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Commodities Volatility - Impacts on CRE & Construction

UPDATED SEPTEMBER 2021: Increasing demand for construction materials, limited product inventory and supply chain disruptions are driving up construction costs and resulting in longer lead times for obtaining materials

Pricing and supply chains for commodities are incredibly fluid coming out of the pandemic. Increasing demand for construction materials, limited product inventory and supply chain disruptions are driving up construction costs and resulting in longer lead times for obtaining materials. 

The following article and report provide an overview of commodity volatility and its impacts on construction, and why it’s important to engage a project manager early in the construction planning process. Our Project & Development Services professionals provide insights into alternative construction solutions and how to prepare for potential delays.

What’s causing price increases

Commodity prices are skyrocketing as corporate and consumer demand returns and supply struggles to catch up. In Q2 2021, lumber prices are up 101% and copper prices are up 77% from a year ago. Diesel fuel prices have more than doubled (+148% YoY) and steel prices are up over 30%. 

During the pandemic, price increases were largely absorbed by general contractors who were struggling to win the limited number of projects in the market. But now that the economy is reopening, project opportunities are growing and causing contractors to pass the cost increases directly through to clients, impacting both occupiers and investors alike.

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While demand has increased during the pandemic, the supply side has not been able to ramp back up as quickly. When the U.S. economy slowed down in March and April of 2020, capacity utilization also dropped significantly. Mills, processing plants and manufacturing operations slowed and/or stopped due to health concerns, supply chain freezes and/or lack of demand. Commodities critical to real estate construction have seen substantial increases over the past year: 

  • Diesel fuel: +148% 
  • Lumber: +101% 
  • Copper: +77% 
  • Steel: +30% 

March 2021 was the first month where capacity utilization for all three of these commodities was as high as it had been in February 2020. Capacity remains below prior expansion peak levels and long-term averages.

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Transportation issues and a scarcity of shipping containers are contributing to longer lead times with many forms of transportation experiencing delays (some intermittently), including ocean freight, air freight, trucking and rail.

Soaring freight rates for 40-foot containers from Asia are compounding the cost increases for construction. Year-over-year, spot rates from Asia to northern Europe jumped from $1,405 to $8,248 and from Asia to the east coast of North America rates went from $2,709 to $6,604. Ocean shipping services struggled to meet demand for imported goods from Asia. Many ports struggled to unload ships in a timely manner due to pandemic impacts on the port workforce.

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How to mitigate construction risk in a volatile market

Commodities do not discriminate by property types (office, industrial, retail or multi-family). Risk reduction/mitigation may be slightly different based on the specific property type, yet these considerations should be evaluated for all project types:

ENGAGE A PROJECT MANAGER EARLY

Given the volatility of the commodities markets, engage early, and as soon as possible, with a professional project management firm that will provide the following value-added services:

  • Specific advice based on market conditions for the anticipated type of construction;
  • Valuable industry expertise with respect to budgeting, scheduling, procurement strategies, suppliers and effective design scope; and
  • Procurement leverage advantage with contractors, subcontractors and suppliers based on their buying activity within a market and/or larger geographic area.

PREPARE FOR ALTERNATIVE SOLUTIONS & EXTENDED SCHEDULES

The Project Team should create and vet all possible project solutions including developing an accurate customized Master Project Budget and Master Schedule, as well as conducting value engineering studies.

  • Consider alternatives to traditional in-demand building materials such as precast concrete panels, PEX plumbing, lumber, CMU, concrete, or steel depending on the material availability, cost and local construction capabilities/techniques.
  • Specify locally produced materials and suppliers with optimal inventory, location and transportation cost.
  • Pre-purchase materials such as steel joists for industrial buildings and steel studs for interior tenant improvement buildouts.
  • Evaluate the use of prefabrication and/or modular construction to expedite the off-site construction, reduce waste and improve field labor productivity.

Commodity risk mitigation examples by property type

Office

  • For high-rise office construction, owners should consider a concrete structure in lieu of a steel structure.
  • Low- and mid-rise construction may benefit from modular construction to reduce waste and improve labor efficiency.
  • Procurement process for interior materials will need to start as early as possible to mitigate supply chain disruptions/delays.

Industrial

  • Design to maximize bay width to minimize steel joist infrastructure.
  • Maximize tilt-up and/or precast construction to reduce structural steel.
  • Consider prefabrication wherever possible.
  • Start the procurement of steel joists as early as possible to mitigate supply chain disruptions or delays.

Retail

  • Embrace prefabrication wherever possible. Modularize key building elements—up to the entire structure, if possible—via a centralized hub to minimize transportation costs of raw materials.
  • Maximize tilt-up and/or precast construction to reduce structural steel.
  • Employ “lean construction” principles, particularly just-in-time delivery, to reduce raw materials stored on site.

Multifamily

  • Low- and mid-rise multifamily may benefit from modular construction.
  • Consider alternatives to copper piping, such as PEX plumbing, where permitted by code.
  • Consider concrete structure in lieu of a steel structure.
  • Fully embrace prefabrication for key building components.
  • Source locally produced finishes to minimize transportation costs.

Impact on commercial real estate market dynamics

  • Increased material costs drive replacement costs higher, which supports the value of existing assets.
  • The faster rents are growing now, the greater the margin of safety developers have to absorb the cost of higher materials prices and supply chain uncertainty.
  • From the occupier developer/build-to-suit perspective, the question is how confident one can be that functional space can be secured in the right locations in order to meet projected needs. The greater level of product specificity will tend to mean greater ability to absorb development cost increases because existing assets are less substitutable.
  • Supply-demand imbalances will likely keep cost growth rates high, but improvements in supply chains should moderate increases.

With these points in mind, now is the time to place value on your partnerships. Developing stronger partnerships earlier on in the construction or procurement process helps diminish risks while providing guidance on how to navigate the shortages and inflation of commodities in the construction industry. Cushman and Wakefield's Project and Development Services team recommends bringing in a contractor at the beginning of your project to advise on reasonable timelines, lock in material pricing, and help with your overall procurement process.

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