Record high building costs have helped sustain asset appreciation and could also help shape new investment opportunities.
Introduction: Building Costs at a Record High
Overall, U.S. commercial building costs have risen 30% over the past decade (Figure 1). Average replacement costs are now also well above existing asset values.1 The positive outcome for CRE investors is that high costs are holding back new construction and limiting over-supply risk, which is driving appreciation and rent growth of existing assets.2
Figure 1: U.S. Rising Construction & Land Costs (2008-2019)
These challenges are largely caused by a few factors:
- Construction labor shortages. Construction employment is now still below its prior peak at 7.5 million.4 These jobs fell by about 2 million after the 2008-2009 credit crisis. Low labor availability is especially prevalent amidst skilled or 'craft' subcontractors, as well as in the largest and most expensive U.S. cities.5 Subsequently, construction wages have increased about 40% so far this cycle across the industry.6 Furthermore, non-U.S. citizen workers are facing visa challenges, which may be having an impact on labor availability.
- Fluctuating commodity prices. Over the past few years, material prices have fluctuated significantly, which can present greater project risk. In 2018, commodity prices rose on certain materials; metals, for example, climbed briefly due to shifting global trade dynamics. However, over the past year, key material prices have moderated noticeably overall. Hard costs typically represent 60% to 70% of the total project costs (whereas soft costs are more like 30%).7
- Rising land costs. Land prices are also historically high nationwide. Since 2017, global institutional investors' race to buy real assets (e.g. farmland, infrastructure, and real estate) has accelerated. Subsequently, demand for land for industrial, housing, and solar energy uses has escalated.
New Construction Levels: Past, Current, & Future
Figure 2: Commercial Real Estate: Annual New Supply as a % of Existing Stock
Construction Costs Highest in Largest U.S. Cities
Figure 3: Construction Labor Costs by Metro Relative to U.S. Average
Figure 4: Functional Obsolescence in U.S. CRE Widespread
Figure 5: 5-Year Cumulative Growth: Construction Cost, NPI Appreciation, & Inflation
Class A properties represent the highest quality buildings in their market and area. They are generally newer properties built within the last 15 years with top amenities, high-income earning tenants and low vacancy rates.
The Federal Reserve Board (Fed) is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.
The NCREIF Property Index (NPI) provides returns for institutional grade real estate held in a fiduciary environment in the United States. Properties are managed by investment fiduciaries on behalf of tax-exempt pension funds. As of the second quarter of 2003 the index contains 3,967 properties with an aggregate market value of $127 billion.
The Turner Building Cost Index includes nonresidential construction and is on annual frequency and is based on a few factors: labor rates and productivity, material prices, and the competitive condition of the marketplace.
The United States Census Bureau (USCB) is a principal agency of the U.S. Federal Statistical System, responsible for producing data about the American people and economy.
1 Clarion Partners Investment Research. Q3 2019.
3 GlobeSt.com. Construction Lending Outlook: Strong Sentiment and Fundamentals Amid Growing Uncertainties. 2019 and Bisnow.com. The Rise Of The Subcontractors: Labor Shortage Keeping Skilled Workers In Control. 2019.
4 U.S. Bureau of Labor Statistics. Q2 2019.
5 Globest. Skilled Workforce Drought Continues to Plague Construction. 2019.
6 U.S. Bureau of Labor Statistics. Q3 2019.
7 NMHC. The Housing Affordability Toolkit. 2019.
8 CBRE-EA. Q2 2019.
9 Ibid. Note: Calculation based on industrial, office, and multifamily only.
10 Jones Lang LaSalle. Q3 2019.
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