Category: Real estate news

Multifamily Construction Costs: An Investor Guide

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By Christpopher DeSantis, DeSantis Property Management

For the past 8-10 years, Pittsburgh PA has been experiencing an apartment building boom. Every single year since 2017, at least 2,100 new apartment units were added to the city’s existing stock, either by new constructoin or conversion of an existing building of another use. Yet despite the rash of new multifamily complexes,a recent CBRE report  ranks Pittsburgh at the bottom for cities with new apartment buildings.

At the same time, CBRE also ranks Pittsburgh as #4 among the smaller tech markets in the United States. CBRE’s Scoring Tech Talent report shows that the city has bright prospects for tech industry job growth and economic impact. Factors driving the growth are cheaper apartments, shorter commutes, and affordable living costs.

The implication is that Pittsburgh will become even more attractive to workers and businesses seeking new opportunities. For property investors contemplating a new apartment complex in Pittsburgh, there could not be a better time. As DeSantis Management explains, the relative shortage of apartment buildings and impending population growth makes this a potentially highly profitable proposition.

But what would be the likely cost of such a project?

What to expect when building a multifamily complex

The biggest obstacle when building a multifamily complex is multiple cost issues. The first of which is increasing prices. Building materials prices have been going up and are likely to continue rising. But the problem of heightening costs is not limited to building materials. There are three main areas of rising expenses:

1.              Regulatory compliance

The National Multifamily Housing Council (NMHC) estimates this as one of the primary costs when building a multifamily complex. Regulatory costs can take up a whopping 32% of the overall costs.

2.              Construction materials

Increase in prices of building materials following the outbreak of the pandemic has been unprecedented. Along with higher costs, there is continuing scarcity of the most vital building materials.

3.              Surging labor cost
The construction industry has always had labor shortages. But this has been exacerbated by the mass retirement of the mostly aging labor force due to fear of Covid-19. The result is higher labor costs.

Estimating your construction costs
The other cost problem is getting an accurate estimate of construction costs. In the early stages, you want a simple guesstimate of what the project might cost you. That will usually depend on the price of similar projects in the area within the last year or two. But this costing barely provides ballpark figures which serve as a general guideline.

That initial costing helps in deciding the feasibility of the project. Once you determine that the project is within the affordable range, you need a professional construction cost estimator to create a detailed budget estimation. It is expensive but necessary; failing to do it at the start of the project could set you back tens of thousands of dollars later.

The two primary costs in a multifamily building project
Your costs for the multifamily project will be divided into hard and soft costs.

Hard costs
These have to do with the physical construction of the building. They are mainly tangibles; foundation works, roofing, landscaping, appliances, and labor costs. They do not include land acquisition costs.

Soft costs
These usually include design costs, permit fees, legal fees, loans fees and interests, and other similar expenses.

On average, you can expect hard costs and soft costs to take up 37% and 24% of your total expenditures, respectively.

Sample of a typical multifamily project construction cost
Costs for multifamily buildings are estimated per square foot, and they increase with the number of units in the building. Buildings with less than six units cost less than mid-rise buildings, which in turn are less more than high-rise buildings. Whether the project is a luxury, mid-range, or builder-grade apartment will also affect construction costs.

Construction costs do not commonly include land acquisition costs, architect fees, parking lots, landscaping, and interior design. Expenses will also vary vastly between the least and most expensive markets. Furthermore, around 15% of the building’s total square footage will be unusable spaces like lobbies, common areas, and elevator shafts.

Here is a rough guide of what your costs will be like:

·               Land acquisition and, possibly, demolition costs: 19%.

·               Commercial architect fees: $125 – $250 per hour.

·               Contractor fees: It ranges from $85 to $200 per square foot. The average price is $125.

·               Mason, excavator, and carpenter fees: $70 per hour.

·               Painter’s fees: $20 – $35 per hour.

·               Electrician’s fees: $65 – $85 per hour.

·               Plumber’s fees: $45 – $65.

·               Average cost per square foot of apartment building: $85 – $400. The average price is $229.

·               Average cost per unit: $64,500 – $86,000. That includes the cost of appliances, finishing, and energy-efficient doors and windows.

Average costs per unit vary widely. In markets like San Francisco and Los Angeles, where the price per square foot is around $330 and $500 respectively, cost per unit can get as high as $352,400. In Pittsburgh, however, $75,000 per unit is a reasonable estimate.

DeSantis Property Management is a Moon Township-based manager of multi-family properties throughout metropolitan Pittsburgh.

