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Commodity Crunch, Lead Time Dilemma and Uncomfortably Low Vacancy

Rebecca Rockey • 3/3/2022

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?

The combination of extraordinary industrial real estate demand and aging building inventories has generated a record-level construction pipeline of 568.3 million square feet. But the recent commodity shortages, longer lead times and increased pricing have slowed the pace of completions, driving already low vacancy rates down even further to a historic low of 3.7%. 
On a positive note, our survey of major U.S. industrial markets indicates that construction delays have been sporadic in those markets over the last several months and that only a modest amount of space that was expected to deliver in 2021 has been pushed into 2022. 
Yet even these moderate delays have been enough to impact market conditions: investors and developers can’t build product fast enough. In fact, material lead times and rising rents have developers pushing even harder to get new projects going sooner. That’s the case in markets such as Phoenix, Indianapolis and the PA I-81/I-78 Corridor where the increased lead times for steel, roofing materials, concrete and other key materials have expanded development timelines—materials are being put on order long before they would have been in different cycles.  

The Forecast

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.
Hot “Rolled” Commodity

Steel has become the most problematic and perhaps the hottest materials issue in warehouse-distribution construction.

How did we get here?

In 2020, many steel mills operated at reduced capacity or went idle amid fears of an economic downturn brought on by the global pandemic. Production fell 1% year-over-year. However, on the heels of a slowdown, significant demand for cars and trucks, construction materials, appliances, and other steel products spurred production.

According to the World Steel Association, a total of around 1.95 billion metric tons of crude steel were produced worldwide in 2021—a 3.8% increase over 2020 and 4.1% over 2019. U.S. steel mills produced 67.66 million tons of steel in 2021, a 20.2% increase over 2020.

According to the Federal Reserve, U.S. steel mills were running at 81% capacity in January 2022, up from its low point of 52.6% recorded in May 2020. Throughout the fall of 2021 and into 2022, capacity remained elevated and near pre-pandemic highs, which were only just being reached after an expansion that exceeded 10 years. As of this writing, capacity remains in the 80% to 85% range, which is well above the prior decade average of 74.8%. These figures illustrate the intense push to increase output as the manufacturing sector has not operated consistently at its current capacity since before the Global Financial Crisis in 2007-2009.

Most steel used in construction is either hot or cold rolled. Hot-Rolled Coil (HRC) steel is common 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 impact commercial real estate. 

U.S. HRC spot prices entered 2021 rallying, already near an all-time high at $1,009, according to S&P Global Platts pricing data. Based on CME Group data, futures prices indicate that prices for HRC are expected to be sharply lower in 2022 (expected to hit $970 by year-end) compared with the highs of 2021 ($1,945 at the end of August 2021 when sheet prices were triple the 10-year average from 2010-2019). However, while moving lower, U.S. sheet steel prices are still expected to remain elevated in 2022 compared with the historical average.  


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