Cost of building shocks developers: Development costs soar 62.5 percent for office, at least 50 percent for retail

The heightened pace of commercial construction in Northern Colorado during the past couple of years is doing more than adding inventory.
It’s making a few heads spin – though for reasons many may not have considered.
When the building pace picked up, primarily in the office and retail sectors, many developers who had been waiting on the sidelines during the slower market jumped in with new projects.
There has been a noticeable change, though: The cost of development has risen by as much as 62.5 percent for some office projects. Essentially, an office project that in the early 1990s cost $80 per square foot to construct foot now runs $130 per square foot.
“It kind of caught me off guard,´ said Dave Veldman, president of Veldman Morgan Commercial in Fort Collins.
David Sitzman, president of Sitzman-Mitchell & Co. of Fort Collins, likens the phenomenon to “sticker shock.
“People like myself hadn’t built for a while, then got back into the thick of things,” he said. “The market did some catching up. Eighty dollars per square foot used to be the rule of thumb.”
At that time, a building that ran $100 per square foot to construct was considered a fairly elaborate project. But now, the norm is $130 per square foot for a routine project, experts say.
Retail construction now runs about $90 per square foot, vs. $50 to $60 in the early ’90s, Sitzman said. That’s a jump of 50 percent to 80 percent.
So what’s driving this jump in the bottom line?
Five major components figure into a construction project from conception to completion: land: land; development; core and shell (the building itself); tenant finish, and soft costs (legal fees, city fees, appraisals, engineering, etc.).
Industry observers say that while land values have certainly risen, they haven’t shot up at the same rate as other components in the formula. Even material costs haven’t ballooned as much as might be imagined.
But some primary components driving more-expensive buildings are drastic increases in labor costs, jumps in city fees and increasing site-development costs.
The demand for labor all over the Front Range has led to premium prices being paid for the work.
“A general contractor doesn’t have much choice but to pay it,´ said Gordon Murdoff, owner of Murdoff Construction Inc. of Fort Collins.
He noted that increases in the cost of worker’s compensation insurance are being passed on as well.
Veldman doesn’t see that changing.
“Even if there is a lull in building, I don’t think a plumber or electrician will be lowering their cost,” he said.
One reason for such dramatic increases in construction costs, Murdoff said, is that the sheer volume of commercial and residential contruction projects in Northern Colorado makes construction workers more valuable and heightens costs in general.
Regardless of the reason for escalating costs, the outcome is fairly clear.
“It affects every step of the process,” Sitzman said. “In order for us to build a $130-per-square-foot building, tenants have to understand that rents have to cover costs.”
In most cases, a $15 net lease rate will cover construction expenses.
Though higher costs end up impacting the price of occupancy, many tenants are willing to pay.
“There was such a drought of new buildings that many were willing to pay the prices,” Veldman said, “especially in the retail world.
“We’re talking quality, basic buildings,” he added. “We’re not talking about monuments where design pushed the cost.”
Some buildings with exceptional design, he noted, likely would cost more than $200 per square foot to build.
Even though some developers and contractors clearly are affected by the jump in costs, others don’t see it as drastically.
“It’s hard to put a thumb on how much things cost,´ said Richard Newcome, president of Hensel Phelps Construction Co. of Greeley. “Each element of a building has its own cycle.
“Everything we do is different,” he added. “We’re still putting buildings in place that are $80 per square foot.”
Jim Swanstrom, a cost estimator with Rhoads Construction Inc. of Fort Collins, said he works on buildings from plain to elaborate.
“I would contend that even in Fort Collins you can do a building for a lot less than $130 per square foot,” he said. “I disagree that there’s been such a big leap.”
General contractors, though, sometimes don’t deal with all the final cost variables that include the land, land development, core and shell, tenant finish and soft costs.
The lending industry, too, has watched prices climb.
“There definitely has been an upward trend,´ said Sue Wagner in Norwest Banks’ Fort Collins’ commercial lending department. “Someone could purchase an existing building for a fraction of what you could build them.”
And in Greeley, where development often is less expensive, the same cost increases are being recorded.
“The city of Greeley is looking at development fees in 1997,´ said Michael Ehler, a commercial broker with The Group Inc.’s Greeley office. “It may be marginally less to build here than in Fort Collins or Loveland, but that margin is getting smaller.
“The real cost savings here will be time,” he added.
Those in the industry who have seen increases in development costs don’t expect any backing down in the near future.
“I don’t think we’ll see any relief,” Veldman said. “I don’t think construction costs will retreat. Lease rates may go up and down, but the cost of putting up a building won’t.”
Even though prices may be higher, they probably have stabilized, Sitzman said.
“I don’t think it will continue at the same rate,” he said. “Eventually, the margins will narrow.”ÿ