Los Angeles Construction Market Mid-Year Report | 2018
In April 2018, US non-residential construction spending exceeded the previous peak in 2008 by 4%. The AIA Architectural Billing Index (ABI), forecasts that this level of activity is expected to extend into 2019. The Western US Region in particular has shown the strongest indicators of continued growth, with a leading average score of 55.7, compared with 54.3 for the South, 53.3 for the Midwest, and 47.9 for the Northeast. Construction employment in Los Angeles alone is projected to grow 3.75% in 2018 and 6.4% in 2019, as reported by the Los Angeles County Economic Development Corporation (LAEDC).
By the end of March 2018, the number of permits issued by the City of Los Angeles alone had already exceeded the total 2017 volume by 1,000. Unique growth drivers for Los Angeles County include robust entertainment, biotech, transportation, defense, finance, and healthcare industries, and an ambitious urban revitalization plan, which includes preparations for the upcoming 2028 Olympics.
Although this report focuses primarily on construction activities within the City of Los Angeles, markets throughout the region are closely linked and our analysis and recommendations are generally applicable to all cities within the County.
Private Development Activity
MGAC Research tracks private developments in the proposed, planned, or under construction stage on an ongoing basis. As of June 2018, this includes nearly 50 major private projects in the pipeline across the County, the majority of which are concentrated in Downtown South Park, Koreatown, and Hollywood.
Over 85% of projects in the pipeline feature a residential component, with many of the units, particularly in Downtown LA, being positioned as “luxury” housing. Among these projects include:
- Angels Landing – A $1.2 billion, 88-story mixed-use tower which was approved in December 2017.
- Grand Avenue – A $1-billion Frank Gehry designed project scheduled to break ground in Fall 2018.
- Chinatown High Rise – A Studio Gang designed 26-story, wavy glass and steel tower that will add 294 apartment units and 149 hotel rooms to the old Chinatown neighborhood.
There are also several other major, non-high-rise mixed use projects that are changing the landscape of the city, notably the $1.2 billion Lucas Museum of Narrative Art which broke ground in March 2018.
Downtown Hotel Developments On The Rise
The Department of Convention and Tourism Development set a goal in 2012 to increase the total number of hotel rooms within walking distance of the Los Angeles Convention Center (LACC) to 8,000 rooms by 2020. As of October 2017, 67% of this goal has been met, with over 4,600 hotel rooms available in the market and over 700 new rooms under construction.
An additional 3,000 hotel rooms have been proposed near the LACC, that, upon completion in 2020, would move the City forward to reaching its goal. Major hotels in planning include:
- Fig+Pico Conference Center Hotels – A 1,000-room hotel developed by the Lightstone Group.
- City Lights Hotel Towers – A 1024-room hotel developed by TriCal Construction Inc.
- W Hotel at 1020 S Figueroa – A 300-room hotel by Chinese developer Shenzhen Hazens.
- 1600 S. Figueroa – A 250-room hotel within the mixed-use tower developed by L&R Group of Companies.
- Figueroa Centre – A 220-room, 66-story hotel by Regalian LLC.
- JW Marriott LA Live – A 850-room, 40 story hotel developed by LA Convention Center operator AEG
Foreign Investment Slows But Interest Remains High
Although LA County continues to draw the bulk of foreign investment in Southern California, the overall volume has fallen.
Construction activities by foreign-owned enterprises have followed this shift with a nearly 60% drop in number of jobs and wages paid. Over the last year, the high-profile withdrawal of Chinese developers and investors due to mainland capital control policies have been a major contributor to this trend, with Chinese investments reportedly declining by 67% since 2017. Only a handful of Chinese developments remain on-track in Downtown LA, including:
- Olympia – a $1 billion tri-tower development and 1233 Grand Ave, a 24-story residential tower. Both projects are being developed by City Century, a subsidiary of Shanghai based Shenglong Group.
- Grand Avenue Project – a $1-billion project developed by Related and funded in part with $290 million from CORE, a subsidiary of China Communications Construction.
- 1020 S Figueroa – a $700 million mixed-use development by Shenzhen Hazens.
- The Wilshire Gate – A 33-story mixed-use tower in Koreatown, developed by Jia Long USA, a subsidiary of Jia Long Beijing.
