Construction costs add to tab for expanding franchisors
Wingstop has made “significant changes” in design to keep build-out costs flat.
Some are finding ways to manage the increases, such as modifying designs ‘on the fly’ and switching to lower-cost suppliers for wall decor or murals. But they’re bracing for more hikes as demand rises.
Franchise groups kicking off new expansion or renovation projects found rising construction costs did not take a break during the recession. And, as development returns and the demand for contractors and building materials grows, franchise operators need to brace for more price increases ahead.
Construction costs have not stood still over the past five years, as Atlanta-based Workout Anytime can attest. Locations range from 5,000 to 7,000 square feet with an average build-out cost of about $140,000 for a brand new “first generation” shopping center and $160,000 for the renovation of existing “second generation” space. Vice President of Development Randy Trotter estimates costs have increased about $20,000, or 14 percent in the past few years for store build-outs on second generation space.
“Construction costs are going up and are a concern,” agrees Dave Vernon, chief development officer for Dallas-based Wingstop Restaurants. Wingstop opened 74 locations in 2013 and plans to open more than 85 locations in 2014. Wingstop has been able to make some modifications to its design and adapt “on the fly” to minimize those increases and keep costs down for franchisees, he adds.
Typical build-out costs for a new 1,500-square-foot inline or end-cap location for Wingstop runs about $200,000. “We have made some significant changes to maintain that price,” says Vernon. For example, the company has found new lower-cost suppliers for its wall décor and murals, and also has modified its soffit designs and countertops to reduce costs. “We have been doing a better job of purchasing core items and a better job of making slight modifications so that we have been able to offset a lot of those costs,” he adds.
Price increases on labor and materials can vary from region to region. Nationally, the Producer Price Index for inputs to construction industries has increased 51.8 percent over the past decade and 16.4 percent over the past five years, according to the Associated General Contractors of America. That data measures the price changes on all building materials that go into a structure from carpeting to steel beams.
Although costs are not rising as sharply as they did during the building boom leading up to the recession, costs have continued to creep higher over the last five years. Products with the biggest year-over-year price jumps in 2013 include gypsum products, which rose 16.1 percent as of December; followed by a 9.7 percent increase in lumber and plywood; and a 7.9 percent rise in cost for insulation materials.
“I have seen every single year in January pretty substantial cost increases in materials such as framing materials, metal studs and sheetrock,” says Larry Jarnes, president and CEO of Northboro Builders Inc. Based in Orlando, Northboro specializes in turnkey build-out packages for franchise groups such as Edible Arrangements, Huntington Learning Center and Shula Burger among others. One reason for that increase is the rebound in the housing market and return of single-family home construction in the past two years.
In some cases, those material costs have moved significantly higher. For example, Northboro was working on a project at the end of 2012 that required a big order of sheetrock. The supplier recommended buying the materials before year-end, because prices were going up by 30 percent as of January.
Flat labor costs and competitive bids from contractors have helped to lessen the overall cost impact for some projects. “Between 2008 and 2010 contractors were cutting their prices just so they could have enough work to keep their key employees on board,” says Ken Simonson, chief economist for AGC of America. Since the beginning of 2011, which is when development began to return, construction bid prices have been on the rise and are catching up with the increases in construction materials, he says.
On a positive note, some products have actually seen prices decrease in the last year, including items such as copper and brass mill shapes declining 6.1 percent; steel pipe and tube declining 5.1 percent; and sheet metal products declining 1.8 percent, according to the AGC. Demand for those materials globally has been subdued with the continued global recession and slowing growth in countries such as China, says Simonson.
Higher costs, along with a forecast for more price increases ahead, is putting more pressure on franchisors to find ways to keep expenses down for existing and new franchisees. “Even in a great economy when construction costs may have been less, it is a never-ending thing in franchising. You can never build it cheap enough, and you are constantly trying to value-engineer,” says Jarnes. Franchisors need to deliver a package as cost-efficient as possible, because cost plays a big role in driving franchise sales, he adds.
One strategy for Workout Anytime is to lease space in new shopping centers where build-out costs are cheaper compared to renovating an existing space. It is easier to plan for design features such as locker rooms and exposed ceilings in new construction, whereas conversions require more costly demolition work to reproduce the same prototype.
Another solution is to ask for a bigger tenant improvement package from the landlord to cover additional construction costs. For example, Workout Anytime now negotiates for $30 to $35 per square foot in tenant improvement dollars compared to $25 per square foot just two years ago. However, rather than getting a freebie, the higher TI package is generally spread out over the length of the lease in terms of higher rent.
Franchise groups have been able to shop proposed projects to multiple contractors to get better pricing. Although construction is returning, it is still well off the activity in 2006 and 2007. So, contractors are willing to be aggressive on their bids in order to land new work, adds Vernon. Some franchise groups can also leverage contractors across multiple projects in the same area or region to get better pricing.