Developers of industrial real estate are facing a multifront battle to deliver more projects amidst rising costs, supply chain challenges and extraordinary demand.
Skyrocketing Material Pricing
Alarms around rising construction costs began to sound in May of 2021 when steel prices hit record highs. At one point in August of that year, sheet prices were triple the 10-year average from 2010-2019 (see sidebar). The costs of a host of other materials that go into a warehouse-distribution (W/D) facility—concrete, roofing material, fixtures and more—have also risen. In many cases, the price tag for materials for a W/D facility alone is higher than what the total cost to build the same facility was just a short time ago.
Supply Chain Constraints Causing Lead Time Issues
Because construction materials are subject to the same broader availability woes that have impacted the delivery of goods and materials for months, lead times continue to climb. Steel is the most problematic. Pre-pandemic, for a straight build of an average speculative warehouse, a steel order lead time was about 12 months. Today, it’s in the 16–18-month range and is expected to get worse before it gets better.
Resolution in Sight?
Raw materials and input prices have historically been volatile and sensitive to supply-demand imbalances. And although insufficient supply is driving elevated pricing across steel, cement and many other critical construction inputs, some signs are emerging that indicate supply-demand resolution is in sight. For example, the Delta variant clearly re-kinked supply chains at a critical time when demand was high. But the Omicron variant has been much less disruptive in the Asia Pacific region, which has allowed the global supply to begin to ramp back up and work through back log.
Additionally, slowing economic growth should ease some supply chain pain. For example, in countries like Greater China, high demand for raw materials should abate as the economy cools. The same is true for broader global growth and fiscally-induced growth in the U.S.—as growth slows, it should be easier for supply and demand to rebalance.
That said, we don’t expect it to happen until 2023.
So, what does it all mean for commercial real estate?
Until the supply-demand bottleneck is resolved, the construction pipeline will continue to grow even as new buildings come online as quickly as they can be built. We anticipate demand to remain strong for the foreseeable future and new construction to remain above pre-pandemic norms for the years to come.
- The forecast for industrial absorption in the U.S. from 2022 to 2023 is a healthy 814 msf.
- New supply—which trailed demand significantly in 2021—will revert to outpacing demand slightly by year-end 2023.
- New deliveries are projected to reach 880 msf from 2022 to 2023. Nonetheless, vacancy will remain low, ending 2023 at 4.2%—only 50 bps above its year-end 2021 level.
- We believe that bottlenecks may put 2022-2023 completions at minimal risk of delays. If even 25% of new supply were delayed by three or six months, the resulting decrease in projected new supply through 2023 would amount to 3.1% or 6.3%, respectively.
- The projected upward movement in the vacancy rate would be more constrained—the impact by Q4 2023 would range from -6 to -32 bps. If that were to occur, vacancy would likely stay around 4.0%. Either way, vacancy will hover at uncomfortably low levels.
How should industrial developers approach this market?
- Secure long lead items ahead of time: roofing, panels, structures/piping.
- Upon site plan approval, utilize experienced design professionals or design-build firms to order steel based off layout. Scrap steel does not typically work for new construction and will waste time and resources.
- Do not delay construction. Demand will drive rents, which will mitigate construction and capital costs. Inflation is always the risk with labor and materials.
- Extensive soil investigation can forecast costs and risks to allow for proper contingency. Soil investigation is extremely important to determine the weight bearing capacity of the soil, its settlement rate and the position of the water table.
- Maximize impermeable surface/building on speculative development plans. Building size can always be reduced to improve circulation and parking.
- Evaluate prefabrication and/or modular construction to expedite the off-site construction, reduce waste and improve field labor productivity.