New Construction off to a Shaky Start in 2023

According to a recent GlobeSt article, the US construction industry should prepare for a 3% drop-off in construction starts (i.e. new construction projects) in 2023. This follows on from a complicated couple of years for the industry in 2021-2022, as soaring materials prices and supply chain disruptions kept developers guessing about their next steps. 

GlobeSt was reporting on data from the Dodge Construction Outlook Conference which took place in November 2022. The Dodge Construction Network provides data analytics and insights to construction executives and industry leaders across the US, and the annual conference is cited as: “the leading economic forecast event for commercial construction.”

Multifamily set to slow

As is often the case, the expected decline will affect specific real estate sectors in different ways. GlobeSt notes, for example, that the value of multifamily construction may see a large decline (around 7% when adjusted for inflation).

In their own report on the data, industry news site Engineering News Record (ENR) adds: “In the multi-family sector, starts are expected to finish the year [2022] up 16%, but will drop 9% next year.”

Mixed bag for Retail, Office and Industrial

ENR also notes that the increases in retail and manufacturing starts seen in 2022 are likely to taper off, though it’s worth pointing out that the manufacturing industry saw gains of 196% over the year.

Quoted in the article, Dodge Chief Economist, Richard Branch, noted that despite an anticipated 43% drop for manufacturing construction, “that is still historically a very strong record level of activity.”

Meanwhile the dollar value of office construction is in for a “slight decline” of 1% in 2023, as remote work trends and the tight labor market continue to put pressure on the sector.

Niche sectors still offer respite

Despite these generally downhill trends, other predictions made during the conference include ongoing strong performance from some of the niche CRE sectors we’ve seen rise to prominence in recent years. As Archinect reports:

“While traditional school construction is set to fall, life science buildings and healthcare projects, including outpatient clinics and hospitals, continue to rise.”

These are assets we’ve seen big things from over the past year, and it seems they’re set to continue attracting investors in the year to come.

Recession effects

As the above predictions show, there are still many factors in play that will influence how things shake out for the construction sector in 2023. Arguably the biggest determinant is the likelihood and severity of a potential recession.

In Branch’s words: “We’re walking the razor’s edge here. In our estimation, there is a very, very, very narrow path to avoiding a technical recession in 2023.”

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Lunch Break

Alec J. Pacella

During my school days, lunchtime was always an interesting experience. In addition to providing a nice break and opportunity to socialize, there was the actual main event – food. And with this came great variety, sometimes in a good way and other times in a bad way. I have similar thoughts when looking back at the commercial real estate investment market in 2022.

To see how our real estate market relates to school lunches, read on.

PIZZA

Nothing made me happier heading down the lunch line than seeing a huge sheet of pizza, cut into squares, of course. And nothing made investors happier last year than seeing a new, net leased industrial warehouse offering. This sector continued to be red hot, both on the leasing and the sale side. Occupancy was at an all-time high and increasing rental rates coupled with falling cap rates led to record activity and pricing. Facilities leased to Amazon led the pack and routinely traded at cap rates in the upper 4% range with pricing eclipsing the $300 per square foot (psf) mark. But even more routine deals were greeted with cap rates around 6% and pricing of $75 to $85 per square foot. These include the JB Hudco facility in Bedford ($83 psf at a 6.25% cap rate), the ID Images facility in Brunswick ($77 per square foot at a 5.8% cap rate) and the True Value facility in Westlake ($75 per square foot at a 6.75% cap rate).

CHICKEN NUGGETS WITH CRINKLE FRIES

Nuggets and fries along with some packets of BBQ sauce was a close second in my book, similar to investor interest in apartment properties being right on the heels of industrial warehouses. And while glitzy complexes such as the 401 Lofts in Akron made headlines with equally glitzy per unit pricing that exceeded the six-figure mark, it was the solid activity amongst the Class B product that carried this sector last year. Examples include Clifton Plaza Apartments in Cleveland (108 units sold for $57,000 per unit), Oak Hill Village in Willoughby (182 units sold for $77,000 per unit), State Hill Manor in Parma (110 units sold for $75,000 per unit) and 200 West in Fairview Park (173 units sold for $65,000 per unit).

SPAGETTI AND MEATBALLS

This lunch choice was always polarizing, with some loving a heaping platter of pasta while others hating it. It reminds me of the appetite for retail properties last year. A favorite type was well-located, smaller footprint centers occupied by credit tenants. Examples include Great Lakes Plaza, a 7,200-square-foot center occupied by Condoda Taco and Sleep Number, which traded for $5 million, and Parma Outlet Center, an 8,000-square- foot center anchored by Bank of America and Verizon, which sold for $1.8 million. Meanwhile, a clear unfavorite was tradi- tional, larger centers in mature locations. Examples include Stow Falls Center, a 95,000-square-foot center occupied by Planet Fitness and Litehouse Pools, which traded for $6.1 million, and Pheasants Run, a 30,000-square-foot center in North Olmsted, which sold for $1.7 million.

