Three years ago, before housing's current "correction," Akron, Ohio, custom home builder Fred Zumpano took on a partner and forged a new division to focus on light commercial work, specifically medical office buildings and treatment centers. By the time the Akron housing market lost steam in late 2005, Zumpano's new venture was picking up the slack. "We were able toeasily translate our skill set to light commercial and provide a high level of service," says Zumpano, president of Fred Zumpano Design & Construction, referring to both the attention to detail and the client hand-holding he honed as a custom builder. "It now accounts for about half our work, and about 60% of our profits."
That's a common refrain among builders nationwide who are finding the low-rise, non-residential realm an easy–and profitable–addition to their businesses. The switch is made even easier by the fact that few builders stray far, if at all, from the LBM dealers that supply their home building projects by taking on work that requires similar materials and volumes. While key differences between the two sectors exist–particularly regarding codes, documentation, and payment terms–building a strip-mall shell or a professional office complex is, as diversified Kentucky builder Fred Dallenbach says, "just a big, dumb house," typically without a kitchen or even bathrooms. "It's an easy transition for subs, suppliers, and builders," Dallenbach says.
And best of all, there's plenty of pie to share. Though only about 10% of housing's put-in-place value, the estimated $50 billion light commercial sector has coattailed the growth of all non-residential building activity. Between March 2006 and March 2007, non-res construction value overall grew 16.5% compared with housing's 14.4% slide, according to the Department of Commerce.
That boost came from such projects as office buildings, medical facilities, restaurants, shopping malls, and (no kidding) building supply stores. Commonly, those types of projects are fewer than four stories tall and, therefore, allowed to employ wood-based structural materials, qualifying them as light commercial. The news gets even better for builders, because funding for non-res projects is almost evenly split between private and public dollars. While private money accounted for 53% of non-residential projects earlier this year, according to the Census Bureau, the balance came primarily from state and local tax rolls and for health care and office projects. Overall, the value of public non-res projects was up 9% in the 12 months since March 2006, according to Census Bureau reports, while public housing has dipped 3.5%. "Public projects are harder to get [than privately funded commercial buildings], but the work is there," says Dallenbach, referring to the laborious and low-bidder nature of public construction.
Beyond the Numbers
The types of light commercial projects that might entice a home builder vary among markets. Akron, Ohio, for instance, where Zumpano operates, is a medical mecca, anchored by a large hospital system supported by various ancillary businesses.
It's the same scenario in Topeka, Kan., where Jeff Wooster supplements his new and remodel residential work by finishing out office building shells for doctors and related service providers and retail suppliers. He also has dabbled in small, specialty food outlets, such as juice bars and cookie stores. "We usually get work through subcontractors in the commercial market who need a general contractor to manage a build-out they want to bid," says Wooster, owner of Wooster Construction.
In Tupelo, Miss., contractor Lynn Bryan has zeroed in on the market's impressive retail sector, hedging his company's residential remodeling work with tenant build-outs that make up about 20% of his annual revenue.
"For a small city [population 38,000], Tupelo collects the third-most sales tax in the state," he says, thanks to commuters that boost the city's working population to more than 100,000.
A downtown revitalization effort, he says, should keep non-residential work, specifically interior remodels, in high demand for the foreseeable future, as will the area's swelling health care industry and the coming of a new Toyota factory by decade's end.
Meanwhile, Georgia developer and builder Ed Feiler, chairman of Metro Developers, has found a niche in providing strip shopping malls and so-called "junior boxes" of up to 25,000 square feet for various retail ventures in Savannah, including within his own housing developments, rather than ceding that work to another contractor. "There are other options that builders and developers can do to reap the benefits of light commercial work instead of handing those projects over to someone else," he says. Examples include joint ventures with a seasoned commercial builder, construction management of a commercial team, and collecting rent from tenants as a landlord.
Another opportunity for home builders within planned communities is construction of the obligatory clubhouse. Rarely more than a story high and with details and finishes that complement those found among the surrounding housing, community centers make sense as a light commercial venture–assuming the developer and the builder are both amenable to the idea. "It really depends on the builder" as to whether he builds the clubhouse in addition to the homes around it, says Arthur Casey, director of development for Starwood-Tiverton in Tiverton, R.I.
For The Villages on Mount Hope Bay, Casey's new 98-acre, active-adult waterfront community in Tiverton with 290 New England beach-style housing units, the developer negotiated with his home builder, Austin Ross Construction, to also create the clubhouse. "It was a stick-framed building with high-end finishes, just like the houses," says Casey. "We only had to negotiate one set of general conditions, and the site superintendent was always around to collar, either about the homes or the clubhouse."
