Bridging the Gap: Improving CRE Development Outcomes
As CRE investment continues to grow, developers face the same challenges: labor and material costs continuing to skyrocket. New technologies could be the solution to help lower costs and speed up construction time. On May 30, 2019, commercial real estate publication Bisnow brought together industry experts at the Chicago Construction and Development Conference to discuss the current landscape of the commercial real estate (CRE) market in Chicago, and how to keep up with industry shifts in the future.
I had the honor of moderating the “Construction Finance” panel, featuring Shaylyn Cullen, President, Cullen Construction Management; John McLinden, Managing Partner, Hubbard Street Group; and Eli Ungar, Founder and Principal, Antheus Capital; which evolved into a fantastic discussion about the friction remaining in industry design and construction processes and what we can do to solve it.
During our organizational meeting, the day before the conference, the panelists and I decided what we didn’t want the panel to be — a brain dump of what the problems in Chicago are without any insights into how we look forward. Instead, we decided to identify and discuss the disconnect, while problem-solving on how to reduce the current disconnect in normal development.
The Disconnect: Investments vs Returns
We began by defining the problem and delved deep into the root causes of it. The heart of the matter is that CRE construction is slowing because of rising costs, which has a direct effect of the caliber of development. What all three of the panelists see is that there is a significant amount of private equity hunting for investments. However, private equity firms are “penciling out” lower potential returns (4-6% as compared to the traditional 10-15%).
What’s behind the lower ROI? Three areas, including rising costs during design and construction, mandated development requirements such as inclusion of 20% low income housing in local projects and the lack of design and construction information transfer resulting in development and building operation inefficiencies. As the industry shifts towards digital transformation, owners are demanding that more high-quality building asset information be collected from early phases of design and construction – according to an information strategy, to enable developers and owners to reduce long-term costs of building operations. While this makes sense from the owners perspective (and mine), the increase in early-stage development information transfer requires architects, engineers, contractors and subcontractors to be on board in adding to the structured information flow.
Can we reduce construction labor and ensuing costs? Unfortunately, there’s not an easy answer for this as it varies from market to market. Regarding information transfer, ultimately owners are responsible for setting the tone by requiring an information strategy that each designer and constructor must follow as part of their responsibilities. This is not a new requirement, rather a focusing of requirements already in place. Done correctly, this effort would lower overall development costs by streamlining information flow. Architects would identify building assets by a set of rules – sorely needed until now. Subcontractors use designer’s specifications to finalize which assets will be purchased for the lowest cost possible, while contributing the next level of information to the asset information model. Ideally, all that information is then transferred to the owner to manage throughout the building’s lifecycle. Unfortunately, today this is often overlooked, ignoring owner needs.
Are construction costs predicted to increase?
Over the next year or two, developers estimate that there will be additional increases in construction costs due to acute labor shortages. Combined with local permitting requirements such as low income inclusion requirements, the 10 cranes on Chicago’s skyline may be the proper amount, for now.
With this in mind, our panelists shared thought-provoking ideas by which the city of Chicago, and developers, can work together to improve outcomes for everyone. In late 2018, the federal government announced the 2018 Tax Cuts and Jobs Act, which included tax incentives for developers and other investors to focus on “opportunity zones,” or underserved areas, to improve investments in communities that lack current interest. Under these provisions, metropolitan areas are now required to identify and set aside as much as 25% of incorporated areas to be labeled potential sites for opportunity, or redevelopment, zones. Some cities, like Phoenix, Seattle and Portland, have strategically defined opportunity zones across high and low income areas to generate higher levels of development across cities (check out more details on opportunity zones and strategy here).
Unfortunately, other cities, like Chicago, have defined their opportunity zones in extremely low income areas and industrial zones with brownfield sites, making them expensive to develop without significant investment in infrastructure and environmental clean-up. Plopping a development in a severely distressed area by itself has not proven a viable strategy for developers or end-users of the property. Reason for continued development must keep investments pouring into the area to create long-term success. With high costs associated with such an endeavor, the tax incentives provided by the federal government aren’t currently enough to offset the cost of the investment.
Opportunities through process improvement and how tech can help
While the panelists provided great insights into how developers can potentially see returns from modified permitting and zoning requirements, technology support of process improvement is quickly becoming the preferred way of lowering costs for initial development and increased long-term return on investment.
By using a technology consultant to set an information strategy up front, baking asset information requirements into design and development contracts and using technologies to support information flow, costs can be reduced through reduced RFI’s, shorter design and construction schedules and immediate handover of building asset data to owner operations applications.
Save construction costs with an information strategy plan and Digital Twin technologies from Invicara. Contact us today!
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