South Side Works is Hot Again

It’s been almost 10 years since the South Side Works burst on the scene with the Cheesecake Factory and a bunch of one-off retailers (at least one-off to Pittsburgh) to join the office and apartments that had been developed earlier. In the intervening years, retail habits have changed and the Soffer Organization had endured some financial pressures. There was also a deep recession. The net result was stagnation in what was a hot spot.

Apartments and a fresh business cycle are bringing the South Side back into the limelight. On Friday there will be a groundbreaking ceremony for the South Side Works City Apartments, being developed by Village Green and built by Rycon Construction. The $50 million development includes 264 luxury apartments and penthouses with 12,000 square feet of ground floor retail/commercial space and a 562-car parking garage.

The City Apartments join the 117-unit Hot Metal Flats (being developed by Oxford Development and PJ Dick) and the 56-unit 3030 South Water lofts (from Ralph Falbo and P. W. Campbell), all under construction. Highwoods Properties has announced plans for a 158,000 sq. ft. office building within a blocks of all this residential development along the river.

Construction continues at Oxford's Hot Metal Flats. Photo by Cody Phillips

Construction continues at Oxford’s Hot Metal Flats. Photo by Cody Phillips

Don’t Bury the Apartment Market Yet

One thing I noticed when the year-end party circuit was in swing was that lenders have about had it with apartments, at least in Pittsburgh. After tow or three years of cautiously making loans to one developer after another, the Pittsburgh banking community seems ready to throw dirt on the apartment boom.

They may indeed be correct. After all, the combined total of apartment starts for 2013-2014 is four times what the average number of units started was for the previous 13 years. I’ve gotten several calls in the last three months from appraisers trying to estimate absorption and looking for starts information. I understand the mentality, especially in Pittsburgh, that looks for the ride to end. Here’s where I think the problem may be in that thinking.

First, there really isn’t any time in the working careers of Pittsburgh lenders and appraisers that is a comparable market reference – at least if the career was here. Population, particularly in the urban core, has been declining for much of the past 30 years so there hasn’t been an apartment driver like in the south or in major landlocked cities like New York or DC.

More important are the supply/demand dynamics. There is net migration into Pittsburgh and there are between 8,000 and 18,000 new jobs being created in the region annually – depending on whose estimate you’re using. Each new job essentially  creates a new household (if you compare Pittsburgh existing households and total employment, the numbers are almost identical). So take the 8,000 job number and do this math: there will need to be 8,000 new dwelling units created for those workers. Single-family homes are stuck at about 2,000/year with no increase expected in the next year or so. Even with 3,838 units started in 2013, there would still be a shortfall of more than 2,000 units.

Currently, some 3,500 units of apartments are in the pre-construction pipeline. Even with most of the 2,500 units from 2014 still to be delivered, that means there won’t be enough apartments to match up to job creation/household formation again in 2015 or 2016, unless the employment picture goes backward significantly – something no one foresees. And none of this takes into account the facts that suggest that the Millennials are starting to emerge from sharing apartments or their parents’ basements.

I imagine that the lenders are going to drag the apartment development down somewhat but I expect that developers will just find another source of funding seeking higher yields than the Treasury or their local bank is giving. With an impressive recent history of rental growth, apartments should still be a hot ticket in 2015.

Apartment development will probably push the envelope a few more years in fact, at least until the growth in rents and birth rate creates the next boom in home ownership.

The Data Doesn’t Lie

Even with the surprisingly strong fourth quarter for contracting, most involved in the construction industry will find 2014 a bit disappointing when the dust settles (especially when the financials are reported). That will be less because of the performance of the market than the underachieved potential.

The last quarter of 2013 showed real economic promise. National GDP was up 3.7% and job creation in Pittsburgh was estimated at 18,000 jobs for the year. That potential for loosening the market just didn’t kick in during 2014. Or at least it didn’t feel that way. The numbers mostly back up that disappointment, although they tell a mixed story.

Non-residential structures totaled $2.77 billion in 2014. That’s a mere $5 million below the $2.82 billion of 2013 but given the outlook coming into 2014, flat was disappointing. The residential market may appear way off the 2013 levels, falling over 24% year-over-year. But much of that decline is due to a 30% drop in multi-family starts to 2,572 units. That’s actually a pretty healthy year in Pittsburgh but the 2013 total of 3,838 dwarfs that number. It’s worth noting that the 2013 total was a 239% increase over 2012 and 2,572 units tops every other year going back to 1995 by at least 15%. More about the apartment market in a future post.

