CALGARY - GWL Realty Advisors is one of a dozen or so developers waiting to pull the trigger on a new downtown tower.
The pension fund advisor owns the land, a site near First Canadian Centre in the core that can accommodate one million square feet of office space.
It paid $188-million six months ago for the parcel, which included a 600,000-square-foot tower and a parcel of land that would allow it to participate in Calgary's speculative boom.
"We're still trying to decide," says James Midwinter, an executive vice-president of GWL, about the proposed project. The site already has its footings in place but even with that it would take close to three years to construct.
In the boom-and-bust world of commodity prices, 36 months is an eternity. The GWLs of Calgary not only have to deal with the possibility oil prices will drop and with them demand for office space, but also rapidly rising construction prices.
Most people in the construction industry says costs are rising anywhere from 1% to 1.5% per month so far this year. Bentall Real Estate Services, for example, which started construction of a 420,000-square-foot office tower last September, says by the time it got around to announcing a plan to twin the tower a mere four months later the costs had risen 10%.
Mr. Midwinter says prices are rising so fast contractors are now refusing to commit to a price on a project that might not be built for two years.
"How can you get a fixed price on drywall when nobody knows what the price will be?" Mr. Midwinter asks.
Anybody offering a fixed price for a service to be done in a few months is likely padding their bill to account for expected inflation. That type of padding is adding to the inflationary environment and is behind the 1.5% monthly increase in construction costs.
"That puts more risk in today's development. You can't fix prices so you don't know what your costs will be. The prices on aspects of a project can be fixed," says Mr. Midwinter. "But the cost ... it's like an insurance policy at some point the premiums make no sense."
Despite the cost uncertainty, builders are still willing to go ahead with projects because of the rising rent environment. Calgary downtown rents, which don't include occupancy costs like taxes and utilities, are now higher than similar locations in Toronto.
Rising rental rates make projects that were unaffordable two years ago make sense today. Most now under constructing in Calgary have lease rates negotiated in the $30-a-square-foot range. The next wave of buildings are now looking at rents in the $40-a-square-foot range.
Mr. Midwinter says as long as rental rates keep rising as fast as construction costs, developers can pass on their costs to tenants. The key for developers is that the income from a building result in a 7% to 9% return.
Most downtown Calgary office towers are generating a 6% return, so anyone planning to build one expects to be rewarded with a higher return on investment because of the risk. As long as there is a possible premium for constructing a new building, developers will continue to plow ahead.