Construction Economic Rebound in March: Vaccines, Jobs, and Manufacturing

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Good Friday began with good news from the labor market. The monthly Employment Situation Summary was released by the U.S. Census Bureau and it showed that employers had added 916,000 jobs in March, the largest increase since August 2020. The gains in employment were spread across the spectrum, with the largest increases in hospitality (280,000) and construction (110,000). Unemployment decreased to 6.0 percent, with 9.7 people unemployed. That’s 4 million more unemployed than at the peak in February 2020. A total of 8.4 million fewer people were working in March 2021 compared to February 2020, meaning that 4.4 million people are no longer in the workforce. Although a portion of those who left the workforce have retired, the largest share of those out of the workforce (most of which are women) are likely to need to be re-employed once the slack in the economy has recovered. The three-month average for job creation suggests that the pace of hiring is accelerating rapidly but would need to continue for 15 months to two years to return to the same level of employment that existed pre-pandemic. Should the March pace continue, that level would be reached at the start of 2022.

Whether the March pace continues is largely a function of how quickly vaccines can be distributed to herd immunity and how well the virus spread can be contained. The current trajectory for vaccination indicates that vaccine supply will outstrip demand in May. The pace of virus spread, however, suggests less optimism. Infections are growing at an alarming rate in northern and midwestern states that have relaxed limitations on public gatherings. In virtually every one of those states there have also been an decline in mask wearing, even though mask requirements have not been removed. The economic progress that has occurred in February and March is likely to be stalled in April or May if the pace of infections remains on the current trajectory. That’s not a prediction so much as an observation of similar periods of relaxation and COVID fatigue that occurred in late summer and during the holidays. COVID-19 has proven to be easy to forecast, with very consistent outcomes following increases and decreases in infections. The good news in spring 2021 is that vaccinations should shorten whatever spike occurs and the economic momentum should rebound quickly if a slowdown follows in the coming month or two.

New hiring increased again in March following the holiday slowdown.

There were other reports on the economy’s rebound this week. On April 1, the Institute for Supply Management (ISM) said its index of national factory activity jumped to a reading of 64.7 last month from 60.8 in February. That was the highest level since December 1983. A reading above 50 indicates expansion in manufacturing, which accounts for 11.9% of the U.S. economy. Economists had forecast the index rising to 61.3 in March. The survey’s manufacturing employment gauge shot up to its the highest reading since February 2018. The ISM survey also found significantly more firms hiring than not. The outplacement company, Challenger, Gray & Christmas, showed planned layoffs by U.S.-based companies dropped 11% to 30,603 in March, the fewest since July 2018. Through the first quarter planned layoffs plunged 35%, compared the October-December period. At 144,686, job cuts last quarter were the fewest since the fourth quarter of 2019.

Industrial construction in Washington County was boosted by the start of construction of HW70, a 28,200 square foot spec warehouse in Bentleyville, and Aragra’s new 50,000 square foot facility in Starpointe Business Park. W. K. Thomas & Associates is building the Aragra facility. Rycon Construction was the low general contract bidder at $11.5 million on the $17.5 million Hillman Library Phase 3 at Pitt on Wednesday. TEDCO was successful on the new $2 million PNC branch on Broadhead Road in Moon Township. Arco/Murray Construction is taking a 35,000 square foot expansion and renovation of Frito-Lay’s facility in Thomson Business Park through the entitlement process Cranberry Township. Jendoco Construction started work on the $10 million Distillery on the South Side. Two multi-family projects got underway in March in the city. Elford Construction started work on RDC’s $60 million 334-unit Brewer’s Block Apartments and PMC Property Group began renovating the Allegheny Building into 177 apartments. Continental Building Co. started construction on the first 78,000 square foot building at Elmhurst Innovations Center.

Hot Housing Market – No Bubble in Sight

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As 2020 ends, the star of the construction industry is clearly the housing market. New starts are up and home prices have soared over 15% year-over-year. The hot market has started to raise fears of an overheated market, but there is no evidence of anything like a bubble forming. In fact, the basic economics suggest that the hot streak will continue.

Price appreciation is being driven by a home inventory that has been steadily shrinking for five years or more. Too few empty nesters are selling their homes and new construction has been (and is) constrained by limited availability of land and lots. Demand for homes has been increasing as the Millennials buy homes at a brisker pace. And COVID-19 accelerated all these trends by the increase in work-from-home and the time spent sheltering at home since March 2020. Other factors, like home sizes increasing again and a surge in remodeling, have also pushed up prices. What hasn’t pushed prices is a surge in speculation such as we saw from 2003 to 2006.

