Speculative office developments, like Innovation One, the 70,000-square-foot office building recently developed by Irgens at the UWM Innovation Campus in Wauwatosa, will be unlikely in 2023, say developers, especially with increased borrowing costs.
Credit: Cara Spoto
With uncertainty abounding, divining what 2023 could hold for the construction industry in southeastern Wisconsin has industry leaders trying to get a clear picture of what lies ahead. BizTimes Milwaukee recently spoke with executives at six development and construction firms in the region, and despite the universal impacts of supply chain bottlenecks, labor shortages, inflation
With uncertainty abounding, divining what 2023 could hold for the construction industry in southeastern Wisconsin has industry leaders trying to get a clear picture of what lies ahead.
BizTimes Milwaukee recently spoke with executives at six development and construction firms in the region, and despite the universal impacts of supply chain bottlenecks, labor shortages, inflation and higher interest rates, most had different stories to tell about what they’re expecting across various sectors.
Schools, clinics and hospitals
At construction firms C.G. Schmidt, based in Milwaukee, and The Boldt Company, based in Appleton, 2023 is shaping up to be a busy year.
That’s partly because they count public and nonprofit institutions among their biggest clients – entities like public school districts and hospitals that don’t have to rely on commercial banks and private lenders to fund their projects.
“For us, broadly speaking, 2023 is shaping up to a be a better year than 2022, and we think 2024 will be even better yet,” said Eric Schmidt, president of C.G. Schmidt. “Our institutional clients, like health care, they are moving ahead regardless of what is happening right now. During the pandemic, virtually all of them hit pause or stop on their capital projects, and now they are all starting up again. … Our K-12 group is also seeing a lot of activity. We got three referendums passed in November 2022, and we have a bunch coming up in April; then there will be more in April 2024 and November 2024.”
While schools take out bonds to fund their building projects – borrowing against their property tax levies – and are seeing some of the impact of the Federal Reserve’s efforts to curb inflation by raising interest rates, many of C.G. Schmidt’s clients keep a close eye on those markets and just end up building those potential costs into capital planning.
The company has plenty of work planned for this year, including in Racine, where it is the construction manager overseeing work being funded by the Racine Unified School District’s $6 million referendum.
John Huggett, vice president of central operations at The Boldt Company, is also expecting this year to bring demand for construction services.
“We are not seeing the stops of projects, which is great. The institutional clients that are either funding their projects with cash or bonds, or the like, those projects, if they are in the queue, certainly they are still moving through the system,” said Huggett, whose firm does a lot of work with hospitals and clinics.
While some health care clients are still in a holding pattern, trying to determine their post-pandemic capital outlay needs, most are moving forward, he said.
“Children’s Wisconsin is still a significant client for us,” Huggett said.
[caption id="attachment_563438" align="alignnone" width="1280"] Projects funded by public entities, like Milwaukee County’s new Mental Health Emergency Center at 1525 N. 12th St. in Milwaukee, which CG Schmidt and JCP Construction completed last year, are expected to remain largely unscathed by spikes in commercial interest rates. Credit: CG Schmidt[/caption]
Diversification key
For both firms, having a diverse portfolio of clients across all sectors is key. Boldt also does a lot of work in the industrial food and beverage production markets, while C.G. Schmidt does a lot of multifamily work as well as some office building construction.
“Certain market sectors are much more sensitive to (market swings), so as an organization we certainly focus on market sector diversification just to be able to take advantage of those opportunities when the conditions are good, and then conversely when conditions aren’t as good you are buoyed by another sector,” Huggett said.
That’s especially been true as a tougher commercial borrowing market and inflation has seen some multifamily developers hit pause on their projects, Schmidt said.
“The school projects kind of fill in that void (left by private developers), so it can be a nice counterbalance to some of the more volatile markets we are involved in,” he said.
Industrial, office
If there is one thing higher interest rates have wrought across nearly all the industries, it’s a near stoppage of speculative development: that’s especially true in the industrial and office sectors.
While 2021 and 2022 saw some developers return to constructing large, speculative industrial buildings along interstates and other major thoroughfares, any projects being planned for 2023 likely won’t gain financing unless a tenant is lined up.
“We have already watched a lot of spec development pulled off the market due to the cost of borrowing,” said Adam Matson, an industrial real estate broker and director in Newmark’s Milwaukee office. “Basically, there are only two groups that are doing industrial spec development right now: developers that locked in their financing before rates went up, and groups that are financing their deals almost entirely with cash. It is going to be extremely limited.”
That’s also true of office developments, said Tom Irgens, executive vice president of Milwaukee-based Irgens. While the company just moved into its recently completed two-story, 70,000-square-foot office building at the UWM Innovation Campus in Wauwatosa, the firm has no current plans to build any more speculative office buildings on the campus or anywhere else for that matter – with the exception of some medical office buildings. The development already includes a two-story parking structure that was completed as part of the first phase of the development, but a six-story office building will have to wait until a large tenant is lined up, Tom Irgens said.
The firm had always planned to hold off on construction of the larger building until a flagship tenant was landed, but that part of the project is even more key now with increased borrowing and construction costs.
“I think the existing office portfolio, especially the Class A, is doing really well, but do I really see us starting new office projects more on a speculative basis? Not without a significant commitment for a pre-tenant,” Irgens said. “We have a lot of great opportunities that are out there, but I think the financing and the interest rate environment is a bit of a perfect storm right now.”
Multifamily
In the multifamily sector, the higher cost of borrowing and rising construction costs might not be pausing all projects, but it is requiring developers to spend a lot more time lining up financing.
“All of a sudden, I’m spending a lot more time trying to understand what lender and investor expectations are now and what they will be, say, six months from now, and the best people can tell you what they are right now,” said Tim Gokhman, managing director of Milwaukee-based development firm New Land Enterprises. “And that’s different because, COVID aside, for the last however many years the expectations were much easier to anticipate. We knew what the market conditions were and so we knew what a project would have to achieve economically in order for lenders and investors to say, ‘OK.’ Now, we don’t.”
Increased project costs are also impacting developers’ ability to provide more middle-range, market-rate apartment buildings, said Gokhman, whose firm is the developer behind the new Ascent, a hybrid mass timber apartment tower at 700 E. Kilbourn Ave. in downtown Milwaukee
“The majority of buildings being built, unless they are subsidized, are the really high-end products, because that is what the construction costs are right now,” he said. “It is a challenge, when the only thing you can produce that is market rate is the highest-end product.”
Stewart Wangard, chairman and chief executive officer of Wauwatosa-based Wangard Partners, also sees the impact of rising construction costs on market rates as an issue. That’s why the company is putting more of its own equity and that of its investment partners into projects these days.
“If we don’t find a way to reduce construction costs, there will be fewer buildings being built, but if we can figure out a way to deliver a project faster and maintain quality, that is one way to address the affordability issue,” Wangard said. “We can still deliver competitive returns, but we have to put a lot more capital in. We can’t rely on borrowing as much from our lenders.”
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