Record industrial real estate demand combined with aging building inventory has helped the sector maintain a record-level industrial construction pipeline. The recent commodity shortages and increased pricing could, however, slow down real estate developers, potentially driving already low vacancy rates down even further. These shortages are also making it difficult for industrial occupiers to source racking, material handling equipment (MHE), and other fixtures and machinery to get production or logistics facilities online. In this article, we examine the current commodities market and how it may impact industrial real estate going forward.
Demand for materials is increasing along with costs
Both consumer and wholesale materials are experiencing supply chain disruptions around the world. As construction picks up, demand for materials is increasing, causing higher costs and longer lead times. According to ENR, 52% of 1,489 AGC member contractors have reported a project delay due to a shortage of construction materials, parts or equipment. According to an S&P Global Platts steel market poll, more than half of the participants surveyed expect U.S. finished steel prices to rise further or remain at their current highs over the next six months. Additionally, 44% of participants said they expect to see domestic finished steel prices increase in the coming six months, with 22% expecting prices to rise by more than 10% and the other 22% of respondents expecting the increase to be less than 10%.
The majority of steel used in construction is either hot or cold rolled. Hot-Rolled Coil (HRC) steel is most commonly used in welding and construction trades to make I-beams and railroad tracks, important components to building out infrastructure, warehouses, racking equipment and other necessary parts that will impact commercial real estate. U.S. HRC prices have surged by nearly 210% since August 2020, crushing previous records set in 2018. The run up in pricing has been spurred by sparse service center inventories, tight mill order books, and a lack of imports since the fourth quarter of 2020.
Why are commodities in short supply and experiencing inflation?
Long lead times for steel, raw materials and other construction supplies are the result of supply chain disruptions caused by transportation issues and a scarcity of shipping containers. All forms of transportation are experiencing delays (some intermittently), including ocean freight, air freight, trucking and rail. Additionally, many domestic steel mills slowed production or went idle last year amid fears of an economic downturn brought on by the global pandemic. These mills have since ramped up production due to a recovery in demand for cars and trucks, construction materials, appliances and other steel products. Capacity utilization rates at steel mills—a measure of how production capacity is being used— is at 75% after falling to 50% in May 2020 but is still below 81% seen in January 2020.
The timeline for supply to catch up to demand and work through the backlog is estimated to be 12 months, which means higher prices and longer lead times for steel will likely continue during that period. April 2021 steel/iron prices were up 57.7% year-over-year according to the Bureau of Labor Statistics and according to Drewry World Container Index, shipping costs were up 278.4% higher than a year ago. The outlook for some metal pricing is more aggressive than others—specifically bar joists and metal decking that have long lead times with recent estimates ranging from 24 to 30 weeks. Companies who are waiting it out for lower prices on these materials likely won’t see much relief in upcoming years, with some experts expecting these price increases to be long-term.
The Bureau of Labor Statistics reported that U.S. steel prices are 70% higher than the global market price and almost double the price of steel in China, even with prices in both China and Europe up over 80% from pandemic-induced lows. The price gap is so wide that even with a 25% tariff, it would be cheaper to import than buy from domestic mills. Some distributors expect imports to pick up by June if the domestic market remains tight.
Soaring freight rates for 40-foot containers from Asia are compounding the cost increases for construction. The spot freight rate for a container to the west coast of North America was $5,144 as of May 11, 2021, up from $1,636 in May 2020. 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.
What does this mean for industrial real estate?
With the current industrial construction pipeline at another new record high for the market, materials are being maxed out and it is becoming increasingly expensive to build industrial facilities. At Q1 2021, 57.5% of industrial construction was speculative, leaving build-to-suit space at 42.5%, a much more conservative pipeline ratio than prior cycles, and less risk for developers. Even so, the speculative pipeline is still over 228 million square feet (msf)—a substantial number—but will it be enough to satiate the market’s demand?
The fact remains that it’s still cheaper to lease than to build, which could mean vacancy rates in the industrial sector will be lower in some markets as the rising cost and demand for steel and other commodities move some occupiers to choose leasing over building. Those who do choose to build should expect longer lead times, higher pricing, and the possibility that some steel mills will not be accepting additional requests for the time being.
Increases in the cost of steel in coming quarters will translate to increased construction costs for both ground-up development and improvement of industrial properties. All being equal, we expect this to slow new construction on the margin and provide a further tailwind for existing asset values. Developers may also experiment with material substitutions to the extent that steel price increases outpace alternatives. More HRC supply is set to come online in the next 12 months and the arrival of more steel imports in the summer months should ease the upward pressure on pricing, but it is still something to consider when planning your next construction project in the industrial sector.
How to budget and plan for these new price hikes and delivery delays.
Occupiers & Developers:
- Anticipate construction delays: Schedules may need adjustment for more realistic timelines with the knowledge of shortages and long lead times for commodities.
- Expect higher overall construction costs: Supply chain and construction costs are rising. Occupiers can expect higher build-out costs and developers can expect higher budgets for inputs.
- Speed up site selection: Site selection decisions should be made early in order to start construction planning and procure materials to mitigate lead time and project delays.
- Order equipment early: Steel delays are pushing deliveries of MHE and other machinery, causing delays in upstarts and assembly line repairs/reconfigurations.
With these points in mind, now is the time to place value on your partnerships. Developing stronger partnerships earlier on in the construction, site selection 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 and Logistics & Industrial teams recommend 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.