Wells Fargo Economics Group pushed out a great commentary on the housing market yesterday. While it looks forward to the market in 2021, the commentary also contrasts today’s conditions with those of 2007, when the bubble burst and left millions of people in economic ruin. One of the points Wells Fargo highlights is the difference in lending environment between the two periods:

“Perhaps the greatest difference with what was seen in the bubble years is the greater discipline on the part of lenders. Mortgage underwriting tightened at the onset of the pandemic and remains fairly tight today. The average FICO score for conventional mortgages originated for the purchase
of a home was 758 in November, according to Ellie Mae.”

As context, the average FICO score in 2006 was around 630, although the median score was above 700. In 2006, it was also commonplace to find lenders that didn’t require income documentation and that lent 110% of the value of the home. There was no real credit justification for those kinds of practices but the robust annual price appreciation was a rationalization that all but the most disciplined accepted. Today’s appreciation levels are nearly equal to those of the bubble years, but the driver is real demand squeezing supply. Prices may level off or back up in the next few years. Father Time is undefeated and Baby Boomers will sell their family homes at some point. That should lead to an increase in supply that will soften prices. That trend may also unfold slowly,  meaning that increased demand will keep up with the inventory growth. But, as long as lenders underwrite loans with the intention of being repaid, the supply and demand dynamics aren’t going to bubble over.

That’s great news for an economy finding its footing for recovery. We saw how a damaged housing market can drag recovery down from 2009-2014. Assuming the vaccination proceeds as expected, we’ll see a housing market that leads recovery in 2021.

Read the full Wells Fargo commentary here.

Some Insight on Downtowns During COVID-19

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Don’t read any further if you are looking for insight into the office market or long-term migration trends in or out of cities. We don’t know yet. We won’t know until COVID-19 is no longer a public health threat. (If you’d like to read what some smart people think about the office market, read the feature article in the Fall DevelopingPittsburgh.)  After six months of data, however, it’s possible to begin to see the impact on commercial real estate located in downtowns. Wells Fargo Economics Group published research on the debilitating impact of the pandemic on central business district (CBD) businesses that is worth a read.

The upshot of the report is that occupancy in downtown workplaces is so much lower that the ripple effect is reaching wider than most of us think. It’s easy to understand that bars, restaurants, and hotels will be hard hit by the lost traffic due to work from home. Travel is picking up slightly but it does not appear that the uptick is being felt in CBD hotels. The impact on apartments is more derivative. Downtown apartments are popular for a variety of reasons but central to their appeal is the proximity to work. People who rent apartments are willing to pay a bit more for a downtown location. With work from home rendering the proximity attraction null and void, it appears people are choosing to move to the suburbs to save a few bucks or get more space for the buck. I don’t have any local data to see how that’s playing out or not in Pittsburgh, but the chart below show the sharp divergence in trend for suburban vs. urban apartment vacancy.

Pittsburgh’s downtown has been impacted like most major metropolitan areas. Commercial office brokers estimate that buildings are at about 20% of the normal occupancy. That means most workers aren’t coming into downtown (NOT that there is an 80% vacancy rate!).Until that changes there will be no recovery to normal for hospitality businesses. The lost traffic for restaurants and hotels translates into lost revenue for parking garages, and has a significant drag on revenues the city collects. Lost nights in the Cultural District magnify that ripple effect.

There is no silver lining if you are operating in one of those businesses being hard hit by the drop in demand. The only upside comes after a medical solution to the virus is widely-distributed. Notwithstanding idle speculation about some shift in where people will live/work/play, downtowns will be attractive for the reasons they have been attractive since the Middle Ages. It’s a question of when not if.

One of the winning sectors in this losing economic moment has been the industrial warehouse sector. Driven by spiking online shopping, the demand for distribution space has jumped by double digits in 2020. That’s showing up in permits around Pittsburgh. Last month Al. Neyer started work on a 400,000 square foot build-to-suit distribution center at Clinton Commerce Park in Findlay Township and a 150,000 square foot warehouse at the Hempfield Commerce Center in Westmoreland County. Also in Findlay Township, Buncher started work on Neighborhood 91, the advanced manufacturing campus being developed on behalf of Allegheny County and University of Pittsburgh. The first building is a 44,000 square foot multi-tenant facility that will be anchored by Wabtec. In other construction news, Rycon Construction has started work on the $6.5 million adaptive re-use of 2400 Smallman Street, which will be home to Pro Bike & Ride. MBM Contracting is doing the $3.1 million AGH pathology lab renovation. Omega Building Co. is renovating the space above Nakama Steak House into 23 residential units, a $4 million project. Sota Construction is general contractor for the $3.6 million renovation for the new office/studio for Headwaters Films in Bloomfield.

