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Waiting for construction industry to recover

October 8, 2011

The recession officially ended more than two years ago. But the number of local construction jobs is still down 27 percent from 2007 levels. Will the industry ever feel relief?

Kyle Anderson is bearish. Construction was the industry hit hardest by the recession, and it likely will be the last to come back, said the professor of business economics at the Indiana University Kelley School of Business in Indianapolis.

“I just don’t see any bright spots for the construction industry,” Anderson said. “The message might be that the worst is over. But the recovery will be very slow.”

However, Ross Reller, who heads up land brokerage in the Indianapolis office of Seattle-based Colliers International, is more optimistic: “We’re already seeing signs of recovery in central Indiana.”

On the next page, others in the trenches share their predictions for when the construction market will revive and what to look for in early signals.

Residential

After a long contraction, homebuilding appears to be on the verge of a slow recovery, said Steve Lains, CEO of the Builders Association of Greater Indianapolis.

He projects that this year will end up fairly flat in terms of single-family housing permits issued, at about 3,700. Permits in August, the latest month for which figures are available, spiked 23 percent over the previous August, but year-to-date totals trail last year.

Anderson agreed, saying, “It’s still pretty weak. I don’t see anything too great going on for quite some time. Home prices aren’t going up.”

Lains expects permits issued to tick up to 4,300 or so next year. That’s still a far cry from the 8,000-10,000 he thinks the market can bear given the number of household formations, interest rates and the availability of loans. But that target will take years to reach—2015 at the earliest, he predicted.

However, gradual growth isn’t such a bad thing, he said. A sudden spike would create challenges for materials and labor markets. Manufacturers have scaled back in response to weaker demand and might have trouble ramping up quickly, he cautioned.

And the metro area has lost 25,000 residential construction jobs since 2005, when a dazzling 13,000 housing permits were issued. The recession also cost BAGI about half of its builder and supplier members.

Over the past couple of years, buyers have purchased most of the model and speculative homes and other fresh inventory in all price points. And most of the remaining foreclosed-upon homes are fixer-uppers that would hold minimal appeal for the typical new-home buyer, Lains said.

“If we can keep spurring that investment and interest, we’re all going to come out of this sooner rather than later,” he said.

The clearest sign that housing construction is rebounding will be month-to-month increases in the number of housing construction permits issued, Lains said. Then there will be more obvious signs: Raw ground being replaced by streets, sidewalks and building pads.

“We’ll need to see dirt starting to turn to know we’re moving in the right direction,” he said.

Multifamily

The collapse of residential construction helped the apartment market, said George Tikijian, principal broker of Tikijian Associates, which specializes in multifamily housing.

constructionHe predicts that 3,000 units will open locally this year, with an equal number breaking ground. And another 4,000 units are on the drawing board.

Downtown is especially active, with projects such as the 320-unit CityWay under construction. The student housing segment also is strong, he said, noting that the 180-unit The Avenue is slated to open near IUPUI next spring.

Although lenders shied away from apartment projects during the recession, they are now participating in deals with developers who have solid track records and significant equity.

“When it comes to real estate, [financial institutions] see somewhat of a safe harbor in rental housing,” said John Hart Jr., president of J.C. Hart Co., a Carmel-based apartment developer.

Hart’s company has more than 650 units under construction in Carmel, Westfield and Lawrence. And rents are rising 3 percent to 4 percent a year.

About three-quarters of young adults ages 24-32 rent, Hart said. And more empty-nesters are opting for apartments. Then there are folks who would like to buy but cannot qualify for a mortgage, or have lost a home to foreclosure.

There is no end in sight, Hart said. The number of seniors in high school is at an all-time high, and many young people who are unemployed are building demand that will break loose once they find jobs.

“We expect to continue to see a pretty vibrant rental market for several years to come,” Hart said.

Commercial

For now, it’s all quiet on the commercial front. Virtually no significant commercial buildings are under way in the Indianapolis area.

As they await the return of commercial construction activity, general contractors like Indianapolis-based Shiel Sexton Co. Inc. are diversifying. The company has shifted much of its focus to government work and found a new market in renewable-energy projects, said John Andrews, vice president of marketing. For example, Shiel Sexton just installed $72 million in solar panels at the Major Gen. Emmitt J. Bean Center at the former Fort Benjamin Harrison.