One obvious efficiency achieved when a home builder diversifies into such light commercial work is that his LBM suppliers' inventories often also translate well into that realm. "There's a 90% crossover," says Dallenbach, an estimate echoed by others. "There are some specialty areas and products for fire suppression and access, but the main structural materials are very similar," and should be, he says, if a builder new to the non-res game expects to succeed.
In addition to the obvious economies from using the same LBM supplier on homes or commercial/retail projects, non-residential materials suppliers typically are accustomed to dealing in higher volumes than what a house might require, thus causing a hardship for a home builder trying to protect his profit margin on a light commercial job. "I look for projects in which I can source my materials from my lumberyard," says Bryan. "I simply don't do the volume that a commercial-only contractor does" to be able to negotiate prices for steel, concrete, and other non-res products and systems from a stable of new suppliers.
The same loyalty cannot always be said for subcontractors, however. Though NAHB's Commercial Builders Council cites a builder's ability to keep trade partners busy and happy with light commercial jobs when housing work slacks, Bryan maintains a different set of subs between the two segments. "A commercial contractor carries more overhead, so there's no way he can make money in residential," Bryan says. As a result, however, subs focused on non-res work often have ample manpower to meet the typically tighter schedules and specs of light commercial contracts.
Despite hiring a different set of subs for his housing and light commercial work, Bryan remains loyal to those teams. "If I don't or can't get a job without them, I won't take the work," he says. "It's just easier on me to work with guys who know what they're doing and know what I expect," in one or the other realm.
The Bottom Line
If the basic structures of the buildings, as well as the suppliers (and perhaps subs), remain relatively the same between a builder's light commercial and residential work, what differences do exist?
Perhaps the most important difference is money. Home builders who venture into light commercial often find work that's more profitable, thanks in large part to hands-off clients and a lack of change orders that erode profits. However, the payment schedule is usually drawn out on non-res jobs. "I can bill a residential project once a week and get a check soon after," says Bryan. "But I usually have to wait to bill and receive payment on a commercial job."
Part of the reason for that delay is that commercial jobs often progress more slowly in pre-production (permitting, zoning, and design development), yet demand tighter cycle times that, in turn, often require builders to order, receive, and warehouse materials far in advance of actually needing them.
"I can start a house in a matter of months" after the client has pulled the trigger, says Zumpano. "A light commercial project might start a year or more after I win the job."
That dynamic can have a direct impact on materials suppliers, even for credit-account customers who can be left hanging by a slow-paying or slow-moving commercial client. "You have to work with your subs and suppliers to negotiate different terms" for commercial jobs, says Dallenbach, a bargain greased more easily if a builder pays on time on his home building bills.
In the end, though, a dealer staring at a slumping housing market might be more willing to negotiate terms with a builder customer trying to hedge his business with some light commercial work that, in turn, leads to a sale. "Like anything else, it has to be a mutually beneficial partnership," says Zumpano. "In a market like this, everyone's looking for a way to survive."–Rich Binsacca is a contributing editor for ProSales.
Points of Distinction
Though similar to residential work, light commercial projects have their nuances. To be an effective supplier to home builders dipping their toes into that realm, consider these key differences between housing and non-residential construction as they relate to the supply chain:
- Likelihood of extended credit terms and account payoffs.
- Longer lag time between order placement and delivery to the site, resulting in potential warehousing of large volumes.
- Requests to source or special order fire suppression, emergency lighting, commercial-grade doors, and other products and systems required by commercial building codes.
- Potential for small orders, fill-in orders, or change orders because of contractor inexperience with light commercial work.
- Requests for or recommendations regarding commercial-focused specialty trade contractors.
- Less likelihood of upselling or offering alternative specifications.
- Knowledge of commercial building codes if offering engineering or design services for structural or other systems.
Tips for Light Commercial Projects
To educate yourself about light commercial activity in your market, either to target contractors working in that realm or to help home builder customers diversify into it, do this:
- Talk to building code officials to find out the requirements, including contractor licensing, for light commercial work.
- Investigate opportunities that mirror residential design and materials and, if possible, provide the builder with cash flow, such as tenant leases or rental space.
- n Ask homeowners if they have or know of any commercial building needs for their businesses or those of their professional associates; if so, match them up with a reputable builder looking to diversify into light commercial work.
- Look for projects that fit into your existing operations and inventory; at most, residential-focused dealers (and builders) should be able to source or special order oddball specifications versus carrying them in volume.
- Consider forming or facilitating partnerships among customers for a light commercial project, such as a home builder, design professional, and subcontractors all looking to hedge a housing slowdown.
- Be aware that competitive pricing (bidding) and reliable scheduling are even more critical and less flexible in light commercial work than for housing projects.