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The New York Times
April 13, 2005

Rising Steel Prices Force Changes in Construction Plans

By Susan Diesenhouse

For Richard L. Friedman, chief executive of Carpenter & Company here, redeveloping the historic Charles Street Jail into a $100 million four-star hotel is a dream project. In two weeks, he hopes to start construction on a major addition and renovation of the majestic stone structure, which has a prime location near the Charles River, world-class hospitals and the State House. It is at the foot of Beacon Hill, a neighborhood with 19th-century town houses, brick sidewalks and period lighting.

But since planning started on the development, which had a $50 million construction budget two years ago, the prices of steel and other construction materials have soared, and Mr. Friedman undertook an eight-month redesign to bring the construction budget, which had risen to $70 million, down to $64 million. Because of the higher total cost, he was also required to put up an additional $6 million in equity.

The architects, Cambridge Seven Associates Inc. and Ann Beha & Associates, removed the basement that had been planned in the addition, reduced the distance from each floor to the floor above and added a 15th story, said the project manager, Darren D. Messina. "We couldn't afford it at 14 stories," he said. Seeking room rates of $250 a night, "we were a little handcuffed in what else we could take out," he added.

Despite a four-year effort to put this deal together, "it's been a nightmare," Mr. Friedman said, expressing a sentiment heard around the country from private, public and institutional developers, builders and architects. To rein in construction costs that are often 10 to 20 percent over budget or even more, they have had to redesign or re-engineer projects, increase investments or borrowing, cut projected profits and delay or cancel construction.

Since June 2003, the price of steel has doubled. The costs of copper, gypsum, plywood, lumber, cement and petroleum used to fabricate, transport and install many materials have also increased steeply, if less drastically.

In construction, steel is pervasive. It is in structural frames, floor decks, ceiling grids, air-handling systems, wiring, plumbing, interior studs and bars that reinforce concrete. Last November, an index reflecting the cost of a theoretical market basket of steel products peaked at 412.6, according to the Producer Price Index compiled by the United States Bureau of Labor Statistics. Prices then turned down and by January, the most recent month for which the index is available, they had eased off to 330.7, but this is still double the level of 165 in mid-2003.

Such nettlesome price increases have been compounded by the difficulty at times in obtaining steel and other materials as the fast-growing economies in Asia, especially China, soak up supplies.

Meanwhile, the output of steel in the United States has fallen. From 1999 to 2002, when prices were more stable, the value of steel products made in the United States fell from $171 billion to $131 billion, said Joseph P. Kowal, the bureau's senior economist for the Producer Price Index, who adjusted these prices for inflation.

All this combines to create risk and uncertainty for developers, builders and architects. "What makes this steel situation scary is the speed of the price change and our inability to control it," said Michael McNally, co-chief operating officer of Skanska U.S.A. Building Inc., a builder based in Parsippany, N.J.

David Manfredi, a partner at Elkus/Manfredi Architects Ltd. here, said: "Every sizable project has been affected by the rising cost of steel. It's the demand in Asia and the decline in U.S. steel production. In a global economy, steel goes to the highest bidder." As a result, he added, "some developers have stopped design work."

In California, foundation work was halted in December on a retrofitting of a 2.2-mile span of the San Francisco Bay Bridge so it can better withstand earthquakes. Construction of the actual span, which was scheduled to start last October, has been delayed indefinitely as state officials and lawmakers grapple with the price tag of $6 billion, up from the 2001 estimate of $2.6 billion, largely because of the rise in the cost of steel, according to state transportation officials.

"The price of steel and concrete went through the roof," said Christopher Traina, the supervising bridge engineer. "We also have an availability problem; the lead time for buying materials went from three to eight months."

At the Pennsylvania State University medical center in Hershey, just three hours east of Pittsburgh, once the heart of United States steel production, the metal is so expensive that the college cannot afford to build a planned 264-bed residence. Instead, the plan was downsized. This summer construction will start on a new 105-bed dorm, and 152 beds will be placed in renovated buildings nearby, said Linn Morris, the senior project manager.

Furthermore, for the college's wider expansion plan, totaling approximately $500 million, "the inflation of construction dollars may delay some projects," he added.

In February, the Trump Organization started site preparations in Chicago for an $850 million, 2.6-million-square-foot mixed-use tower. To keep costs in line, it now has a concrete foundation rather than the steel frame that the architect, Skidmore, Owings & Merrill, had originally planned, said Donald J. Trump Jr., the vice president for development. He cautioned that if steel prices spiked again and interest rates rose, "the real estate market will decline."

According to William Wheaton, professor of urban economics at the Massachusetts Institute of Technology, developers in markets where demand is strong for housing and industrial facilities are not hurt as badly by rising construction costs. For those that specialize in office construction, however, "this could ultimately put a damper on development because tenants are not in the mood to pay higher rents," he said.

One company that has not suffered with higher construction costs is the AMB Property Corporation, an industrial real estate investment trust based in San Francisco with a $6.4 billion portfolio. It has ramped up its construction of new warehouse-distribution space worldwide even though it must pay more to build it, because many prospective users are doing so well that they are less resistant to higher prices than office tenants. "We're compensated by double-digit growth in global trade and 10 percent rent increases near airports," said Gene Reilly, an executive vice president.

But many developers working on office projects are struggling with rising material costs. In suburban Framingham near here, for example, the profit margin was halved on a $10 million office that National Development, based in Newton, is constructing for a tenant that has leased the entire building, said a partner, Jack O'Neil. From last August, when he started negotiating rents with his tenant, to December, when the lease was signed, rising steel prices consumed much of his profit.

Patrick Lee, a partner at Trinity Financial Inc. here, which develops mixed-income multifamily housing, often with public tax credits, said the jump in steel prices "put us at risk in every project we're doing."

"We finally put the financing together, and our construction comes in 15 percent over budget," he said. "Our lenders don't believe it, and it's making me cry." In Newport, R.I., he started construction last fall on the second phase of Newport Heights, 147 units in a 425-unit apartment project, but rising costs forced him to replace shingles with vinyl and cut some trim from the facade. "The architecture isn't all we'd hoped," he said.

Architects must design years in advance with prices of land, financing, materials and construction in mind. Now, by the time construction starts, "it's difficult to foresee what will happen to costs," said Mark Sarkisian, a partner at Skidmore, Owings & Merrill in San Francisco.

While steel prices have eased off about 3.5 percent since January, developers' woes have not ended, said Peter Timothy, president of A.M. Fogerty & Associates, an independent price estimator in Hingham, Mass. Fabricators that supply steel components will guarantee prices for only a few weeks rather than for several months as they once did, and construction contractors are reserving the right to charge developers more if material prices rise.

Indeed, Mr. Timothy added, because of "the largest price increases I've seen in 25 years" for steel, he estimates that overall construction costs in 2004 increased about 12 percent compared with a more common annual inflation rate in construction of about 3 percent. "Private developers can adjust by cutting quality, but cities and states everywhere are finding it real tough," he said.

Recently, the nearby city of Waltham delayed construction of two schools in its $154.2 million eight-school expansion plan as high building costs compounded other problems. "If the United States still had a major steel industry, this wouldn't be such a problem," said John Cervone, chief of staff to Mayor Jeannette McCarthy. "It's gone beyond a ripple to a domino effect."



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