The perks and perils for developers who do their own construction

Being your own general contractor can cut costs, but is it worth it?

New York /
Sep.September 12, 2017 07:00 AM

In 1898, Julius Tishman built a six-story tenement building, ultimately sparking the creation of the family’s development firm, Tishman Realty & Construction. The “construction” portion of the company’s name initially indicated that it was self-sufficient, that it could build its own projects — but the construction arm grew to one of the most active shops in the city and eventually was bought by engineering giant AECOM.

More than 100 years later, several developers are returning to that model of self-sufficiency, opting to do their own construction work rather than hiring outside companies. JDS Development, Two Trees Management, DDG Partners, Related Companies, SJP Properties and others have taken on the role of general contractor and construction manager as a way to cut costs and to guide as much of the building process as possible.

Acting as both developer and general contractor allows a certain hyper-control over a project. The developer can dictate exactly what subcontractors are hired, they can control the project’s cost and also avoid the messy he-said-she-said litigation that often arises when the construction team and owner don’t see eye-to-eye. But at the same time, developers who do their own construction are taking on significantly more risk: They are responsible for insuring workers and are held accountable for any accidents that may occur on site.

“A developer of scale, all the big guys, they can afford to do this,” said John Livingston, chief executive of AECOM Capital, the firm’s investment arm. “But if the world slows down, they are probably taking on more risk than they bargained for.”

Large and in charge

If developers are the puppet masters of the skyline, then builders are the marionette’s wayward limbs. Disputes between construction companies and their clients are fairly common, given the complexity of building in a city of 8.5 million people. Delays, design changes and other sources of cost overruns often lead to lawsuits between developer and builder.

“You really need the give and take between the developer, contractor and architect to happen fairly regularly,” said Kirk Goodrich of Monadnock Development, which often does its own construction through a separate division of the company. “It allows you to resolve any kind of issues that may exist with the construct-ability of the building before beginning construction, which is the ideal scenario.”

But many developers feel that their agendas and that of their contractors are fundamentally mismatched. Put simply, the property owner wants to save as much money as possible, while the contractor wants to make as much as they can. To avoid this clashing of agendas, many developers over the years have opted to eliminate the middleman.

“We know ultimately what we’re building, and there doesn’t have to be this finger pointing,” said David Schwartz, principal at Slate Property Group, which does its own construction. “When you are the owner and the general contractor you can cut out a lot of that.”

In addition to enabling greater control over a project’s cost and timeline, acting as their own general contractor or construction manager can allow developers to buy building materials in bulk, Schwartz said. In Slate’s case, the company specializes in mid-rise multifamily buildings — so they know they can buy wood flooring for their next 10 projects (and likely, due to the volume, at a discount).

Developers can also forge closer relationships with their subcontractors. David Lombino, managing director at Two Trees, said that hiring a third party to handle construction can insulate the owners from the subcontractors out in the field. Conversely, working directly with the carpenters or concrete pourers allows the owner to build a rapport — while also ensuring quality work.

“There’s something to be said about the fact that you sign the checks for the subs,” Lombino said. “That has an impact on their performance.”

Working directly for the property owner can be a great motivator.

“If there’s a dispute between a general contractor and an owner, you risk not getting paid,” said Schwartz. “They know they are dealing with the decision-maker and are going to potentially get repeat work.”

Risky business

Acting as one’s own general contractor, however, does limit the type and volume of projects developers can take on. Two Trees, for instance, usually limits its projects to two at a time because beyond that, their dozen-person construction staff would be overstretched. But there’s an even bigger downside to assuming dual roles, one that is a great motivator for developers to hire a third party.

“It’s taking on liability and risk that most developers don’t want to take on,” Livingston said. “Generally, you’d want to outsource.”

Another risk attached to developers who do their own construction is handed off to lenders. It’s obvious when a third-party contractor has gone over-budget on a project, said Chris Tokarski, managing partner of Acore Capital. A self-performing developer, however, has an easier time disguising cost overruns.

“When they are self-performing they are not as quick to recognize that they are off budget,” he said. “A contractor says, ‘hey I need more money.'”

In general, the tightness of the current lending environment means that banks and the like aren’t going to be keen on working with a developer who’s doing their own construction work for the first time. Just as lenders look at the financial wherewithal and experience of a project’s sponsor, they also scrutinize the construction team. The ideal team is one with deep pockets and a history of successfully completing similar projects.

Often, the larger subcontractors — like steel, concrete, electrical and plumbing companies — are selected before closing on financing, another non-bank lender told The Real Deal. When working with a contractor, a developer can agree to a guaranteed maximum price, which can assure the lender that any cost overruns will be the responsibility of the construction team. Major construction companies often also have long-standing relationships with experienced subcontractors and are able to bring them onto a project more easily than developers who don’t have the same connections, he said.

At the same time, developers who do their own construction are much closer to the subcontractors and tend to provide more accurate cost estimations, said David Blatt, of CapStack Partners. He said developers sometimes haven’t selected their general contractor or construction manager when they are negotiating financing.

“When developers are working with contractors, they get quotes, but they are not settling on one contractor, so a lot of that is an estimation,” he said.

But general contractors are also responsible for buying insurance for construction workers and are the party penalized by the Occupational Safety and Health Administration in the event that an injury or fatality is caused by a work site violation. Construction safety is on the minds of many in the city: Forty construction deaths have occurred since 2015, and the City Council is considering a contentious bill that will increase the amount of training required for workers on certain buildings. Construction companies will be largely responsible for footing the bill for the training.

A developer acting as general contractor runs the risk of carrying the fatalities and injuries from one site to the next, in the form of higher insurance rates — which are based on accident history — and, possibly, a difficulty in securing financing from lenders wary about the company’s ability to get through a project injury-free.

Joseph Maraia, general manager of Lendlease’s development arm, said that developers also don’t necessarily have the same level of experience dealing with the Department of Buildings or with safety issues as a well-seasoned general contractor.

“There are a lot of tools in our profession that you don’t acquire overnight,” Maraia said. “The experience is not easy to get.”

It’s easier for some

Companies like Monadnock, the DeMatteis Organizations, Gilbane, Lendlease and AECOM are able to insulate themselves, to an extent, from some of these risks because their development and construction arms are completely separate entities. Their construction divisions don’t just serve their development arms — they are also hired by other developers. AECOM Capital, for instance, signs on to projects as a general partner by investing between $10 million to $35 million. As a general partner on a project, one of AECOM’s three construction companies — AECOM Tishman, AECOM Hunt or the Leeding Builders Group — is almost always guaranteed a contract on the job. At the same time, AECOM Tishman is working on major office projects at Hudson Yards and SL Green Realty’s One Vanderbilt. Similarly, while Lendlease’s development arm is teaming up with the Victor Group on 281 Fifth Avenue, its construction company is working on some of the most expensive residential towers in the city.

MaryAnne Gilmartin, CEO of Forest City New York, said her firm did its own construction in the early 2000s, when it was the developer on the New York Times’ headquarters at 620 Eighth Avenue. She said that for many companies, it doesn’t make sense to act as both developer and general contractor on every single project.

“You have to keep a fully loaded team of talent to have the luxury and benefit of doing that,” she said. “We could do that tomorrow, again, if we wanted to.”

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