CORRECTION: The Oct 22 post (The Case for Getting the Stimulus Done) incorrectly listed DiMarco Construction as the contractor for Robinson Township’s new $3.8 million police station. The general contractor is Masco Construction.

The Case for Getting the Stimulus Package Done

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Congress and the White House seem to be ready to get a second major economic aid package done (or not). I have to admit that I don’t understand the politics of this latest round of stimulus talks. An unpopular sitting president, struggling in the polls, would normally be cheerleading a bill home that put thousands of dollars in the hands of voters in the last weeks before an election. But these aren’t normal times. This morning’s press conference by Speaker Nancy Pelosi characterized the negotiations as “just about there,” which gave Wall Street a boost after a brief plunge this morning. The S&P 500 fell 20 points by 10:00 but is now up 17 points from yesterday’s close. Reports from the Senate are less encouraging. Majority Leader McConnell is reported to be against passage of any aid ahead of the election, fearing it will limit Republican leverage in the event the Senate flips to a Democratic majority.

The best case for the stimulus came at 8:30 this morning, when the unemployment claims report for the week of Oct 17 was published. The good news: first time jobless claims fell under 800,000 for the first time in a while. The bad news: total unemployment insurance claimants have fallen by less than 8,000 since Oct. 3. The total number of people receiving unemployment claims was over 23 million.

Setting the politics aside (since politics will not feed the family or pay the rent), the need for more aid is clear as a third increase in infections and hospitalizations washes over the U.S. Doctors and researchers are still learning about COVID-19 but what is abundantly clear is that it will continue to drag down the economy until a vaccine is found. Because the opinions about how to deal with the outbreak have become politically polarized, a central economic reality has been glossed over. That is, that the steep decline in demand for services in major sectors of the economy is due to consumers avoiding those sectors to avoid the infection. Marker posted an excellent article about this demand shock. It’s not shutdowns that slowed the economy. Consumers have shown they will be wary, regardless of the government’s position. The best example of this is Sweden, where the official approach has been to allow the virus to move through the less vulnerable population to achieve herd immunity. Sweden’s GDP declined 8.9% in the second quarter without lockdowns. Its neighbors, Finland and Denmark, saw decline of less than 6%, even though they imposed short-term lockdowns and guidelines like mask-wearing and limited gatherings. A slower economy seems inevitable until a medical solution is found. Government aid for those impacted the most will help keep a floor under the economy until then. Absent such aid, evictions and foreclosures will begin to spike. What follows that is a double-dip recession. At this point, there aren’t any fiscal conservatives left in Congress. Moreover, there are some compelling cases made for the efficacy of borrowing money at near zero rates to stimulate growth above 3% again. Fiscal policy can tighten once the corner has been turned.

At the regional level, while unemployment in Pittsburgh is higher than most of its benchmark cities, the real estate market is recovering. Residential real estate has, in fact, seen growth across the board, with the exception of apartment construction. Sales of homes and home values have risen sharply. New construction of single-family homes is up over 29% year-over-year. New multi-family projects have fallen off last year’s pace. Through nine months, there were only 785 new apartments built in Pittsburgh, compared to 1,459 during the same period in 2019. Commercial real estate is beginning to reawaken as well, particularly in the industrial sector.

In construction news, Pittsburgh Glass Center took proposals from A. Martini & Co., Dick Building Co., A. M. Higley, and Massaro Crop. for its $6 million expansion. Burchick Construction is doing a $3 million build-out for Oculus on the 3rd floor of Schenley Place. Burns & Scalo Real Estate is building out a $12 million research space for Hillman Cancer Institute and a $4 million wet lab space for NeuBase at The Riviera. Al. Neyer was selected to build the second 60,617 square foot building for Elmhurst at the Heights of Thorn Hill. DiMarco Construction was awarded the general contract on the $3.8 million Robinson Township Police Station. Allegheny Construction Group is CM for the $4 million Jefferson Hospital chiller replacement. BJ’s Wholesale Club is taking bids on two 100,000 square foot-plus new stores in Ross and South Fayette. The $33 million New Kensington Wastewater Treatment Plant Upgrade is due Dec. 8.

 

Pittsburgh Office Market: Focus on Data – Not Speculation

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Earlier this week, JLL issued its Skyline Report, which got a bit of media play, particularly in the doom-and-gloom Pittsburgh Business Times. JLL’s report highlighted concerns about the surge in sublease space and the media emphasized JLL’s opinions about the impact of tech work-from-home on future office demand and the uncertain future of office because of WFH. These concerns are legitimate. If WFH becomes another trend that leads to downsizing of office usage by even 10%, it will add five million-plus square feet to the vacant inventory. That stuff makes for good headlines and click bait. The problem is that we have no idea when we’re getting out of this pandemic, let alone what things will look like on the other side. The better course is to look at the data.