Despite this slowdown in investment activities, interest in Southern California real estate, particularly trophy assets, continues to remain strong.
According to Young Kim, Managing Director of 8th Bridge Capital, an LA based investment management firm specializing in Asian EB-5 and private equity funding, “Chinese investors are still very much interested in what they consider to be stable and often undervalued assets here in LA when compared to other global Tier 1 cities like Beijing or Shanghai. Many of my Chinese clients believe that these capital controls are a temporary measure employed by their government due to sensitivities in the current US-China trade relationship.”
Investors from other Asian countries share a favorable image of LA and, less restricted by government policies, are continuing to ramp up their exposure to real estate across the County. “Koreans, Taiwanese, and Vietnamese investors are very eager to invest here” notes Kim. “I am asked on a weekly basis to find a real estate deal that ranges anywhere from $1 million to $500 million”.
Korean and Taiwanese investments are primarily conducted by institutional players looking to participate in syndicate deals, while Vietnamese investor activity is focused around ultra-high net worth individuals looking for private equity deals, typically under $30 million, or EB-5 deals.
In an upcoming report, MGAC’s development advisory and lender services groups will be analyzing foreign investment trends including challenges and misconceptions of EB-5 funding.
Linkage Fee for Private Developments in DTLA
In December 2017, the LA City Council approved the Linkage Fee, a fee on development that is expected to generate $104.4 million in annual revenue. The City plans to direct these funds toward the construction and preservation of affordable housing.
The linkage fee will have an immediate cost impact for developments filed after June 18, 2018. The current fee employs a tiered structure in which residential developers are charged between $8-15 per square foot, and commercial developers $3-5 per square foot. However, the City is exploring the feasibility of increasing the linkage fee amount to $18 per square foot for residential development projects in wealthier “high market” areas including Hollywood and DTLA.
The linkage fees would be phased in 3 steps, beginning four months after the ordinance effective date of February 17, 2018:
- One-third of the total linkage fee amount will be charged for developers submitting building permit or entitlement applications on or after June 18, 2018
- Two-thirds of the total linkage fee amount will be charged if applications are submitted on or after December 20, 2018
- The full linkage fee amount will be charged for applications submitted on or after June 17, 2019.
Challenges In The Entitlement Process Continue
With the amount of large developments planned in LA, the entitlement process is becoming more difficult.
Owners of large development projects may go through lengthy deliberations with the local community to address various issues including affordable housing, environmental concerns, and employment opportunities.
One example is the $1.2 billion Broadway Square development (The Reef) in South Park. Over a year since it was approved in November 2016, ground-breaking was finally able to proceed after a public benefits package was agreed upon. This package included the provisions that 5% of the 1,400 units would be set aside for low-income residents, an $18 million contract to preserve affordable housing contracts in the community, and a commitment of giving 30% of the construction jobs to local workers.
Challenges in entitlements are one of many nuances in the local development process that have deterred foreign developers. Even sophisticated Chinese developers with successful overseas developments have faced issues in navigating complex local regulations and procedures that have resulted in schedule or cost overruns and stalled projects.
Although Los Angeles continues to remain an attractive destination for foreign capital, these complexities have steered overseas developers to other global cities such as London and Melbourne, where the development process is less cumbersome.
Public Sector + Institutional Development Activity
Many of the major public-sector projects in Los Angeles County are focused on either upgrading aging facilities or preparing the County to host the 2028 Olympics, with multiple public agencies and institutions making a concerted effort to transform the city’s infrastructure over the next 10 years. As of June 2018, there are nearly 20 major public-sector/institutional projects or programs in the pipeline including:
Partnerships and M&As Formed To Tackle Mega Projects
The ongoing transformation of the County has resulted in several billion-dollar mega-projects that have required companies to join forces in order to compete and deliver on. These projects include:
- Harbor-UCLA Medical Center Campus – A pre-planning exercise which will pave the way for a major master plan project at the 72-acre campus. A JV team led by AECOM includes JGM, Citadel CPM, and Jensen + Partners.
