Construction-cost spikes may prompt some developers to consider delaying, canceling projects
By Ashley Fahey
Tampa Bay Business Journal
Published: Oct 14, 2021

There's no question construction material shortages and subsequent price increases have created new headwinds for real estate projects in 2021.

But just how much are spikes in steel prices or weeks-long delays in delivery timelines affecting the industry? In some cases, and within specific sectors, quite a bit.

A recent report by Jones Lang Lasalle Inc. (NYSE: JLL) found, through August, average final construction costs for a commercial project had increased 4.5%. Total cost growth by year-end is likely to surpass 6% and, in 2022, cost increases between 4% to 7% are projected.

Henry D'Esposito, JLL's construction research manager, said pent-up demand after projects were delayed in 2020 has generally overpowered hesitation developers may've had over cost or scheduling impacts to their projects. Projects today are sometimes slower to kick off but it doesn't change real demand, D'Esposito said.

But once the pandemic backlog catches up, and if construction costs continue to escalate at, say, double-digit percentage increases, projects could start to not pencil out.

"That may begin to become more of an issue going into next year," D'Esposito said.

One of the biggest challenges that has faced general contractors and, as a result, developers and tenants has been trying to predict which material is facing a shortage or pricing issue at any given time. For months in the first half of 2021, lumber was seeing price surges. More recently, pricing has moderated for lumber, but steel has become a bigger headache.

That also means different real estate sectors are impacted at different times. Lumber shortages tend to more adversely affect homebuilders while steel is more likely to affect industrial and high-rise commercial projects, D'Esposito said.

So far, cost increases haven't materially been passed on to the end users yet because pricing was set before many of the spikes occurred. Heading into 2022, that will likely start to change.

"New starts in 2022 will probably have (construction-related) cost increases in projects ... That’s where we might see some hesitation," D'Esposito said.

Lisa DeNight, national industrial research director at Newmark Group Inc. (NASDAQ: NMRK), said construction costs and shortages are probably the most critical issue facing industrial real estate developers right now. She said, anecdotally, she's heard of some developers canceling or significantly delaying planned projects because they cannot guarantee timing.

Others are shying away from speculative warehouse development and instead only embarking on build-to-suit projects, DeNight continued.

Industrial tenants, meanwhile, are trying to occupy space — many before end-of-year — in a national market that has less than 5% average vacancy. Several markets are well below that. Bidding wars have broken out for warehouse space in the tightest markets, such as the Inland Empire in California.

Even with escalating rental rates for industrial, tenants are snatching up space.

"Tenants at this point are less concerned with economics, it’s more about when (they) can get space," DeNight said. "It’s very much about timing at this point and less about the rental rates, which are, indeed, increasing at a rapid clip because of the competition for the handful of existing spaces that can accommodate immediate space requirements."

Some developers that haven't ordered steel yet aren't setting rental rates for projects they hope to break ground on, as construction pricing will likely be a factor in where that rate ends up.

Construction costs will likely more directly impact rental rates for industrial in 2022 but tenant demand isn't expected to wane.

"The hypothetical tenant (is) going to want that space and they will bid as high as they can," DeNight said.