Andrews is keeping his eye on the American Institute of Architects’ Architecture Billings Index, a leading indicator of construction activity. The index fell in July, the latest month for which figures are available. The Midwest score of 44.9 was the lowest in the country. A score below 50 indicates a decline in the demand for design services.

However, Kort Cole, vice president of Indianapolis-based Rollins Construction Co., said he has talked to several local architectural firms that have pretty full plates. He expects that work to roll down to construction firms in late 2012 or early 2013. In the meantime, “We have a year yet of struggle,” he said.

A commercial rebound hinges on factors such as job growth, wage increases, higher consumer spending and the availability of financing.

Colliers’ Reller said, “We’re now in year three or four of not having a commercial lending market.” In the past, multitenant buildings were often constructed not in response to demand but because of the availability of credit. In fact, building in anticipation of need has been a cornerstone of real estate development, he said.

“That contraction of credit, the absolute withdrawal of leverage from the commercial real estate industry, must return in order for new construction to return,” Reller said.

The pro formas on which many loans previously were based often turned out to be disastrously wrong. So, for the time being, development is largely limited to borrowers with deep pockets, such as Indianapolis-based Dow AgroSciences, which is building a $240 million research and development center on the city’s northwest side.

Office

“There won’t be a need for another office building for a while,” Reller said. He noted that the office vacancy rate remains at about 25 percent downtown and is holding at just under 20 percent in the suburbs.

“We’re going through a period of time where we have too much of everything,” he said. Complicating matters is that technological advances have significantly reduced square footage needed per worker.

Office development should resume in early to mid-2013, but not at levels seen in recent years, predicts a report issued this summer by the local office of St. Louis-based Cassidy Turley Commercial Real Estate Services. In the meantime, most office projects involve changes to existing space, often to accommodate tenants taking over space from businesses that failed.

Retail

It’s a similar story in retail, where tenant improvements dominate activity, said Ersal Ozdemir, CEO of Indianapolis-based Keystone Construction Corp. The company has handled a number of local retail projects and is building Sophia Square in Carmel, a $40 million apartment and retail development.

Although retail occupancy rates are firming up, Ozdemir predicts it will take at least a year to burn through existing inventory, pushing any major new development into 2013. One of the first signs of a strengthening market will be a reduction in rental concessions, he said.

“Everyone thought by now everything would be OK,” Ozdemir said. “But everything is not OK.”

Industrial

Things are a little brighter in the industrial category, where warehouse rental rates are climbing slowly and vacancies are edging down. The vacancy rate stood at 5 percent at the end of the second quarter, according to Cassidy Turley.

Seattle-based Amazon.com, which this summer opened a 900,000-square-foot warehouse in Plainfield, may have more construction in mind.

“Obviously, the Amazon story is not over. They continue to have an appetite for big-box distribution centers,” said Colliers’ Reller. He expects to see other major warehouses built in the next few years.

Institutional/health care

“The health care sector has been pretty robust locally,” said Shiel Sexton’s Andrews.

Health care facilities and government projects account for eight of the 10 most expensive Indianapolis-area construction projects, according to IBJ research.

“Big hospitals are strategically locating where clients need best-in-class health care. It’s a more reasoned, strategic approach to real estate than what we saw in the past,” said Colliers’ Reller.

However, even in health care, the reins are tighter, said Cole, of Rollins Construction, which does 90 percent of its work in the sector.

“More and more of the projects over the last three years have been necessity projects instead of ‘want-to’ projects,” Cole said. By and large, hospitals are repairing damage and buying needed equipment, but otherwise are “updating what they have and trying to get the best bang for the dollar out of existing facilities.”

One exception is the $94 million expansion to Community Hospital South that Rollins is completing. Other major projects, including the $754 million new Wishard Hospital and a $475 million expansion at Riley Hospital for Children, will keep workers busy for another couple of years.

But competition continues to be fierce on every job, an indication that there is still not enough work to go around, Cole added.•

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