JLL’s headline data point, a vacancy rate near 20%, is not comforting either, but it’s only marginally higher than 90 days earlier. Newmark Knight Frank released its thrid quarter reports today, and the data is similar. According to NKF, the overall vacancy rate moved from 17.9% in July to 18.5% in October. The more troubling trend is the year-over-year decline of 2.2 points. New construction deliveries of a million square feet were the main reason for the jump, with lower occupancy having a small impact. Rents held steady, rising three cents to $24.10/square foot. Rent is a lagging indicator, however, and the likelihood is strong that rents will fall as leases renew during the next 12 months. One interesting view of the NKF data is the stability of the market overall. Occupancy is above 80% for almost all submarkets. The east market is an outlier to the downside, with vacancies at 26.5%, and Oakland/East End vacancy is the outlier to the upside, at 11.8%. These two are the smallest submarkets by far, at just over three million square feet each. The remaining suburban and urban markets are between 16% and 18% +/-.

Vacancy has been growing in Pittsburgh since mid-2019. Source: Newmark Knight Frank

Office occupancy is a function of employment. Until there’s a medical solution to the COVID-19 virus outbreak, employment will be significantly lower than in February 2020. At last week’s meeting of the Federal Reserve Bank, the governors looked forward to unemployment staying below eight percent at year’s end and a steady decline in unemployment that returned to the four percent range in late 2022 or 2023. It won’t take that long for office occupancy to tick back down in Pittsburgh, but it’s worth remembering that 1) Pittsburgh’s office market was much softer in February 2020 than in February 2017, and 2) the speculation about declining office demand because of COVID-19 response is not unfounded.

The Fed’s observations about the economy were made before the Trump administration walked away from negotiations over a third major economic safety net package. The House of Representatives hurriedly passed a $1.3 trillion bill last week that was set to provide direct aid to households, additional assistance to small businesses, and funds for state and local governments, which have seen their revenues decimated. Aid for local government is particularly critical to the economy, according to the Fed. The bill contained a number of non-economic provisions that the Senate was not likely to accept but there was the basis for negotiations to continue. Reactions to the president’s shutdown of negotiations have been strongly negative and the White House today hinted that discussions had re-started. That would be good news. Fed Chair Jerome Powell cautioned in the FOMC minutes that the risk from providing too little aid was much greater than overshooting government intervention, especially since inflation remains well below two percent. Absent more assistance, the economy is expected to remain in declining GDP growth through the winter.

Regional construction activity has begun to pick back up, with more bidding and RFP’s out. Carlow University is looking for developers to partner in its proposed 400,000 square foot research/mixed-use tower in Oakland. Cavcon Construction is starting work on a $4 million-plus Education and Tech Center in Indiana PA for Westmoreland Community College. New-Belle Construction was awarded the $4 million new manufacturing facility for Barchemy in Donora. Facility Support Services was awarded $2.7 million in contracts for renovations to the Dept. of Energy National Energy Technology Lab in South Park. PJ Dick is the contractor for $3 million in renovations to Aramark concession areas at PPG Paints Arena. A separate $1.5 million package of renovations for Rivers Casino at PPG Paints is out to bid to Mascaro, Massaro, and PJ Dick. Turner Construction is doing preconstruction on the $35 million AGH Neurology Center for Excellence.

Pittsburgh Planning Should Approve This Project

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On September 15, the Pittsburgh Planning Commission will again hear from JMC Holdings about its plans for a $200 million mid-rise office building proposed for the for Wholey refrigerated warehouse site. The project , 1501 Penn Avenue, is a 525,000 square foot office building, with 12 floors of offices atop a podium that includes parking and retail. JMC has worked with Turner Construction on preconstruction, although the project is expected to eventually bid to Turner, Mascaro, Rycon, and a PJ Dick/Dick Building Co. joint venture.

Rendering by Brandon Haw Architecture

When the geometric 21-story structure was first revealed to the public earlier this year, Mayor Peduto panned the design and the Planning Commission was lukewarm about the project. One of the principal concerns is the building’s height, which will be roughly twice that of the next tallest building, the Penn-Rose Building one block east. The 1501 Penn project presents the city with the perfect opportunity to transition what is Pittsburgh’s second-hottest office market (and the one with actual land on which to build) towards Downtown. Real estate professionals have considered the Strip District to be the fringe of the Central Business District for a while now. The Pittsburgh Downtown Partnership includes it in its description of the Greater Downtown. If the vision of developers matches the demand from Pittsburgh’s emerging technologies, the Strip could ultimately look like what Fifth and Forbes are becoming in Oakland – blocks of 10-15 story tech “towers” that put thousands of well-paid people in proximity to the city’s center. The image above shows the glass tower rendered in the context of the 1500 block of Penn Avenue, with Downtown beyond. Its location does not threaten the character of the Strip’s iconic retail blocks to the east and provides a reasonable first step towards denser, taller construction between the 16th Street and Downtown.

