Understanding construction costs before buying the development site
When shopping for a development site you’ll often obtain only basic information on the property. The summary will tell you the address, plot size, and something called the “allowable buildable area”. Based on this very sketchy outline you’ll need to calculate your expected rate of return on the investment, probably on a napkin or something of the like. The quality of this calculation will decide your ultimate fate with the investment. The initial cost you’ll use to calculate RoR is basically comprised of the acquisition and construction costs. The acquisition cost will be up to your judgement as you evaluate future cash flows, however the construction cost is relatively fixed and out of your control, so the quality of your “quick” construction estimate will be crucial. As an example, imagine the purchase of a development site where the allowable buildable area is listed as 100,000 s/f. As you take out your napkin and pen you’ll start scratching something as follows: 100,000 s/f @ $300 psf = $30 million. Now with this simple math you have carved into stone the ultimate success or failure of this 8-figure investment. So how accurate is the calculation? The answer is, unfortunately, not very. Let’s take a look the 100,000 s/f of allowable buildable area. The allowable buildable area is the basis for calculating all of your expenses and revenues. If your aim is to max out the size of the building in order to maximize your profits, are you going to build (and pay for) a 100,000 s/f building? The answer is no, you will need to build more. The allowable buildable area, calculated by the allowable FAR under local zoning regulations, only accounts for what will be built above the ground. Most buildings will have at least one basement and the cost of subsurface construction needs to be accounted for, as does the construction of various mechanical spaces and roof-top structures or bulkheads, which are also exempted from FAR restrictions. On a ten-story building of 10,000 s/f per floor, a basement can add 10% to the gross construction area, and other structures could increase that figure to 15%, equating to a gross construction cost of $34.5 million, a significant step up in our napkin calculation. Now looking at the $300 psf cost estimate, you may ask again, how accurate is that? I’m going to have to answer again, sorry, not very. Even if you feel that you are very plugged into the market and you have precise knowledge of the going rate for the exact type of construction you are planning, there are still too many variables affecting the figure. There are market variables to consider such as the point will be at in the business cycle when construction actually starts. Will we booming or busting? Construction costs are extremely sensitive to market demand. What is the location of this development? Is it in a cramped site in Times Square or in a roomy green field in suburban New Jersey? Is there a requirement to build with union labor? Carefully consider these questions. The geometry of the building you’re contemplating is also crucial to estimating the construction cost. For the 100,000 s/f building, is it a 100-story building with 1,000 s/f floor plates? Or perhaps it’s a one-story building on that green field in New Jersey? These are two extremes however clearly the shape of the building will greatly affect the psf cost. The perimeter ratio, or the ratio of total façade area to total floor area, has a great effect on per-square-foot price. A slender building will have much more façade for a given amount of floor area, a cube-shaped building will have the least. More façade area means a higher construction cost per square foot not only for bricks and windows, but since the building has more exposure to the elements, the heating and cooling for the building will have a greater cost per square foot. That will affect HVAC and electrical trades, and together with the façade will amount to an extremely high impact to the overall construction cost. The bottom line is that when considering placing an offer on a development site, it is crucial to get the basic information before calculating your offer. Have a qualified architect review the zoning and likely geometry of the building (the massing), and have a construction expert give you some good thoughtful advice on the likely construction costs. The success and failure of this investment, or needless loss of opportunity, is worthy of even the most basic due diligence.