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Roundtable: The Business of Commercial and Residential Building

Posted: May 21, 2013 12:59 p.m.
Updated: May 21, 2013 12:59 p.m.

Lance Williams, Williams Homes

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A perfect storm is beginning to brew on some construction fronts.

Residential construction is leading the way in California. However, rising demand for product, lack of skilled workers and rising cost of materials has new home builders in a crunch.

Commercial building is slowly recovering but varies from market to market depending on space vacancies in retail, office and industrial. These builders say they rarely do any speculative building as the risks are still too high and financing hard to come by without anchor tenants.

For both sectors, the number of construction jobs plunged some 42 percent between 2006 and September 2010. While building has slowly returned, many of those skilled workers walked away for good during the recession – from an industry that always had peaks and valleys. And local experts said the SCV is slowly running out of land upon which to build.

The SCV Business Journal sat down with local building experts to take a look at the local market: Tom Di Prima, KB Homes; Lance Williams, Williams Homes; Dale Donohoe, Intertex Companies; and Jim Backer, JSB Development.

Describe the building activity you foresee in 2013.

TOM DI PRIMA: We’re definitely seeing a resurgence in housing. It started on the coast, and it’s continuing to move forward inland. Clearly, there’s been a dramatic reduction in resale homes.

JIM BACKER: On the commercial side, the only activity that’s happening now is based on need. We’ve seen tremendous growth in the medical office field in this town, including the purchase of several office buildings that are being converted. But I don’t think anybody in their right mind is doing speculative building right now. On the industrial side, I think we’re heading in the right direction.

There’s a lot of tepidness in the commercial markets still.

LANCE WILLIAMS: After about a five-year hiatus, we’re seeing a return of buyer demand to the new home marketplace. Certainly, we’ve seen a big turnaround in our markets. Housing typically leads the economy, and when home construction is active and healthy, commercial usually follows immediately thereafter.

DALE DONOHOE: For office construction, building is nonexistent. If it’s in the mid-teens, it’s very soft. There’s no way a builder can justify building a new office.

For retail space, we’re seeing some signs of building in specialty retail. The medical market is very hot right now. We’re the general contractor for the old Newhall Land & Farming building, and it’s being repositioned from office space into medical space.

Project the growth rate for the rest of the year.

BACKER: Commercial is still recovering; it needs to absorb space. We’re extremely dependent on employment, and without growing employment rates, people don’t need space.

On the industrial side, the local market is strong. It’s still relatively large – it’s just going to take us some time. Leasing rates have to go up at least 15-20 percent in order to justify development. That’s at least two years away.

DONOHOE: Nationally, retails are growing 25 to 30 percent, and office is growing 30-35 percent.

We’re in a good position right now for housing, but we’re about three to five years away from where people want to be to jump into commercial building on a speculative basis.

WILLIAMS: Our industry was down 85 percent from average historical rates. So it doesn’t take much to show recovery. The numbers on new home starts will probably be triple what they were this year, but it’s still not a big number from historical rates.

The biggest challenge in California and in Santa Clarita is still the fees. Impact fees are structurally out of balance, and we haven’t been successful in getting local leaders to reduce them. It’s easy for them to raise them – they do that all the time. But it’s a structural problem that will hold back this valley in competition against other markets.

DI PRIMA: We’ve seen substantial growth from where we’ve been, but that growth is minute compared to where we came from. We built housing at levels that are probably the lowest we’ve seen in many decades, so we’re undersupplied.

In other downturns, it’s seemed that where one market falls, another market surges. This is the first downturn I’ve seen where every state, with maybe the exception of one or two, crashed.

So the numbers are multiplied 10-fold. Everybody stopped doing everything. In a few years, we may see ourselves in a new crisis: an undersupplied market.

Is lack of inventory for new homebuyers in resale market driving demand?

ALL: Yes.

