Inflation forces school construction managers to get creative

Bonds

California school districts are delaying projects or speeding them up to get ahead of accelerating prices as they contend with supply challenges and rising construction costs.

“By and large, inflationary pressures on construction costs is where they are getting hit the worst,” said Blake Boehm, a managing director with KNN Public Finance, a municipal advisory firm.

In some cases, the districts have a local bond measure with authorization remaining, others are accelerating projects to try to get in front of further construction price escalation, Boehm said.

There is the capacity to speed projects up to a certain degree, Boehm said.

“But once districts change the issuance schedule, that is where folks in my position need to encourage the district to slow down or it will affect their tax rate commitments — or we need to come up with something creative that will allow them to do that,” Boehm said.

He added that KNN tends to be “pretty conservative with adjustments.”

“We don’t like to make mid-year adjustments to our assessed value projections, or create something where we are hoping interest rates will be better in two or three years. Like, this will work if there is a drop in interest rates. We don’t do that,” Boehm said.

The state’s 1,018 public school districts face demographic and infrastructure challenges.

Since peaking at more than 6.2 million in 2013, K-12 enrollment has fallen more than 6% to less than 5.9 million, according to a Public Policy Institute of California report.

But they need to spend an estimated $3.1 billion to $4.1 billion annually to maintain school facilities — and more than $100 billion in the coming decade for both modernization and new construction, according to PPIC.

School leaders also have to shoulder the costs to adapt classrooms or build new ones for a transitional kindergarten program championed by Gov. Gavin Newsom that expands public school offerings to four-year-olds and add security features as the era of school shootings continues.

San Diego Unified School District, where Lee Dulgeroff, senior executive director of facilities planning & construction, is managing a 10-year, $11.8 billion construction program, is grappling with all of those challenges.

The district is spending about $110 million to modify classrooms for transitional kindergarten — each classroom needs its own restroom for four-year-olds, for example — and building additional classrooms at the district’s 110 elementary schools to accommodate the students, Dulgeroff said. This school year roughly 4,200 TK students were enrolled, and an estimated 5,000 TK students are expected next year, he said.

San Diego saw a 1% decrease in enrollment to 476,760 students, even with the addition of the TK students, according to California Department of Education data.

San Diego Unified voters approved the $3.2 billion Measure U bond measure in November, as the district exhausted the authority in 2012’s Measure Z.

The district also has two other bond measures it can tap, providing total authorization of $5 billion in unissued bonds. San Diego Unified, which has 15.7 million square feet of school and administration buildings, has been spending about $790 million a year on its capital program, Dulgeroff said.

The building cost index produced by the Engineering News Record’s analysis for southern California averaged 3.6% in the 90s, and 3.7% over the past decade, but it’s now at 9.5%, slightly down from the 11.7% posted in 2021, Dulgeroff said.

He said San Diego has experienced a higher level of construction inflation than the rest of California.

“We probably saw a 14% increase in 2021, not 11.7%,” Dulgeroff said.

Though it has dropped this year “it’s still higher than the 5% we had planned for,” he said.

The school facilities chief is reviewing projects to figure out what can safely be postponed.

“We address the highest needs first, across the district,” he said.

“We look at things that have some useful life, and we try to extend that,” he said. “When the purchasing power of your voter-allocated funds are diminished, you can only buy less.”

For instance, he said, if a roof has hit the 25-year expected life, but it appears to be in good shape and it’s not leaking, the district might delay replacing it and just keep an eye on it, he said.

How much the district issues at any one time depends on the bond market and the district’s ability to spend proceeds, Dulgeroff said.

“We have been trying to get the work done as quickly as possible, because the longer it takes, the more projects cost,” he said.

The economic bumpiness hasn’t knocked San Diego off its regular schedule of issuing bonds each year in September, Dulgeroff said.

District leaders are mindful of not issuing more than they can spend, which, he said, can be constrained by labor shortages and increased demand for contractors amid a building boom in the county, combined with supply chain problems.

“We have to expend 85% of the bond proceeds within three years of issuance, based on IRS guidelines,” Dulgeroff said. “We do, and we are careful of that, because we don’t want to lose the tax exempt status on our bonds.”

Mark Young, a KNN managing director and San Diego Unified’s municipal advisor, said they have been using an assumed interest rate of 4% for SDUSD’s multiple-series authorization on bond sales, and the results have been averaging 3.6%.

“We haven’t experienced a situation where the interest rates ticked up, so we have had to downsize the deal. At least in terms of my portfolio, it has not been an issue,” Young said.

Irvine, California-based advisory firm Fieldman, Rolapp & Associates has modeled interest rates out 15 years in many cases, and in those cases, its GO bond program still anticipates higher interest rates, so many of their issuers have been able to continue to sell bonds, said Adam Bauer, the firm’s chief executive and president.

“Dealing with inflation means existing bond measures don’t go as far as they previously did,” Bauer said.

It also means that he has been having conversations with clients who are focused on value engineering, working with the design team to eliminate certain parts of projects, and prioritizing certain projects, Bauer said.

“Some got ahead of this a bit and were able to take advantage of the growth in assessed valuations that occurred over the last two years,” Bauer said. “One school district saw its AV go up by 8%.”

Firm-wide, KNN has lots of clients exploring new ballot measures for 2024, Young said.

“There are a lot of very old campuses in the state,” Young said. “In some cases, modernization could be razing buildings and replacing them with new buildings.”

If a district has passed a bond with full expectation of meeting agreements with voters, but finds it hard to complete projects because of increased construction costs, “we might have to explore the viability of another bond measure,” Boehm said.

Lawmakers’ inability to put a statewide school bond measure on the ballot has put more pressure on the school districts to fund their own construction programs without state aid, where once there was a greater availability of matching funds, he said.

State school construction funding used to cover half the cost of new construction and 60% of renovations, but the state programs providing matching funds have been running on fumes for years, and voters defeated the $9 billion state bond measure Proposition 13 in March 2020.

Proposition 22, a second stab at the effort, introduced by state Sen. Steve Glazer, D-Orinda, last year died in the Assembly in November. At least one state school bond measure is active in this year’s session.

The state included $100 million in one-time general fund money in the fiscal 2022 budget to support the construction of new school facilities or retrofitting existing school facilities for the transitional kindergarten program. But the $500 million proposed for the fiscal 2023-24 budget has been pushed forward into next year’s budget amid the state’s $31.5 billion revenue shortfall.

Another impact of inflation may be that voters are less inclined to pass bond measures.

Most school bond measures in California require 55% of the vote to pass. Other local bonds require two-thirds supermajorities.

2016 was the pinnacle of local bond measures being passed in terms of quantity and the passage rate, Boehm said.

“The low point was 2020, particularly March 2020, but in 2022, things have rebounded, not as good as 2016, but passage rates have matched historical standards,” he said.

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