Wholey’s warehouse

For those concerned about the cold, symmetrical architecture, let’s remember what building will be replaced by 1501 Penn (see above).

If your argument is that the project is overly ambitious for the times or the market, I understand. That’s the call the developers and their investors get to make, however. The same argument was reasonably made about Bakery Square in 2009. That turned out rather well. Like 1501 Penn Avenue, Bakery Square was the latest in a series of attempts to redevelop a legacy building that was unworkable in the 21st century. Bakery Square was also started during the depths of the Great Recession. The Wholey’s warehouse has been proposed as a telecomm center, apartments, condos, and offices over at least two decades. The structure is poured concrete. The concrete is meant to act as one of the insulating materials so the walls are extremely thick. It simply won’t be re-purposed within the bounds of economic sense. If JMC and its investors see a diamond in the rough, I hope the City of Pittsburgh allows them to polish it. The city may no longer need to offer enticements to attract developers like JMC Holdings from New York, but Pittsburgh isn’t Seattle. Planning Commission would do well to remember that we’re still the pursuer, not the pursued. JMC isn’t proposing a chemical plant, just a place where 1,500 or so people will work. After the obstacles that were put in front of McCaffery Interests for five years to make development of 1600 Smallman and the Terminal Building possible, it might be a good idea to put 1,500 customers one block away. How do you think McCaffery feels about the vision rendered below? Seems like the occupants of 1501 Penn Avenue might like having those lovely lifestyle amenities close by.

Rendering by Studio 97.

1501 Penn Avenue can be another linkage between Downtown and the burgeoning Strip District. The Downtown market has gotten softer in recent years. Allowing the Strip Dictrict to become more like Downtown will make for better connections and better rationale for renting Downtown. Planning Commission should let the rising tide continue.

Another interesting project on the agenda for September 15 is the Uptown Tech Flex development proposed by Westrise. The former commercial laundry on Jumonville Street will be converted by Omega Building Co. into a 63,000 square foot office/lab/shop for emerging tech companies. The property type is suddenly a hot item and the Uptown Tech Flex project is located about midway between Oakland and Downtown, just a block from the route of the Bus Rapid Transit (BRT). You can view Desmone Architects’ design at the Planning Commission’s website. The Westrise development is one more private investment that is slowly bringing Oakland and Downtown together, with Uptown and the Hill District standing to benefit. You can only imagine what might occur in this neighborhood if the BRT was running.

Healthcare Construction Update

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One of the reasons the Pittsburgh construction market looks weaker for the next 12-18 months is the uncertainty in the healthcare market. Just two years ago, the major programs at UPMC and AHN were going to bring billions of dollars in construction projects to the region from 2019-2022. Some of those projects were being pushed back already (UPMC Heart & Transplant, UPMC Shadyside/Hillman were probably 2021-2022 starts at best), but the financial stress caused by the COVID-19 pandemic. If you want an in-depth look at what’s going on in the healthcare market in Pittsburgh (and beyond), the July/August BreakingGround dropped this week. Check out the feature.Earlier this week, AHN presented the updated institutional master plan for West Penn Hospital to Pittsburgh Planning Commission. Among the major highlights of the ten-year plan were a $100 million outpatient/medical office, a replacement for the Mellon Pavilion, and a 450,000 square foot inpatient tower. Along with the inpatient tower, a 100,000 square foot inpatient infill project will be built, an investment of $300-400 million for new or expanded inpatient facilities. AHN’s other major project on the boards is the $300 million cardiovascular tower planned as a vertical addition above the new cancer center (see cover above) at Allegheny General Hospital. No schedule has been set for construction but CM proposals are expected to be sought this summer.

Following up two projects that had been bid earlier in the spring, PJ Dick is doing preconstruction services for The Watson Institute’s $9 million expansion in Sewickley and Evans General Contracting is building the 250,000 square foot global distribution center for Komatsu. That’s being developed by SunCap Property Group at the Alta Vista Business Park in Fallowfield Township, Washington County. That’s a big win for Mon Valley Alliance and Washington County.