- LAX Automated People Mover – A $4.8 billion a public-private-partnership project designed to shuttle travelers to and from LAX more efficiently. LAWA entered a 30-year contract with LINXS, an integrated team consisting of Fluor, Balfour Beatty, ACS, Dragados, Hochtief, Flatiron, HDR, HNTB, and Bombardier Transportation.
- LAX Midfield Concourse – A $1.25 billion expansion planned to add 11 passenger gates to the airport by 2020. LAWA awarded the design and construction contract to a JV between Turner and PCL.
In addition to joint-ventures and public-private-partnerships, a growing number of AEC firms are looking towards mergers and acquisitions as a key strategy to position themselves for both the specialty and integrated services demanded by large infrastructure projects.
In Q1 2018, California led the nation in the number of M&A deals. According to Morrissey Goodale, California saw a total of 13 M&A deals in Q1 2018 involving A+E firms, with 10 deals involving firms ranked on ENR’s Top 500 Design Firms list including Tetra Tech (ENR #5), NV5 (ENR #54), CannonDesign (ENR #79), HBK Engineering (ENR #220), EnSafe (ENR #222), Salas O’Brien (ENR #232) (two deals), Advantage Engineers (ENR #425), Steinberg Hart (ENR #440), and DAHLIN Group (ENR #487).
Impact On Construction Costs
Construction cost indices such as the ENR Building Cost Index (ENR BCI) and the California Construction Cost Index (CCCI) offer useful benchmarks when estimating project budgets. However, Owners should take care to update their calculations as the indices update, or better yet, reconcile their projections with actual cost data from recent comparable projects.
In markets as dynamic as Los Angeles, it is not uncommon for indices to be outpaced by real-time costs by the time the project breaks ground, especially among larger, more complex institutional works. The CCCI for instance, is a popular index routinely used by major regional agencies and institutions such as the California State University (CSU) and Judicial Council of California (JCC) to set budgets for their future capital programs. The CCCI reported an annual construction cost increase of 4.4% in 2016 and 3.5% in 2017. In our experience, however, real-time construction costs increased by 6-8% per annum over that 2 year period.
Uncertainty around the recent steel tariff has also contributed to greater risk around construction costs. This may be further compounded by the recent extension of the Tariff to now include Mexico, Canada, and the European Union. Although the tariff has broad implications across the US steel industry and steel-framed structures, the actual direct cost impact on projects will, in most cases, still be less than 1%.
Putting It Into Context
Moving forward, the current volume of construction activity is expected to remain strong over the next 18-24 months. As many major projects near planned completion in 2020, the tension between demand and supply of skilled labor and key materials will become less pronounced. The general consensus is that the market will begin to level off in 2020.
We are also of the opinion that the market is moving into the latter stages of what tends to be a historical cycle of activity that ebbs and flows over 5-10 year durations. The current cycle of increased investment, construction activities, and costs began in 2013, putting us in the fifth year of continued and rapid growth.
The other factor to consider is how are projects being procured both now and in the future. The current trend is heavily weighted towards early and continued engagement of the general contractor or construction manager during the design phase through either design-build, Construction Management-At-Risk (CMAR), Integrated Project Delivery (IPD), or other variations of these selection methods. On many projects this practice is also being extended to design-assist strategies for major trades such as curtainwall, MEP, and elevators.
While this brings benefits to the Owner relative to constructability input during design, it can lead to a less competitive climate as Owners lock in contractors and subcontractors through negotiation or limited bidding. While it seems unlikely that the market will revert back to the “not so traditional anymore” hard bidding environment, it will be important for Owners to evaluate their options for procurement and to ensure that their budgeting reflects their preferred or selected strategy.
A number of our clients are asking about all of this relative to planned projects and how best to set budgets in today’s market that are still realistic knowing that they may not break ground for 3-4 years. Our advice to them is to be cautious but not overly conservative in budget planning.
The rising cost of construction over the past couple of years is unlikely to be sustainable in the longer term and when the market does re-adjust it will lead to improved competition at the trade level. In anticipation of this we are recommending that escalation factors should be dialed back to a more historical average of around 3.0% to 4.0% per annum when planning for investment in 2020 and beyond.
MGAC will continue to track this over the short-term and provide updates as further data is gathered and analyzed.