“Bonkers” build-out costs: How escalating construction expenses are influencing site selection
By Tim Schooley – Reporter, Pittsburgh Business Times
May 15, 2024
Fred Rogers Productions Office
When he and his team were negotiating the move of their office, Chris Arnold remembers getting blindsided by the costs it took to build out the new space. Arnold, chief operating officer at Fred Rogers Productions, said the gap between what he expected it would cost and what the actual expense was just for building out the company’s new 11,000-square-foot office at SouthSide Works in 2022 was large.
“It’s not like we wanted waterfalls and rainbows,” said Arnold, remembering the back and forth with the company’s designer and builder for the modest construction project. “They’d say, ‘well, walls are expensive.’” Added Arnold: “It was bonkers.” Just how did he quantify bonkers? Arnold said the initial cost estimate from the team was 20% over budget, requiring a major rethink.
The build-out cost factor
He’s not alone in facing the challenge of rising construction costs. “Bonkers” build-out costs for tenants moving to new space, be it for office, retail space and everything in between, has become a major issue influencing site selection. While escalating costs have been much discussed for how they’re hampering new construction projects, the demand for more expensive build-outs of space in established buildings is having a significant influence on how and where companies are moving.
“For every tenant that’s in the market right now, that’s a factor … especially if they want to look at new space,” said Jack Donahue, president of Donahue Real Estate Advisors. In its recent quarterly research on the office market, Cushman & Wakefield attributed the tenant improvement cost issue as one factor that’s resulting in 90.2% of the region’s office leasing happening outside of downtown.
Why?
“The distressed loan status facing several downtown buildings has made it difficult for landlords to finance generous TI packages, forcing tenants to look elsewhere to secure desirable deal terms,” reports the firm. Donahue, who works most in office tenant representation, said he often finds himself negotiating more tenant improvement funding for an office move against lower rents, noting that “often times the tenant improvement allowance doesn’t cover the cost.” He added higher build-out costs can quickly negate better lease terms and other concessions from landlords. “In the past few years, the increased costs for construction has had more of an impact because the tenant improvement allowances haven’t gone up quite as high as the actual construction costs,” he said.
Jeffrey Deitrick, an executive vice president and broker of record for Oxford RealtyServices Inc., a division of Oxford Development Co., said he sees how the construction build-out cost issue plays out at his company’s 3 Crossings buildings in the Strip District. “For us at 3 Crossings, all of our activity has been on second-generation space,” he said, meaning offices already built out for a previous tenant resulting in less costs for newcomers. “Those all got eaten up in the last four months.” Such spaces represent easier deals to work through with prospects compared to the empty shell space Oxford has elsewhere at 3 Crossings. Deitrick, who also recently represented Giant Eagle Inc. in its new headquarters move to 700 Cranberry Woods Dr. in Cranberry, tabulated just how much more expensive it is now to do full build-out on new office space than before. “I just know that taking shell space now where we could build it out for $120 a square foot five years ago … now it’s $170 to $180 a square foot,” he said. He emphasized that undergoing that kind of expense makes less and less sense for shorter-lease terms. Anything less than a 10-year lease commitment is likely to not make sense for such an investment. “I think most tenants get it. Most of my clients understand,” he said. “It has presented some challenges. But remember the market like any other market is cyclical. I anticipate these construction costs we’re seeing today will right themselves over time.” Deitrick expects raw space that requires a full office build-out, such as at a few remaining floors at Oxford’s 75 Hopper Place, will lease out in due time. He expressed optimism that the market will reward a high-quality location and asset. “Things will lease,” he said. “This is one of the challenges that has presented itself from the pandemic that we’ll eventually get through.”
Different kinds of offices
Along with negotiating higher prices, companies have different needs for new offices now.
“For the interior office trend, the designs have changed so much,” said Anthony Martini, president of Verona-based A. Martini & Co. General Contractors, the general contractor for the Fred Rogers Productions space. “The drawings that we see for these interior spaces are completely different from what we were seeing pre-Covid.” Often, that means more open spaces and wellness rooms, approaches that emphasize a desire for more collaboration and a greater priority of employee health. “It’s a different design,” he said. “I don’t know that that necessarily is driving prices, but it’s a sign of the times.”
Jim Sheehan, a principal and architect for R3A Architecture, the firm that did the design work for Fred Rogers Productions and does work for the University of Pittsburgh and Carnegie Mellon University as well as many others, understands the need for different kinds of office space since his own firm operates with a hybrid expectation that staff bein the office once a week. He lists the typical requirements companies are requesting now: Sit-to-stand desks, open space, more comfortable couches and rooms to sit down in. “We’re doing that because we know that will bring people back into the office here,”he said. Sheehan said he’s seeing construction pricing coming down over the last six months. But he also attested to dealing with the kinds of supply chain challenges that have been a pinch point for inflation issues elsewhere in the economy. “It’s been the delivery of product and the timeline for the delivery of product that has got everybody concerned,” he said, noting how electrical equipment has been a major source of frustration in both cost and timing. “If you do a new office building and need a transformer, it could be 50 to 100 weeks to get it delivered. A lot of these companies are backed up with orders that they really couldn’t produce because they didn’t have people in the manufacturing space.”
Martini, whose firm does many tenant fi t out jobs, including one in the works for law firm Dickie, McCamey & Chilcote PC’s move into an 80,000-square-foot office at Gateway Center next spring, acknowledged higher costs overall but also offered a broader perspective. The cost “can vary so much” depending on how companies negotiate the various priorities of any job. Higher cost build-outs typically come amid companies shrinking to smaller offices. “A lot of the interior renovation work that we’re doing downtown or even in the office parks in the suburbs are definitely people downsizing from their original spaces,” Martini said.
Arnold with Fred Rodgers Productions was happy with both R3A and A. Martini for being able to bring costs into line. “The total project for us came in under budget and on time,” he said. “And that was only possible with their creative minds being able to meet the needs in different ways.” One decision that helped to reduce costs for Fred Rogers Productions was opting againsthigher cost lumber to instead choose particle board covered with a high-density felt. “The space looks fantastic, but it was done on a very conservative budget,” he said.
Retail build-out costs large and small
The issue may be hitting the office sector the hardest, but other real estate types aren’t immune. Retail can be a challenge particularly downtown, where small building owners often struggle to fund store space improvements and find tenants. Jeremy Waldrup, president and CEO of the Pittsburgh Downtown Partnership, described a challenge for smaller building owners in the Central Business District to be able to pay for build-outs for shops and restaurants, motivating the organization to work to increase the funding in its Paris-to-Pittsburgh facade grant program. “We are trying to find creative ways to spur investment from both the property owners and new tenants,” Waldrup said. “We are constantly talking with owners and brokers about individual spaces and deals and attempting to find ways to fill gaps and get leases signed.” John Jackson, a first vice president in the Pittsburgh office of CBRE who specializes in retail leasing, expects retail landlords dealing with chain stores are less susceptible to construction build-out price shock. “I would say the landlords of your larger mixed-use developments realize they need to subsidize some of these retail deals to get done and they’re more willing to do so now more than ever,” he said.