SPECIAL FOCUS >> RISING CONSTRUCTION COSTS

Stories from the Front

BY BENDIX ANDERSON

AFFORDABLE HOUSING FINANCE • OCTOBER 2007

When Hurricane Katrina knocked down trees and cut electrical power to Meridian, Miss., Michaels Development Co. was just preparing to negotiate contracts and lock in construction costs for J.T. Davis Court, the first phase of a HOPE VI redevelopment of the public housing project there called Victory Village.

But the cost of labor and construction materials immediately began to rise throughout the Gulf Coast. Michaels had just a few months to close a $300,000 gap in its construction budget in time to close on a tax-exempt bond-backed mortgage for the 76,000- square-foot project, which would cost $9.8 million to develop, with a hard construction cost of $6.3 million, or $83 per square foot.

Michaels was helped by its habit of bringing experts into the design process early, even though the HOPE VI program urges developers to extend the bidding process and wait to hire general contractors until shortly before the project’s financing closes. With the general contractor already chosen, Michaels began to cut costs.

“We were going through every page of the [construction] documents in order to get the numbers down,” said Jim Miller, vice president for Michaels.

The company saved $140,000 in site work by closely reviewing the geotechnical engineer’s report. Some of the soil under the project site was wet and had to be replaced with dry soil for the 72-unit development’s foundation—but the development didn’t need nearly as much dry soil as the engineer had specified.

If the general contractor had joined the team later, it might have been impossible to make the change and recoup the savings, said Miller.

The contractor also suggested switching from copper piping to much less expensive Pex, a type of flexible plastic piping. The cost of copper was already rising fast, and the change saved the project $30,000. Ditching copper also helped J.T. Davis avoid the break-ins suffered by other area developers who stored copper on their sites. “No one’s going to come in and steal the Pex,” said Miller.

The contractor also suggested going from a three-step painting process to a two-step process recommended by the paint manufacturer that saved $23,000. Switching Kohler and Moen plumbing fixtures for less expensive “builder grade” fixtures also saved the development $6,000.

Thanks to its more than 20 years in the business, Michaels has the knowhow to close budget gaps fast, although the developer has never had to contend with a gap that grew as fast as the one that resulted from Hurricane Katrina.

Last-minute cuts save Evergreen Vista

When rising construction costs carved a $1.5 million hole in the budget to develop Evergreen Vista II, an affordable housing project in Olympia, Wash., Mercy Housing had to dramatically scale back its plans for the 50-unit community.

Mercy, a nonprofit affordable housing developer based in Denver, closed roughly $450,000 of the gap simply by negotiating with contractors and pushing for lower bids.

The nonprofit cut another $450,000 by poring over details of the project’s design and construction to find any expense that could be trimmed. It was a painful process, said Walter Zisette, vice president for Mercy.

Eliminating a playground from the project saved more than $60,000. The nonprofit developer also shrank 100 bedrooms from 10 feet by 12 feet to 10- by-10, saving $100,000. And Mercy removed 1,200 square feet of office space and cut back on landscaping details like trellised gateways.

All those cuts still left a $600,000 hole in Evergreen’s budget, which had to be filled with new capital. Mercy started by deferring $310,000 of its own $400,000 developer fee. The nonprofit also raised an extra $260,000 from foundations, including the Bill & Melinda Gates Foundation. Plus, city and state subsidy programs contributed more financing. “We went back to every funder and asked them to share the pain,” Zisette said.

Finally, Mercy balanced Evergreen’s $9.7 million total development budget. The hard cost of construction for the 51,000-square-foot project came to $6.1 million, or $120 per square foot. Construction started in October 2006 and is slated to finish this year.

Stalling for time

In 2005, Simpson Housing Solutions had four projects that ran over their budgets by 15 percent as construction costs swelled, a gap totaling more than $4 million. Simpson solved the problem by talking its general contractors into accepting notes from Simpson—effectively IOUs—to cover as much as half of the construction cost overruns, or an average of about $450,000 apiece.

For example, when rising costs pushed the Villa Monterey Apartments, a 9 percent low-income housing tax credit project in Blythe, Calif., almost $1.5 million over its construction budget, the general contractor accepted a note from Simpson to cover nearly $400,000 of the overrun. Otherwise, the deal would have collapsed, and the contractor, which had worked with Simpson on several other deals, would have lost the job.

The note will be paid, with interest, from Villa Monterey cash flow. Simpson, an affordable housing developer based in Long Beach, Calif., also deferred all but $100,000 of its $1.2 million developer fee for the $11.9 million project. The hard cost of construction for the 104,000-square-foot development came to $7.8 million, or $75 per square foot.

So Simpson, a for-profit developer, has surrendered most of the income from Villa Monterey. “It’s a pain, but we needed to get these communities done,” said Moe Mohanna, senior vice president for Simpson.