Riding the Up-and-Down Construction Cycle
The coming construction boom will be very different from the last one: different kinds of projects, new ways of financing and maybe fewer rising costs.
It’s often hard to say exactly when the business cycle turns.
Some date the end of Hawaii’s last construction boom to the 2008 bankruptcy of Lehman Brothers, then the fourth-largest investment bank in the country, and the principal lender for Maui Land and Pineapple’s ambitious Ritz-Carlton Kapalua resort. Others say the end began a year earlier, with the demise of subprime mortgage goliaths such as New City Financial, Countrywide and Bear Stearns. In any event, the end came quickly and Hawaii’s construction sector has struggled to deal with the consequences ever since.
Now, the question is: When does the cycle turn again?
Most local experts seem to believe construction is finally ready to come out of its six-year funk. (Although, given the slow pace of recovery, it’s worth remembering the famous Churchill line: “This is not the end. It isn’t even the beginning of the end. But it is, perhaps, the end of the beginning.”) Bill Wilson, president of Hawaiian Dredging, is one of those who seem cautiously optimistic. “It certainly looks like we’re at the beginning of a period of increased construction activity in the state,” he says. He points to the well-publicized list of projects proposed for Kakaako, as well as the City and County of Honolulu’s imminent rail and sewer projects and a variety of road improvements planned by the state. “So, I think we’re moving into a growth period for the industry,” Wilson says. “That means greater employment for everyone with the skills needed to build.”
In some ways, Hawaiian Dredging is at the leading edge of the growth in construction activity, winning a streak of recent bids on major construction projects, including Alexander & Baldwin’s Waihonua project just Ewa of Ala Moana Center, and Halekauwila Place, Stanford Carr’s affordable housing project in Kakaako, adjacent to the 650-foot tower that Carr and Forest City Hawaii plan to build at 690 Pohukaina St.
“Both of those started just about the first of the year,” Wilson says. He also notes that Hawaiian Dredging is the general contractor for the Marshall Homes project on the makai half of the former Honolulu Advertiser site at 801 South St. Demolition started shortly after the “Hawaii Five-0” lease ended, he says, and construction will continue until mid-2015. Similarly, Wilson points out that Hawaiian Dredging broke ground in July for the Ewa expansion at Ala Moana by General Growth Properties.
But, for now, the construction boom is fairly one-dimensional, says Brian Sunada, senior VP for commercial real estate at First Hawaiian Bank. “If you look at all the projects that are on the drawing board, a lot of those are high-rise condos, either in the ground or in the planning stages. That’s the biggest story in the real estate industry right now.” He ticks off the list.
“One is OliverMcMillan’s Symphony project,” he says. “That’s for market as well as affordable buyers, so it’s a combination. Then there’s the A&B Collection project that’s planned for the old CompUSA site. And then you’ve got Howard Hughes. They have 700 units planned, affordable as well as market.”
“There are several others that have announced plans,” Sunada adds, “though I think they’re preliminary right now. There’s a Korean company, SamKoo, that’s looking to develop the old Motor Supply Co. site on the corner of Kona Iki Street and Kapiolani, mauka of Ala Moana Center. They’ve talked about developing a high-rise condo on that site. And, recently, of course, the old YMCA site (on Atkinson Drive) traded hands and a San Francisco developer is looking to build condos on that site. Then, you’ve got the Ritz Carlton Residences in Waikiki. They’ve announced and are in sales and purportedly 75 percent sold.”
This list of projects is what has Hawaii’s construction industry quietly licking its lips. But there are still potential snags. Almost all of this development, as Sunada points out, is high-rise condo and subject to changes in that residential demand. Many projects are also still in the planning or entitlement stage, which suggests the construction cycle hasn’t reached full swing yet, and may account for some of the caution still tinging the industry’s optimism.
“I personally think this is more of a 2014 story than a 2013 story,” says Lance Wilhelm, who, as both the senior VP for Kiewit Building Group in Hawaii and a trustee for Kamehameha Schools, has a unique perspective on the current cycle. “When you look at what it takes to really get into the ground and start doing work – the time for the design development, the time for permit gathering, the time for working through the entitlement process in general – and then you look at the projects everybody has heard about and where they are in that process, it’s hard to imagine that a large number of them will actually come out of the ground this year. You almost have to be shovel-ready today to start building by the end of the year. That’s why I think it’s more of a 2014 story. But I just can’t believe it can be anything but much busier next year than this year.”
