for a compromising re-bid.

Awareness, focus on design, schedule protection, and a sharp bidding edge are key. Any single element will in part help provide some insulation to the radically rising construction costs, but value will be significantly increased if all elements are maintained.

And last, as an industry, we all need to recognize in some part that the current cost acceleration will eventually slow and level off, and what will emerge is the new norm, or baseline, for construction costs in our industry going forward.

Ricka IwatsuRicka Iwatsu
Chief Estimator
C.W. Driver Companies (San Diego)

Rising construction costs are a major challenge facing the Southern California CRE sector currently. One of the most important ways to manage costs and avoid surprises down the road is to plan an accurate project budget from the start. To accomplish this, it's important to involve and negotiate costs with material suppliers and subcontractors as early as possible in the construction process. This also allows you to use subcontractors on a design-assist basis to maintain costs as the project moves forward. The sooner materials and a labor force are secured, the more control you'll have over costs. Consistent communication with the owner and design team is important to manage expectations and discuss cash flow requirements.

There are many approaches to managing material cost escalation during the bid process, one of which is to use an accepted cost index for materials. Subcontractors provide material quotes and the name of their suppliers when bidding a job, and when it's time to buy and install materials the general contractor can reference the price index. If the price increase is minimal, the subcontractor may absorb the change in price. But if it goes up significantly (5-plus percent), the subcontractor likely won't be able to absorb the full increase. If the price goes down, on the other hand, the owner may receive a credit. Who is responsible for what percentage increase/decrease should be outlined in the initial contract, which allows general contractors to have more control of rising material costs and ensures there isn't a "blank check" for materials on the project.