Rising Construction Costs Changing CRE Landscape

According to construction management firm JLL, in 2021 the costs for a commercial project increased more than 6 percent with a to 7 percent increase expected by the end of 2022. National nonresidential construction spending was up 1.3% in January and nonresidential spending totaled $838.9 billion. Mountain West Commercial Real Estate details why the the cost of construction is increasing and how it impacts the local economy.

Supply Chain Shortage

Pandemic lockdowns, workplace restrictions, border closures, and natural disasters has caused significant interruptions in the production and manufacturing of building materials, and both domestic and international supply chains. These factors have resulted in noticeable supply chain disruptions and shortages in materials affecting the construction industry, resulting in both prolonged delays and increased costs. Utah based Merrill Sheriff Construction says they are seeing delaying in steel, door frames depending on wall thickness, PTO roofing, higher efficient HVAC equipment, and glazing in certain materials.

Costs of Material

The rising cost of material like crude oil, asphalt, softwood lumber, and a labor shortage are partly to blame for rising costs of construction in Utah and across the county. At the same time, steel prices have risen by about 17% in March 2022.

“Steel is the biggest issue we are seeing right now and it is the first supply construction must lock down before starting any new build,” Mountain West Agent Tyler Jones said.

Experts say the combined impact of this surge in input costs is likely to escalate cost of construction and thus impact pricing in the commercial real estate market. Experts say, the increase in raw material costs can lead to price escalation, especially for projects that are already under construction.

Labor Shortage

The Associated Builders and Contractors (ABC) released new numbers that indicate, this year, an estimated 1.2 million construction workers will leave their jobs to work in other industries. The impacts from the so called “Great Resignation” are being felt in Utah.

The ABC says the construction industry will need to attract nearly 650,000 additional workers on top of the normal pace of hiring in 2022 to meet the demand for labor.

Property Value

Currently, Mountain West has 179 properties on the market either in the planning or construction phase. This, as construction prices in Utah are up 40% from last year. Which Experts at Mountain West say impacts commercial real estate property values.

“Because it costs more to build, landlords are also increasing rent. In some cases, rents are unattainable, so people aren’t leasing,” Director Brett Palmer said. “It is tough to justify building when tenants potentially won’t be able to pay rent prices to offset the cost of construction”.

Despite rising costs of construction, an article by Atlantic Business Inc. says commercial properties will see values increase in sought after industrial and multifamily properties meaning investors have an opportunity to get a positive return on their investments. By investing early before demand increases exponentially over time due largely from economic growth spurred mainly through greater office space utilization rates among other factors.

Reshaping Lending Opportunities

The increase in construction cost and the labor shortages are forcing lenders to adapt to how they are making deals. An article from Real Estate Capital USA says the rising conflicts in Ukraine and Russia could create further supply chain delays. Some companies are requiring all subcontracts be bought out and singed to lock in prices to avoid future changes in pricing. In New York, one manager is building in bigger contingencies to cover price uncertainties and trying to source developers with more liquidity. In California, Fabio Baum, managing director at Parkview Financial says the firms deal structure is changing to all value- balance in their loans either through a pay-down or through the borrower contributing more equity to a given project.

Outlook

According to a report from Think Economic and Financial Analysis, 2022 will be a much better year given early signs of stabilization in non-residential construction activity. As more people returned to the office, cities were getting busier again, with bars, restaurants and hotels also seeing increased demand. Since the beginning of 2022, the retail division has sold or leased 21 properties used for food and beverage compared to the same time last year. More food and beverage establishments opening means more jobs in the community and a potential boost to the local economy.