But Wilhelm doesn’t think this cycle will be as robust as the last one.
“If you think back to the last peak in the industry, what was going on?” he asks. “There was a lot of government spending, especially in privatized housing. That was Forest City and Lend-Lease getting these large contracts to go into military bases and convert housing from military-run to privatized. So, there was strong federal spending on military bases – Kaneohe, Hickam, Wheeler – where they were building these new facilities.”
That’s probably not going to happen for this cycle, he says. “Much of the optimism is driven by the private sector this time, the talk about Kakaako, in particular. There’s also the possible development of the Kam Drive-in in Aiea and various towers in town. But there isn’t the big privatization project out there on the military bases; there isn’t the big military initiative to point to that would suggest that there will be a lot of growth on the federal side. There isn’t a major new freeway being contemplated from the state level. And UH West Oahu has already been built.”
For this cycle, Wilhelm says, most of the government spending will likely be at the county level. “On Oahu specifically, we have two significant infrastructure initiatives. One, of course, is rail. Obviously, as a participant in those contracts, I have some interest in that, but I look at rail as one of those key investments for Honolulu’s future, an example of not just rehabilitating the infrastructure we have, but putting new infrastructure in place, which we haven’t done for many, many years. And this is infrastructure that’s really going to shape the way Honolulu looks and runs and functions in the next several generations.
“The second important initiative is the sewer, the need to satisfy requirements that were mandated through legal proceedings to fulfill the sewage treatment requirement. That’s imminent. Those are court-ordered improvements that have to happen. When you add those two initiatives up – rail and the sewer – there’s big, big money that has to be put into place.”
The question is whether these multibillion-dollar projects will be enough to support the kind of construction boom that started in the early 2000s. “They’re both big,” Wilhelm says. “They’re game-changers. But I’m not sure they’re big enough to offset flat spending by the federal government and flat spending by the state. So, my personal opinion is that the peak in the next cycle isn’t going to be as big as the last peak.”
The bulk of the construction work will be on Oahu, though there are also a few Neighbor Island projects in the offing, including construction of the Thirty Meter Telescope on Hawaii Island beginning in April 2014 (see story on page 44).
Most of the other Neighbor Island projects are on Maui. For example, the state is reviewing bids for work on the Kahului Airport access road and parking lot – the first stage of a long-delayed airport expansion project. Work on the airport itself, budgeted at about $50 million, will likely start by the end of the year. Sunada notes that there are also some private construction efforts, including Hyatt’s 131-unit timeshare project in Kaanapali and the renovation of the Wailea Beach property into the new Andaz Wailea. Hilton’s $250 million project at the Grand Wailea will also be a boon to Maui construction.
One of the surest signs that the cycle has turned – not just for Hawaii, but around the world – is the increased availability of money to build.
“I think the capital markets are improving,” says Dave Striph, The Howard Hughes Corp.’s senior VP for Hawaii. “I think lenders are anxious to put good deals on their books right now. I think they need the business. There was a long rut for the last few years, so I think everybody’s hungry for business.”
The capital markets have changed since the last peak in the construction cycle. “From a condo-financing standpoint, it’s a different group of lenders,” Striph says. “During the boom, there were really two large forces in the condo construction business: Corus Bank out of Chicago, and Fremont Investment and Loans. Those two players did an enormous amount of the financing. They were also able to hold very large-balance loans. If somebody wanted a $150 million construction loan, those lenders would do the whole $150 million themselves. Today, you’ll find lenders generally want to hold smaller pieces. They don’t want to hold all that risk, so they want to share the risk with other lenders and ‘participate’ the loan.”
One interesting result is that, as the big national players, like Fremont and Corus and I-Star have either gone out of business or given up on the Hawaii market, the local banks, particularly First Hawaiian Bank and Bank of Hawaii, have become much more active in putting together the financing for local development.
“They’re players in the process,” Striph says. “Either one of the larger banks here will act as lead and bring in participants, or a mainland bank will lead and the local banks will participate. But, from a mainland bank’s point of view, having the local banks involved in the deal gives them a great deal of comfort. That’s because they know the local banks know the market better than they do.”
