As construction costs climb, state government looks to private developer for help
State government’s largest agency has been planning for a decade to build a new headquarters in Raleigh for thousands of employees. But years of delays have collided with surging construction costs. Complicating matters: The state can’t wait for costs to come down.
The North Carolina Department of Health and Human Services has to vacate its current headquarters by next year.
So the state — which typically builds and owns its own buildings — is trying a new strategy: Asking a private developer to help make it happen in a public-private partnership.
State officials are negotiating with Raleigh-based office developer Highwoods Properties to build some of the new 780,000-square-foot campus for DHHS on Blue Ridge Road in Raleigh, across from the North Carolina Museum of Art. The Raleigh-based real estate investment trust, one of the biggest suburban office developers in the Southeast, would build a significant portion of the campus and lease space back to the state.
The plan to build a new DHHS headquarters has been in the works since at least 2015, when the state sold its Dorthea Dix campus to the City of Raleigh, which is converting the land to a central park. City leaders agreed to let DHHS stay on site until 2025 while the park has been built up — a move-out date that’s approaching even as costs to build a new headquarters balloon by tens of millions of dollars, due to rising inflation.
Prices for nonresidential construction inputs — such as lumber, concrete products, steel, plumbing fixtures and other materials — were up almost 40% between February 2020 and January 2024, according to an Associated Builders and Contractors analysis of U.S. Bureau of Labor Statistics Producer Price Index data.
“We were reeling quite a bit with that,” William Johnson, a top state government construction manager, told state lawmakers at an oversight hearing Tuesday.
Projected overruns forced his staff to get creative, he said, redoing plans for the new headquarters and also coming up with the idea to approach Highwoods, a publicly traded company with a portfolio of more than 28 million square feet, including several of the biggest skyscrapers in North Carolina.
Top budget writer Rep. Dean Arp, R-Union, said other big state government construction projects have gone way over budget, and he was pleased to see how officials handled this one differently, by finding a private sector partner to take on cost and risk.
The exact details of the partnership are still being worked out, Johnson said after the meeting. Broadly speaking, he told legislators, Highwoods will assist with design and construction and then pay the state cash on top of that. In exchange, the state will give Highwoods a 20-acre piece of the new headquarters site and will allow it to lease out the office space back to DHHS or other tenants, over the next 40 to 50 years.
Both sides appear to get something they need out the deal: Fast cash for the state as it rushes to move out of its old Dorthea Dix headquarters ahead of the end of its lease next year, and for Highwoods, a steady source of income for decades to come from a coveted institutional tenant as it deals with declining demand from corporate tenants.
As a publicly traded company, Highwoods is required to list risks to its business model. The first risk listed in its 2023 annual report: People continuing to work from home.
Its occupancy rates have been dropping since the Covid-19 pandemic, the company wrote, adding that “occupancy in future periods will be lower, perhaps significantly, if potential changes in customer behavior, such as the continued social acceptance, desirability and perceived economic benefits of work-from-home arrangements, result in reduced future demand for office space over the long-term.”
A representative of Highwoods didn’t immediately respond to a request for comment.
The DHHS headquarters move has been broken down into three phases. The first phase is already under construction and should allow DHHS to move into its new headquarters by December 2025, Johnson said.
The second and third phases are where the Highwoods partnership will come into play. Those aren’t expected to happen for at least several years; the second phase is currently in planning.
Johnson said that even though DHHS was forced to significantly rework its initial plan for the new headquarters due to rising costs for construction materials and labor, the outside help from Highwoods allows the state not to cut corners on the nuts and bolts of the project: The large glass panes that will make up most of the building’s exterior, he said as one example, are the highest quality option available.
He added that the public-private partnership idea, while rare in state government construction, isn’t unprecedented. North Carolina State University built its Centennial Campus using a similar strategy, he said.
Arp wasn’t the only state lawmaker expressing an interest in more public-private partnerships in the future.
“I wonder how we can get you in charge of other projects, so that we can start saving some dollars,” Rep. Matthew Winslow, R-Franklin, told Johnson after his presentation.
