The challenges presented by the pandemic “are far from over” with persistent inflation and supply chain disruptions, according to Justin Brown, President and CEO, Skender.
He tells GlobeSt.com that he continues to see cost increases and volatility in materials, labor and technology.
“Despite some recent easing, nonresidential construction input costs are up 16% from a year ago and 41% since the start of the pandemic,” Brown said.
Supply chain issues have driven up lead times for many essential materials. Glass, curtainwall, roofing, metals, resins, mineral wool and electronic components, such as electrical panels, air handling units, electrified door hardware and card readers, have all been mired in delays up to 10x the normal delivery time, according to Brown.
“While conditions are starting to improve, lead times still far exceed what for years was considered ‘normal,’ he said.
“With rapidly rising interest rates, an expected recession and uncertain economic headwinds, our industry will inevitably experience some contraction. Construction projects tend to incubate over 6 to 18 months, so contractors don’t experience the effects of economic conditions until about a year later.”
‘Alternative Real Assets are a Good Place to Be’
Mike Gordon, Global Chief Investment Officer at Harrison Street, tells GlobeSt.com that there is certainly some “angst” related to the increase in construction costs.
“Increased costs and a challenging financing environment are leading a lot of developers to shelve or adjust their projects, and as a result, we are being very selective and we’re underwriting very conservatively.
“From a new development perspective, we endeavor to target those markets wherein new supply growth will be moderated due to high and irreversible barriers-to-entry. And in fact, given the overall challenges, we expect the development projects we invest in to benefit from the substantive market decrease in development across our sectors, as well as moderate new starts expected during the next 24 months.
“Finally, beyond just the development and construction side, it’s important to remember that certain real estate sectors, such as student housing, senior housing and self storage have the ability to re-price rental rates during inflationary times and are also resilient to an economic slowdown.
“If you’re going to be stuck in a push-and-pull battle between inflation and the Fed’s measures to curb it, alternative real estate asset classes that are tied to long-term secular trends, such as healthcare and education, are a good place to be.”
Seeking Pricing Stabilization
Brian Gallagher, VP, Corporate Development, Graycor, tells GlobeSt.com that overall, there continues to be volatility in construction costs.
“Demand remains solid in many markets, so there is upward pressure on construction materials,” he said. “Construction input prices are up 15% to 16% year-over-year, but we are beginning to see some stabilization in the rate of increase in pricing on many materials.”
Doug Ressler, business manager, CommercialEdge, tells GlobeSt.com that Class A buildings, on average, cost $50 more per square foot (20%) in the fourth quarter of 2022 than 2021, while Class B buildings have only increased $11 per foot (8%) over that time.
Transportation Costs – Among Other Things – Soaring
Rose Williams, Head of Client Solutions, Americas at Unispace, tells GlobeSt.com that the industry anticipates input cost pressure to remain high over the next two years, with some expectation that the pace of the cost increases will slow.
And along with wage/salary increases, the rise in fuel/energy costs, and material costs – higher taxes cannot be forgotten for the role in additional business costs.
Williams spelled out other areas seeing increases.
In the past 12 months, there’s been a 15% to 20% jump in transportation costs, and Williams expects to see that go up another 5% to 10% in the next 12 months.
Materials costs have risen between 5% and 15% this year, and that’s likely to keep going up between 5% and 10% over the next 12 months.
Additionally, labor costs have risen between 5% and 10%, with another 10% to 15% increase expected in the next year.
“While the pricing trends look like they will continue to increase over the next 12 months, we’re hopeful we will see some stability on supply and demand pressures as we progress into 2024 and beyond.”
Facing a ‘Double Whammy’
Jeff Wilcox, principal, Gantry, tells GlobeSt.com, that given the secured overnight financing rate (SOFR) has moved from 0.25% in January to 4% today, it has a dramatic impact on borrower’s carrying cost during construction and project stabilization.
“Any project delay now translates to a real project cost,” Wilcox said. “Adding project cost while cap rates may be moving higher is a double whammy of loss.
“To mitigate this, both developer and contractor should work hand in hand to ensure projects deliver on time. This can be accomplished through both incentives (contractor profit and time bonus) or consequences (enforcement of liquidated damages). Time is not on anyone’s side in a rising rate environment.”
Getting Creative with GC Contracts
Clark Lundy, President of RREAF Construction Services, tells GlobeSt.com that his firm has been exposed to the rising building material costs, but also an increase in general overhead, labor costs due to qualified and experienced employees and subcontractors, and logistic supply.
“To decrease risk and detail schedule and sequence, joint communication and negotiation between owner and GC prior to contract finalization has led to updates or addendums to the traditional AIA contract documents,” Lundy said.
To decrease risk on current projects, RCS had to get creative with its general construction contract, he said. RCS developed a cost-plus contract that allows for economic price adjustment to specific line items by breaking out these commodities by quantity and unit price.
Lundy said that estimations on future projects have increased by 15% to 20%, specifically driven by commodity changes to the following divisions: concrete foundations and paving, metals, wood trim, amenities, appliances, PVC, electrical wire and paneling.
“As we move into Q4, I believe that prices will plateau and be realized by Q2 of 2023,” Lundy said. “Currently, we are witnessing an uptick in qualified subcontract bidders, but not realizing the price adjustments on materials due to inflation and shipping cost.”
Release of Lockdown Period Unleashed Demand
Mark Fergus, Executive Vice President, Cumming Group, tells GlobeSt.com, “The underlying reasons for the recent increase in cost inflation on building projects has predominantly been a result of the slowed construction activity during the pandemic, which led to a spike in construction activity following the release of lockdowns.
“This increased demand coupled with the existing labor constraints in the construction industry and supply issues resulting from a breakdown in the global supply chain in manufacturing facilities being shuttered and logistics and transportation links affected by the pandemic has led to a spike in commodities and materials in the short term.
“We are seeing relief in some areas as prices are stabilizing with drops in Steel, copper, and aluminum but expect prices to remain high for the next year.”