A Tale of Two Overlooked Trends

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With two full months of pandemic mitigation under our belts, we are finally beginning to understand the secondary effects of the health crisis. Here are a couple of derivative financial impacts to consider. Unlike previous recessions, the peculiarities and uncertainty of the COVID-19 pandemic are creating unusual stresses on primary care medicine and bankruptcy. As the divergence grows between the health of the stock market and the health of the underlying economy, the shutdown is impacting each of these in an exceptional way.

The fact that there are likely to be a dramatic increase in bankruptcy filings is not unusual for the coronavirus-induced recession. Recessions create different winners and losers. Sometimes it’s just bad luck or timing for a firm that was doing well prior to a downturn. Regardless of the reasons, the steep reduction in business and disruption of credit that accompany recessions results in businesses having to declare bankruptcy. For many of those firms, the bankruptcy allows for reorganization and forbearance that leads to recovery, and ultimately to creditors being repaid. In many cases, the act of filing bankruptcy motivates creditors to reassess their positions and the bankruptcy is avoided altogether. Of course, a significant share of the bankruptcies filed during a recession is Chapter 7 filings, which result in liquidation.

This recession is causing a shakeup in the bankruptcy landscape and the pattern of financial distress is different from any post-World War II recession. One factor that leads to bankruptcy is corporate debt that can’t be paid. Coming into 2020, the levels of corporate debt held in speculative BBB or junk bonds were high, and the stress since then has elevated worries of default. As defaults increase, bonds will be further downgraded, meaning it will be harder for U.S. corporations to raise debt and more costly when they do.

One measure of this problem is the rise in distressed credits, or junk bonds with spreads that are ten points higher than the corresponding U.S. Treasury bonds. In other words, a distressed two-year corporate bond would yield 10.13% on May 20. Standard & Poors estimates that distressed credits as a share of junk bonds rose from 25% to 30% from March 16 to April 10. During that same period the default rate for junk bonds rose in the U.S. from 3.5% to 3.9%. Two-thirds of global defaults in April were by U.S. corporations. This is strong indicator of coming bankruptcies. Moody’s predicts that the global default rate for junk bonds will be twice the 10% rate that marked the financial crisis.

Should this trend play out to bring a steep rise in bankruptcy filings, another issue looms: inadequate bankruptcy court capacity. Courts are already stretched thin and the looming wave of bankruptcies threatens to overwhelm them. That would leave corporations and creditors floundering without resolution while the courts try to catch up.

These dynamics suggest that there will be an increase in pre-packaged bankruptcy agreements and other alternatives to dissolution. Unlike in 2009, liquidity is not a problem in capital markets. There has been dramatic growth in private equity rescue funds. Viable companies should be able to access credit to survive the business disruption or to negotiate satisfactory payments and refinance debt with creditors. But the peculiar nature of this recession makes it almost impossible to determine corporate value. That makes it tough to assign share prices for investors in exchange for equity, or to determine credit worthiness when there are limited revenues, cash flow and view to the future of the market.

Solutions to these challenges for bankruptcy and debt refinancing could keep businesses from closing their doors in the coming months.

The plight of hospitals during the pandemic has been well-documented. What has received less attention is the financial stress of the healthcare system’s foundational element, the personal care physician (PCP).

Mitigation measures in all states included avoidance of doctors’ offices for anything other than emergency or necessary visits. That has resulted in a massive loss in revenues for PCP practices across the U.S. Physicians switched gears fairly adroitly as the virus spread, moving quickly to telemedicine as a way to treat many patients; however, fees for telemedicine appointments are lower, as are reimbursements. Compounding the revenue problem are the delays in getting reimbursements from insurers during the shutdown and the delays in billing from the more limited staffing in PCP offices.

Losing PCP practices, either to closing doors or mergers with large practices, will be bad for healthcare consumers. If there are fewer PCPs competition is reduced, raising prices. In areas that are already underserved by PCPs, consolidation will just broaden these healthcare deserts. Losing more density of healthcare providers will reduce the number of referrals to specialists. More people will put off treating nagging ailments and chronic conditions if the PCP office is inconvenient. That will result in higher hospital admissions and escalating costs of treatment for serious conditions that could have been treated cheaper at an earlier stage.

The problems facing primary care and bankruptcy are downstream from the obvious healthcare and economic crisis. But they represent systemic weaknesses that will present challenges that are mostly unforeseen now.

Innovation Research Tower at Fifth & Halket. Image courtesy Walnut Capital.

Some construction news: PBX is reporting that the $55 million Evans City Elementary School is out to bid due June 19. Continental Building Co. is taking bids for the $12 million North Shore Lot 10 445-car parking garage on May 27. Rycon Construction was selected as CM for the $25 million redevelopment of the former Sears Outlet on 51st Street. Construction will resume on the $80 million, 280,000 square foot Innovation Research Center in Oakland being developed by Walnut Capital and built by PJ Dick Inc.