Total Pittsburgh MSA 2014 1,971 2,902 4,873
Total Pittsburgh MSA 2013 2,164 3,838 6,002
% Change -8.9% -24.4% -18.8%

There were over $900 million in non-residential starts in the 4th quarter of 2014. That’s a good start for backlogs. While the bid market isn’t racing out of the chute in the first 2 weeks of the year, more than $250 million has already been awarded or started already in 2015.

Last week NAIOP Pittsburgh presented PNC’s Gus Faucher talking about the economic outlook for 2015. Faucher was very upbeat, mostly because of the improved job market, lower gas prices and the lack of any economic headwinds from consumer or government de-leveraging. PNC is predicting GDP growth above 3%, even with the global economy tanking.  It’s worth pointing out that PNC’s Kurt Rankin was the one economist willing to say that he thought surprises in 2014 would be to the upside and he turned out to be very accurate in guessing what those upside numbers would be.

Business wasn’t as bad in 2014 as it felt. One of the tougher tasks of business is separating emotion from reality and that cuts both ways of course. My forecast for 2015 is that it will be a breakout year. That doesn’t mean gangbusters necessarily. I think too much Pittsburgh business is tied up in global business for the Pittsburgh economy to not be impacted a little by the world’s problems. But I do think that 2015 will be the year that we see the long-term optimism about Pittsburgh and its maturing technology and energy industries translate into bricks and mortar.

Confused? You’re Not Alone

I tend to meet with a lot of business owners in December and January to talk about the coming year. At the present time, confusion seems to be the prevailing wisdom about the market’s direction.

The fundamentals are very supportive of a breakout year in 2015. Space is tight in commercial property; industrial and manufacturing are expanding rapidly because of the natural gas exploration and its related businesses; employers are creating a lot of jobs in Pittsburgh; interest and investment in the region are very high. Add to that macroeconomic recipe the fact that construction has been stagnant for 5 years and you would expect a boom to begin. Somehow, no one seems to keen on that happening in 2015, including your correspondent.

Look for a better year in 2015, especially if your market is commercial construction, but don’t expect to fill up your belly in the first half of the year. By mid-year we’ll discover what a new governor might be thinking (especially about the gas industry) and what a Republican-controlled Congress will be doing or not doing. After that, all bets are off.

As the year turned, a couple of big projects that were out were resolved. The Cambridge Healthcare Solutions development team – which includes Mascaro Construction – was selected to build the $75 million VA Butler Outpatient Center. Johnson Controls selected a team that includes PJ Dick and IDC Architects for its $100 million office/research center in York, PA.

Bids were opened Jan. 8 on the Parran/Crabtree Hall project at the University of Pittsburgh in Oakland. The 3 low bidders on the prime contracts (from base bid #1) were:

General #1: Volpatt – $10,499,000; Gen #2: Burchick – $10,771,000; Gen #3: Massaro – $10,760,000

HVAC #1: McKamish $6,725,000; HVAC #2: Ruthrauff/Sauer – $6,798,000; HVAC #3: Tomko – $6,,887,000

Plumbing #1: Tomko – $1,857,000; Plmb #2: McKamish – $1,882,000; Plmb #3: SSM Industries – $1,937,000

Electrical #1: Farfield – $4,388,000; Elec #2: Lighthouse – $4,824,000; Elec #3: Westmoreland – $4,897,000

A Big Third Quarter

The government’s December 23 final estimate of GDP growth for the third quarter was a massive 5.0% surprise to the upside for the economy. The original estimate in October was 3.1%, which was later upped to 3.9% in November when the Commerce Dept. uncovered surprisingly higher healthcare, consumer and business spending. Using a more thorough survey methodology, Commerce research showed that those estimates were low as well.

The big jump in the third quarter can be attributed to higher business investment, which bodes well for construction and real estate. The biggest driver was the jump in consumer spending, which is a double-edged sword. Here’s what a closer look shows:

Consumer spending has risen somewhat because of better confidence in the future but most of the increase is probably related to the plunge in gasoline prices. The increase in consumer spending was 3.2% or slightly less than $100 billion in the quarter. Gas prices have dropped almost 90 cents during the quarter. The rule of thumb historically is that one penny in gas price decline yields a billion dollars in spending increase. That formula would explain most of the spending increase.