DONOHOE: We have existing inventory that needs to be absorbed. You can either buy something that is cheaper than what you’re building for, or you can lease cheaper than what you can build for. Until that existing inventory has been exhausted, nothing can happen. Because our topography in Santa Clarita, as well, there aren’t many sites available for commercial – very few, if any, sites are available. Land is a huge hurdle for commercial building.

What kind of long-term development do you see in the SCV?

DONHOE: On the industrial side, we have three projects that are nearing completion, so you’ll have land available. So industrial vacancy rates are very low, and prices will have to start increasing. Trying to find zoned, usable commercial property for retail is extremely difficult.

BACKER: I think they’re starting to feel the pressure of it going up, but I think it’s been relatively flat. People have been holding the line. Eventually these buildings are going to get filled. And I’d like to see it happen in the next couple of months, but it could be a couple of years.

DONOHOE: Industrial rates have been relatively flat for the last 10-12 years. The only thing that kept developers going was cap-rate compression, so you could get more value out of the same rent. And even though costs went up, the cap-rate compression came down even further, so you created more value even though you had the same rental rate.

I’m not sure if rates are going to go up, but you’re still seeing industrial rates in the 55-65 cents per square foot range. We were quoting that back in the 90s. The only thing that’s changed is we used to sell those buildings at cap rates.

BACKER: The other thing that’s driven the growth of this valley for the past nine to 10 year is the individual business owner has been able to buy their building and been able to lease it themselves – they lease it to their company. Because of the interest rate environment that we’ve been in, that mortgage has been typically cheaper than a rent. That’s made a big difference.

During the recession, those same business owners hit liquidity crunches and needed to sell those buildings just to get some liquidity out of them. Their business is what they needed liquidity for, and that’s tough.

DI PRIMA: Another challenge on the commercial side is business owners are looking for a different style of building, and business owners incur the construction cost for converting an office. There are telecommuters, Google-style offices, no walls, no cubicles. I’ve seen some very beautiful office property that can’t lease, and I’ve seen some stuff that should be torn down – but it’s being picked up by the Google guys, who are camping out to get into it. Maybe it’s because the old-style courtyards or the office outside – it’s changing things. We definitely feel it on our side.

Do you expect new home prices to continue rising?

WILLIAMS: We have seen prices increase this year, and we’ve seen it in our phase releases. The prices are finally on board.

We had trouble with appraisals last year, because appraisers didn’t want to see them increase, but this year, the appraisers are on board. We’re seeing phase-over-phase price increases. And lots are difficult to replace. You want to be careful how you price and sell them because you may not be able to replace them for some time.

DI PRIMA: We have seen two things consistently: the demand for bigger housing is coming back. We’re always trying to follow what the consumer is asking us to do. The trend was more affordable housing, and it’s now moving toward larger homes again.

It’s getting very difficult to replace what you have, so you have to make sure you’re maximizing the best you can. I think that’s going to lead us into where we’re heading. Second, we need to see more appreciation and values for the next group of land that’s going to be worked. The market has seen a slow evolution of homes and appraisals moving up. The reality is, if prices were to go all the way to where they peaked in 2006, today that home would be about half the cost because of historically low interest rates.

WILLIAMS: You combine those two effects, and what you get is an affordability index where half the median priced homes can be purchased by 50 percent of the people in this market. That number has never been that high in my career. It is really an extraordinarily good time to buy a home if you have job security.

Is financing still tight? Is the cost of materials an issue?

WILLIAMS: Financing for our buyers is still challenging, but it can be done. It’s a difficult process, but you can get the loan. Once you get that loan, as a homebuyer, it’s the best loan you will ever see. It’s 30-year fixed, at 4 percent. Those numbers are extraordinary. It’s a difficult process, but we can still get our buyers through that process and get them into a home.

As far as cost increases, we’re still seeing that in material, including lumber.

As skilled workers get more work, will they start increasing the prices?

WILLIAMS: Yes.