Sunada agrees. “For the most part, your best bet is to stay local, as far as your financing is concerned,” he says. “Only because the local banks here understand the market a lot better than mainland lenders. And for mainland lenders, if you’re doing a construction project, unless there’s a local bank involved in the project, it’s pretty hard for them to participate.”
The other big change in the capital markets is that lenders simply have higher standards, Sunada says. “Things got skewed back in the mid-2000s, when a lot of these off-shore institutions got aggressive in our marketplace. You may not be seeing that type of aggressiveness from the off-shore lenders this go-round.” This time, developers will need more equity, more experience and, especially, more pre-sales.
Those pre-sales probably need to come with binding deposits, which will likely change the mix of projects that actually get done, Striph says. “What that does is, it stops a lot of projects from going forward that may not be as well-conceived. A guy may say he has plans to build a 200-unit condo here, but if it’s in a bad location or there’s something wrong with his plan, and he can’t get the level of pre-sales, then his deal’s been stopped because he can’t get the financing. So the lenders act as a governor on development, to some extent.
“Having said that, though, I think there’s plenty of construction financing available for well-thought-out, well-planned condo transactions in strong markets and with strong sponsors. I think, if you have all those ingredients, getting financing is not an issue.”
Not surprisingly, Striph believes Howard Hughes’ Ward properties have those ingredients in spades. “Honolulu is a very supply-constrained market,” he says. “It’s difficult to find land here and it’s difficult to get it entitled, so you naturally have barriers to entry here. If you do have a project that you’re getting off the ground, there’s not as much competition as there might be in other markets. And lenders love that type of environment.”
Cost of Materials
Another change that may affect the construction cycle this time is the reduced price volatility of construction materials.
“When you think of the cost of materials,” says Kiewit’s Lance Wilhelm, “you think of commodities, like steel, concrete, things like that. Steel, in particular, works as global commodity today; the price of steel moves on a global scale. It’s no longer a domestic question. It’s not about whether or not the United States is busy. It’s really how the global economy is moving, and increasingly how large consumers like China are operating. So, as their demand goes down – and China’s demand has gone down some – prices of these commodities go down some.”
Wilhelm also believes technology has made the market for building supplies much more efficient than it used to be. “Fifty years ago,” he says, “it was very difficult to adjust the manufacturing cycle to meet demand. You didn’t have the technology to manage the supply cycle. If you were an iron company – say NuCor Steel – and you supplied steel, you almost had to run your plant even if there was no demand. You had a plant and it took a lot of manpower to run that plant, so you made steel beams whether anybody needed steel beams or not. Consequently, when demand fell, prices would fall dramatically, because you had all this supply sitting there. When demand went up, prices went up dramatically, because there was almost a fixed supply.
“Flash forward to now: There’s a lot more technology in the entire supply stream, from the mining of the raw ore that comes out of the ground, to the milling of the finished steel that comes out of the plants. So, as an example, in an iron ore mine, you might be able to run your trucks without drivers, because there’s so much technology now, and you can do things with GPS systems and computers and all this stuff. You can be super-efficient. If demand drops, you can drop your production; you can just not do as much work. So the movement of the supply and demand curve is much tighter, much more efficient. What that means is there’s far less price fluctuation than there used to be, because supply and demand move together, so you don’t get those wild swings. There is still movement, there will always be movement, but you don’t see the kind of wild swings that you used to see.”
That’s not to say there’s no volatility. Supply is still a little less elastic than demand, for example, which can lead to imbalances. “Also,” Wilhelm says, “there’s a lot more speculation in the market then there used to be. People are buying and selling steel who have no interest in the steel product; they’re just trying to make money on the movement in the prices. So, these commodities have become part of the financial markets, and speculators probably move the volatility of the price as much as anything else. That’s my Wilhelm Theory, untested.”
If material costs are less volatile, and capital is both cheaper and more readily available, what will be the key factor in construction costs in this cycle? Wilhelm believes it’s likely to be a shortage of skilled labor.
“General contractors, like Kiewit, have the capacity to do a lot of work,” he says, “but we rely on specialty subcontractors to do much of the actual labor, especially on vertical construction. You have your roofer, your glazier, your reinforced steel installer, the guy who hangs drywall, the painter, the floor layer – all these subs go into the construction of any given building. But there are far fewer of them, so the subcontractors have less ability to expand and contract.”
