Speakers at the recent Lodging Conference say a labor-shortage-driven dearth of quality contractors and subcontractors and tariff-induced higher prices for key materials are slowing the rate of construction enough for it to be a concern in the U.S.
PHOENIX—A tight labor market that has hotel developers scrambling for quality contractors and subcontractors, and escalating costs associated with tariffs being implemented on certain materials and products, have pinched the hotel construction landscape in the United States, according to speakers on the “Current pace of new construction” breakout discussion at the recent Lodging Conference.
The lack of reliable and skilled subcontractors has been a challenge for hotel developers for some time. Vinay Patel, the 2018-2019 secretary for the Asian American Hotel Owners Association and president and CEO of Fairbrook Hotels, said there are subcontractors available, but in many cases it’s a “buyer beware” situation because of a lack of quality.
“You really have to be careful with the subcontractors,” Patel said. “One issue at our hotel was the plumbing contractor was so horrible that after we opened, it was such a big problem. It’s just a challenging problem for contractors and also the owners. It’s just tough to find good, quality people. And labor is short everywhere.”
Nate Gundrum, VP of real estate development for Mortenson Development, said the lack of quality subs hasn’t affected schedules as much as it has affected the cost of a project.
“Labor accounts for 40% of the cost of a construction project, and labor shortages are putting an upward pressure on wages and affecting total project cost,” he said. “That’s one of the reasons the industry is having such a strong push into other building systems like modular and pre-fabrication techniques.”
Developers and contractors are always searching for workarounds for sub shortages, said David Bader, managing principal for Cumming Construction Management.
“There’s a quality issue, there’s a shortage issue, and it’s a big cost issue,” Bader said. “We look at bringing the major subs in really early so you can … tie them up and give them a project that they actually want to work on, get them involved in design, design assist or design build.”
Spending more time on the front end qualifying contractors and subcontractors is most important in times like these, said Mark Laport, president and CEO of Concord Hospitality Enterprises Company, which has approximately $800 million of projects in its construction pipeline.
“We will pay more to make sure we have the right competency on our jobs,” he said.
“It’s a highly relational business, so when we’re interviewing contractors we’re actually asking them to bring the four or five key subs to the table,” Bader said. “They’re going to have the relationship, and we want to know if that’s going to extend through the coordination of the process.”
Vetting subs to know their true capacity is an important step for developers as it allows them to determine whether they can accelerate their plans, he said.
“We’re looking at their backlog—we’re competing with hospitals, we’re competing with other major construction (projects)—so we’re really looking at their full scope of work,” he said. “We’re actually pushing the gas to build as fast as possible because time-related costs are massive. It can be a couple million bucks a month for larger projects.”
Other variables affect the timeline, too
However, the timeline isn’t always construction driven. Laport said he heard at a recent meeting that a franchisor application to opening hotels has now extended to 34 months for select-service properties. Ten years ago it was about 25 months.
Julienne Smith, SVP of development and owner relations for Hyatt Hotels Corporation, said Hyatt’s boilerplate agreement accounts for 12 months to start construction and 12 months to complete construction—but there’s almost always negotiations to extend that timeline.
“You really have to have your deal completely fully baked at that point of execution with financing and everything, which isn’t the case these days, in order to paint that timeline,” Smith said. “We’re seeing the extension of that timeline in a huge way.”
There were more than 188,000 rooms in the in-construction stage in the U.S. at the end of September, according to STR, the parent company of Hotel News Now.
Things outside the control of developers often shape construction trends and timelines. Smith said when labor appropriately pivots to relief from natural disasters, such as the hurricanes and other weather-related situations during the past 18 months, it affects hotel development.
“It takes away from labor on-site at the hotels, but it also creates a divergence of materials coming to the hotel side as well,” she said. “The cost is not getting any better either, both in labor side and the product that is coming overseas, so it’s been tough.”
All of this adds up to a sense of urgency among developers to get projects locked in and finished as quickly as possible, speakers said.
“The fear and the reason why a lot of people are putting the gas on the construction timeline is the tariffs,” Smith said. “We just heard that a certain product out of China might increase by 30% to 140%. That’s a huge range, so we’re quickly looking at alternatives for that specific product. I think that’s just the beginning. We’re going to see a lot of that, and we’re going to need to respond to that.”
Rising costs because of new tariffs are on top of Gundrum’s list of what’s accelerating construction costs.
“We spent the first half of 2018 trying to figure out how the steel tariffs were going to impact the industry,” he said. “You break down a building, around 20% of the components of the building include some form of steel or aluminum. You think about a hotel, you got hollow metal doors, door frames, studs, conduit … those are all parts and pieces with aluminum steel or aluminum. Part of that is accelerating the cost escalation that we’re facing. Just when we think we’ve absorbed the steel and aluminum tariffs, now we’re dealing with this new round of tariffs.”
Patel said the adjustment to such cost increases is for the developer to go back to their pocketbooks.
“That’s the risk in terms of construction,” he said. “Some of the stuff you put the onus on the contractor and say, ‘Look, here’s what we agreed upon,’ and I understand things happen, but I’m hoping that they would have done their due diligence and got what they needed to get prior to all of this stuff happening. But it’s a negative consequence. You can go back to your lender, but today the lending environment is not as easy as it was two or three years ago. So at the end of the day, it will have to come out of his pocket to pay the difference.”
Finding the right contractor in the form of a fixed price is how Concord usually is successful at mitigating cost escalation, Laport said.
“It’s just starting to reverberate through our industry, all construction industries,” Laport said. “I do know we basically built the same hotel 14 months apart, square footage almost the same project, and we saw about a 16% increase.”
Rising costs mean underwriting challenge
All of this means it’s much more difficult to underwrite a project that it had previously been, speakers said.
“Of course, construction costs are rising faster than average daily rates and (revenue per available room), so we see it being more difficult to do the velocity of projects,” Laport said.
“There’s no good—it’s all bad or ugly,” Bader said. “We’ve literally killed two projects in the past two weeks because of the predatory pricing on the steel and aluminum. Even if the stuff’s coming domestically, the prices are up ticking.”
Bader said he’s seen structural steel bids come in 20% or 30% over expectations, which makes a project difficult to pencil out.
“We’re having to do what we did back in 2005, ’06 and ’07, specifically with the big healthcare providers, is actually negotiate escalation ranges on the commodities first,” Bader said. “Now with the second and third passes on the tariffs, we’re looking at (furniture, fixtures or other equipment) the same thing because so much FF&E is coming from overseas. So pre-negotiating at least some ranges for the escalation.”
Laport said Concord is careful to make sure there’s a fair contingency on the construction side to keep all parties happy.
“At the end of the day, we want our contractors to make money—we want them to feel they’re on our team and we’re on their team,” he said. “But it’s a dance for sure.”