DONOHOE: The guys that did make it are getting more work (during the recession); their prices are going up a lot more than the consumer price index. When there’s only a few guys left, they can choose their rates or drop the job because there are other jobs available, especially after five years of struggle. We only have so many skilled guys to go around, and we are going to choose the jobs that make money for us. Construction is definitely going up, even if material prices are staying the same.

DI PRIMA: When things get busy, builders start to realize I’m cash flow positive, but I’m negative on profit. The theory that you can make it up on volume isn’t true – you’ll go bankrupt faster. More guys actually fold when it gets good than when it gets tough because that’s when it catches up. At some point, you have to instill that back into the people that are left before you hire new people. They’ve gone into a different industry, and they don’t want to come back. And there’s the issue of a sustainable, trainable workforce for when things do improve.

DI PRIMA: It always depends on job growth. We’ve seen what we think is exciting job growth, but it’s still at historic lows. We need greater growth. That’s clearly the greater challenge.

Is housing the start of the job growth or the result of job growth?

DI PRIMA: One of the things that clearly became evident during this last downturn is that we don’t manufacture very much anymore in the U.S. Housing is one of the last things that we still manufacture. So a lot of these kids, who are very bright but aren’t school driven, wanted to go into different careers. They used to have manufacturing, and when housing went away, they really had nowhere to go.

Is anyone in the industry advocating for renewed focus on occupational training?

DONOHOE: It needs to be more of a cultural change. For the last 20-30 years, college has been the focus. It’s really put a negative spin on trades people. College is not for everybody. Right now, we need to focus on getting back to shops, and learning a trade, which I think they’re starting to do.

We just need to change that perception. There are some people that are perfectly suited to do trade work, and there’s nothing wrong with that. There are advocacy groups that push that perspective.

BACKER: A lot of people have given up on the real estate and construction industry. One of my biggest concerns is the regulatory atmosphere is beyond reasonable, and we continue to get the brunt of it. The public doesn’t realize how out of balance it’s become. People don’t want to locate in California. I’m not resentful, but people need to realize how out of balance we’ve become. It’s because of the regulations, the cost and the expectation that business should pay for everything. That is the biggest concern because we can’t run from that in Santa Clarita.

California is a great place. But we are not in balance at all with the cost benefit analysis of regulations. If we don’t get that back, more and more people are going to leave.

What does it take to change that?

WILLIAMS: The final number for Santa Clarita building permits is $70-80,000, and you’re looking at that for a $300,000 home. There are some lots that we can build on now. Those are some lots that people have already lost money on. We can build on those now because the prices are a little bit better.

It’s because the fees are just crazy. Now the prices are down 50 percent, but your fees are still through the roof. We can try to get them to reduce it by one dollar, but there’s no resonance there. It’s a real challenge.

BACKER: People still have this view that their land is valuable. And their land is not valuable at all unless it has its entitlements for some development, and that’s only the first part. Because then you’ve got to make sure of everything.

I don’t think a lot of people are going to bring most of this undeveloped land to fruition. Land takes all the hits – every cost, every regulation takes the hits. It goes against the land. You could argue land takes all the benefits when the value goes up, but it takes all the hits.

DONOHOE: The process has become so long and arduous that it’s just not worth it. The times when we’ve got burned is when we tried to take raw land to finished product, and we got stuck somewhere in the cycle. You don’t know when you can deliver the deal. And the rules have changed so many times, and the costs keep going up. You can’t predict where your revenue is going to be.

We’re not building spec anymore. First of all, you can’t get the financing anymore. Second of all, you’re a fool if you do because you just get caught in the middle.

Financing is great for commercial. As long as you have your tenant, their rent will pay the mortgage, and you can get a really attractive loan. But they won’t even consider loaning on anything speculative.

Why do you stay in the business?

WILLIAMS: Building homes is a wonderful business.

BACKER: It is a great business. It is a chance to take on enormous complexity and try to make something great. And hopefully, you benefit your community and make some money along the way. There’s this perception that we’re all just loaded and made of money. In the good times, you can do very well, but in the bad times, you have to be able to thrive until things come back.

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