Consumers could also have used that increased disposable income to save more or pay down more debt. Neither of those things happened in the third quarter; in fact, the savings rate declined to 4.1%.

The last time that GDP growth was as strong as the past six months was in late 2003, just before the economy took off. That boom was fueled by consumers, especially consumers using their home equity as ATM’s for depreciating assets or non-assets like vacations. No one expects a repeat of that foolishness again, especially since banks can’t really do what they did in 2005-2006. At the same time, lenders need a place to use cash and Fannie/Freddie are looking at ways to get 97% loan-to-value deals to “qualified” buyers to stimulate home ownership. That’s a huge mistake and is exactly how the housing bubble started. Perhaps we could trust the GSE’s to maintain strict standards but I would rather not.

Better that the next few quarters cool off if that is what is in the cards. the rest of the world is in a bad economic state, which makes investing in U. S. bonds or real estate very attractive. That’s a good thing for our economy.

Winding Down the Bids for 2014

There are a few large projects out to bid that will carry contractors over into 2015 but the market is shutting down for the holidays. Last week there were a few projects bidding that stood out as the backlog-builders for next year.

Mechanicsburg-based Lobar Inc. struck twice, getting low on a $7.8 million wastewater project in Masontown WV and the general trades piece of the $40 million Montour K-4. The 3 low bidders on Montour were:

1) Lobar – $28,973,000; 2) Burchick – $29,596,000; 3) Nello – $29,867,000

Bethel Park’s $6.6 million Fire Station came in under budget, with TOMLYN edging Yarborough Construction. Those results were:

1) TOMLYN – $6,613,000; 2) Yarborough – $6,644,000; 3) DiMarco – $6,709,000

The jury is still out on how the year will kick off in 2015. Right now the total contracting volume for 2014 looks like it will be better than I expected just 60 days ago. Fourth quarter volume will be above $700 million – a good omen for 2015. The total for 2014 should end up around $2.65 billion. There are a lot of $15-30 million opportunities hanging around ready to get to the streets. If these pop in the first quarter, contractors should be happier sooner rather than later.

The forecast for 2015 looks very positive. There are a few potential problems lurking but contracting volume should exceed $3 billion, possibly even $4 billion if the cracker gets going earlier in the year.

Thoughts on the Astorino/Cannon Merger

This morning’s Post-Gazette story on CannonDesign’s acquisition of Astorino followed a few days of rumors of the deal and has of course spawned its share of speculation about the deal. Given Cannon’s reach and the fact that the firm has regularly – if not frequently – worked in the Pittsburgh market, it seems like Cannon could gain market share without buying Astorino. If you look at Cannon’s announcement of the deal, however, you get some insight about the motive.

I haven’t spoken to Lou Astorino yet and Cannon’s CEO Gary Miller is out of the office, so what follows is speculation. Cannon positions the acquisition as the merger of two like-minded firms serving similar clients. They point out that the two firms have worked together before and share similar philosophies. Once you get into the meat of the news you see that Cannon makes a point of touting the additional capabilities that Astorino Development’s design/build team brings. This construction management arm, that Lou P. Astorino leads, is the value that the Astorino side brings to the table. Astorino’s resume is impressive (how many companies can boast PNC, the Pirates and the Pope as clients?) but no more so than Cannon’s; and Cannon’s billings are roughly 14 times that of Astorino’s. But Cannon didn’t have that construction resume.

Delivery methods are evolving. It was Lou Astorino’s recognition of this fact that led to the launching of the construction management group. I believe it’s more than a gesture that Lou P. is going to lead the design/build operation from Pittsburgh. Whether it’s design-led design/build or just the opportunity to act as as CM-at-risk, Cannon now has capabilities to serve clients that are looking at streamlining the process with an alternative delivery method. In particular, healthcare clients – one of Cannon’s major client groups – are looking at ways to deliver expensive construction with less cost and more predictable outcomes. Highmark/AHN has used Astorino that way. Other large CM/design firms are pitching a modular approach to hospital construction. This puts Cannon in the mix with competitors that it couldn’t joust with before.