In fact, the big general contractors have already begun adding staff for the upswing in construction. Hawaiian Dredging, for example, which cut salaried staff nearly 40 percent during the recession, is already back up to 2006-2007 levels. But, as the cycle heats up, the shortage of subcontract labor is likely to be the main constraint on growth. The most successful general contractors will be the ones that figure out how to deal with that shortage.
But the main way to manage risk, Hawaiian Dredging’s Bill Wilson says, is to diversify. “We are the most diverse general contractor in the state of Hawaii, and have been for many, many years. We build new buildings and renovate others that have already been built. We do large jobs and small jobs. We work on Oahu and on different islands.” He points out that this work involves everything from roads and bridges, to harbors, to five-star hotels and high-rise condominiums, to serving as the foundation subcontractor for other builders.
Wilson’s point isn’t to gloat, but to highlight the value of a diversified skill set. “You need to be prepared to build what your clients or the community wants built.”
Lance Wilhelm says much the same thing for Kiewit: “Besides towers and things like that, we do roads and bridges, we do underground utilities, we do power plants, we do terminal facilities, we do harbors and pier work. In some cases, we might move resources, for example, from building construction to industrial construction, because a crane doesn’t care whether it’s building a hotel or a power plant, it just wants to work.”
In addition, he says, Kiewit has the option of looking for work elsewhere. “For example, we can do vertical construction, like a high-rise condominium or a hotel tower, in Honolulu. But we can also do that in Denver, or in Arizona, or in California, or in New York City. And, we can and do move resources from one location to another as markets adjust. That’s one way we address the cyclical nature of markets.”
The smart players know the cycle itself is opaque. They can never predict the peaks or the valleys. Local conditions will always be subject to events far beyond their control. Capital will come and go. Government spending will ebb and flow. As Bill Wilson points out, all they can do is hedge their bets by being prepared.
“Contractors don’t decide what’s built,” he says. “And we don’t decide what the market cycles are. We respond to these conditions.”
Skyscraper Index: tracking Booms and Busts?
It’s interesting to look at the Honolulu skyline through the lens of the famous Skyscraper Index.
This theory, first proposed by the economist Andrew Lawrence in 1999, posits that the construction of the tallest skyscrapers usually presages major economic downturns. He offered as examples the Singer Building and the Metropolitan Life Building, which were once the tallest buildings in the world, and which both began construction just before the Panic of 1907, and 40 Wall Street Tower, the Chrysler Building and the Empire State Building, all of which began construction just prior to the stock market crash of 1929 that precipitated the Great Depression. To this list, you could also add more recent examples, such as the Sears Tower and the World Trade Center, both built immediately prior to the stagflation of the early 1970s, and the Petronas Twin Towers, completed in 1997, just in time for the Asian Economic Crisis.
Does the Skyscraper Index apply to Hawaii?
Before answering that, it’s worth noting that not all economists buy the Skyscraper Index. They point to the construction of prominent buildings, like the Woolworth Building, in 1913, that aren’t associated with a financial crisis, or to major recessions, like Japan’s “Lost Decade,” that weren’t preceded by the construction of any iconic skyscraper. Lawrence himself proposed his theory at least partly in jest – in a paper whimsically entitled, “The Skyscraper Index: Faulty Towers” – so it’s probably a mistake to take it too literally. But, to the layman, the correlation between the construction of giant skyscrapers and the incidence of financial crises seems hard to ignore.
That’s true even in Hawaii – notwithstanding that none of the buildings here are tall in the sense that Lawrence meant. For our purposes, maybe they’re just tall enough. Think, for example, of the towers that were either completed just before the last cycle peaked (Capitol Place, Moana Pacific and Keola Lai) or whose completion was stalled or complicated by the credit market collapse that began in 2007 (The Allure and Moana Vista). Previous recessions had their own symbolic Hawaii high-rises (for example, the Japan Bubble: Prince Hotel and Ihilani). Indeed, this is how it’s been for almost every cycle in the Hawaii economy. The question today is simply: Which of the towers on today’s drawing boards will make its own mark on the local Skyscraper Index?