The Confusing Future of Office Space

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Imagine you’re the owner or developer of office buildings. For the past two months most, if not all, of your properties have been nearly empty. A pandemic has forced the adoption of new work habits for tens of millions of people, now working from home and thinking differently about what their workplace should be. Some tenants may not survive the disruption. Those that do are going to have new needs. Think of the questions running through your mind as the landlord:

• When will my tenants come back to the building?
• What do they want from me that is different from what they wanted in January?
• How many of them will work from home now?
• Will they expect me to clean more often? How often?
• What do I do with that million-dollar amenity space I just renovated in the lobby?
• Will they need less space?
• Will they need more space?

This is hardly a parlor game for landlords. As two weeks of social distancing has turned into two months (or more) of shelter-at-home, experts have begun regularly speculating about what the post-pandemic office will look like. Since I’m on record opposing any kind of post-crisis predictions made while the crisis is ongoing, I’ll refrain from commenting upon the many predictions being offered, except to say that I agree the workplace will be different. Bear in mind, however, that there is rarely a time when it is untrue that the workplace of the future will be different. There were already a number of workplace-altering trends in place in 2020. The pandemic has accelerated, eliminated or exaggerated most of them.

First among the trends being accelerated is the move away from the open office plan. Hundreds of articles had been published about the fatigue that was setting in about open office plans. Whatever benefits came from that office design trend are currently being weighed against the fear of easier infection transmission. Likewise, the need to maintain a safe distance from co-workers is inspiring fresh looks at collaboration spaces and shared amenities, which were among the “must haves” for occupiers looking to use their real estate to attract talent.

Developer Jim Scalo is among those looking to understand what changes will be required of the post-COVID-19 workplace. He’s an advocate for the idea of attracting talent through better real estate. He also believes that on balance the pandemic will create demand for more space and he’s not alone. Former Google CEO Eric Schmidt recently made the same prediction on Meet the Press.

The rationale behind this theory is the need to make space less densely populated in order to reduce the risk of infection. Fewer people per square foot mean more space. This flies in the face of one of the primary motives driving the more dense open office plan: lower rent. Open plans may have been trendy for any number of reasons, but the most compelling (and mostly unspoken) was the decrease in space needed. CFOs became very trendy people once they realized the bottom line benefit of density was a smaller rent payment.

Countering the argument for more space is the change in perception about work from home (WFH). Forced to work from home for two months, the American office worker has adjusted very well. The same is true for employers. Most of them look at their next lease renewal with the new perspective on WFH and see the potential for a smaller office footprint. One big North Shore tenant was looking forward to expanding space to keep up with a growing workforce. A month into shelter-at-home, he wondered if he could get smaller space for the same number of people.

You can start to understand why office building owners and occupants are searching for answers. There isn’t much data on the subject and what exists adds to the dilemma. Continental Office did a survey of 424 people, ranging from admins to CEOs, during April and published the results today. Here are some highlights:

• 95% expect the office to be disinfected before returning to work and 96% expect the office to be cleaned and disinfected more often.

• 76% of people think shared seating should be eliminated. 71% think adding partitions to workstations is important.

• 58% of CEOs say they are re-thinking the amount of space they use.

• 74% of people aged 25-34 say they want a WFH option. 72% of all people said they were as productive or more productive working from home as from the office.

• 94% still want to have a physical workspace, regardless of how often they work from home.

• 72% said they missed the social interaction of an office.

Now try reconciling the last two bullet points with the three above them. Work from home can reduce the physical footprint of a business, but not if the company still needs to maintain a workplace for 94% of the workers! That’s probably the reason that Perkin Eastman’s Jeff Young guesses that some form of shared address seating will be part of the future office plan.

Young was one of just a few architects who said that clients had requested that they look at actual space requirements as a result of the pandemic. For their part, architects are being proactive and have generated some interesting guidelines for post-COVID offices, like The Post Quarentine Workplace from Dan Delisio at NEXT Architecture, or We are Here to Help from Perkins Eastman, or WELL Building Cleaning Protocol from Chip Desmone.

At the end of the day, it will be the occupants of the offices that drive whatever the office of the future looks like. Thus far, occupants are just as confused. Two veteran tenant reps, Kim Ford from COEO and Dan Adamski from JLL, were clear that it was too early to draw any conclusions. In fact, they both indicated a lack of specific requirements from tenants. Searches for space are on hold, except for those who absolutely must move.

It’s tough to count your blessings in the midst of a pandemic and business shutdown. You can, at least, thank your lucky stars that you don’t own an office building right now.