SLICED HAM WITH GREEN BEANS

When this showed up on the menu, most students opted to pack their lunch, which is similar to the activity in the office sector last year. When an office building showed up for sale, most investors headed in the opposite direction. The sector continues to struggle with weak fundamentals, including static occupancy, flat rent but rising expenses, all against a backdrop of uncertainty of the future of office space. As a result, pricing has languished. Examples of this softness include Westgate Plaza, a 92,500-square-foot building in Fairview Park that sold for $25 per square foot. Springside Place, a 97,000 square-foot property in Montrose that sold for $37 per square foot; the PDC Building, a 70,000 square-foot property in Beachwood that sold for $50 per square foot; and One Independence Place, a 100,000 square-foot building in Independence that sold for $50 per square foot.

ICE CREAM SANDWICHES

No matter how good or bad the lunch choices were, there was always a line when the ice cream freezer opened. This is very similar to investment activity in the single-tenant, net leased sector. Regardless of what may be going on in the broader real estate market, investors always seem to be able to make room for a good net leased offering. There were plenty of examples last year. A newly constructed Jiffy Lube in Avon traded for just over $700 per square foot, at a 7.2% cap rate. A Citizens Bank in Bainbridge sold for $1,400 per square foot, at a 5% cap rate. A Starbucks in Aurora sold for $1,100 per square foot, at a 5.75% cap rate. And a Wendy’s in Cleveland sold for $1,450 per square foot, at a 4.5% cap rate.

While the full effect [of the Fed rate hike] on the commercial real estate market isn’t readily apparent, the activity level clearly slowed over the last part of the year. More importantly, this sluggishness is anticipated to continue into the first part of 2023.

NEW MENU COMING

One of the most interesting days in the cafeteria was when the new menu for the upcoming month was posted on the bulletin board. Everyone would gather around to figure out what days they would packing their lunches and what days they would be buying them. Last year, the bulletin board was replaced by our phones or computers. But we weren’t looking for a menu but rather a news release on the results of the most recent Federal Reserve Board meeting. The Fed met eight times last year and raised the fund rate at seven of these meetings. As a result, the rate went from 0.75% to 4.5% and has obviously had a dramatic impact on the cost of borrowing. While the full effect on the commercial real estate market isn’t readily apparent, the activity level clearly slowed over the last part of the year. More importantly, this sluggishness is anticipated to continue into the first part of 2023.

But I’m starting to get into 5th period so for now, let’s just kick back and enjoy the rest of our lunch!

What I C @PVC

PAINTING A PRETTY PICTURE Last year ended with a bang when it was announced that Sherwin- Williams was entering into a sale/leaseback for the new 1 million-square-foot corporate headquarters. Benderson Realty Development is paying $210 million for a 90% interest in the property, which is currently under construction and scheduled to be completed in early 2025. –AP

For February 2023 Properties Magazine

Deconstructing the cost of building materials in 2022

Throughout 2021, the cost of building materials was a constant pain point for the construction industry. In an analysis by the Associated General Contractors of America (AGC) earlier this year, prices were found to have jumped over 20% between January 2021 and January 2022. The cost of specific materials like steel and plastic sky-rocketed, leaving construction firms caught between shrinking profit margins and a sharp decrease in available labor.

As we head into the second half of 2022, the question that’s top of mind for building contractors and many Commercial Real Estate (CRE) professionals is: Has the situation improved?

Well, the cost reports from the first and second quarter this year are in. Here’s how it’s looking.

Prices climbed in Q1

Overall, the first quarter was still rough for price increases, with the National Association of Homebuilders (NAHB) indicating that the cost of residential construction materials jumped 8%. One of the biggest price hikes was softwood lumber, which increased 36.7% over the period.

Meanwhile, a Q1 report from construction consultancy Linesight showed increasingly high costs for resources like copper (3.3% estimated increase from Q4) and steel (4.7 and 8.9% for rebar and flat steel respectively), accompanied by moderate hikes in cement, asphalt and limestone. Bear in mind that these increases are on top of the price surges many of these materials already saw last year.

Materials costs still (mostly) soaring in Q2

Any hopes of price relief in Q2 were also met with resistance, as costs for many materials continued a steady climb. In an analysis of recent Producer Price Index (PPI) data, AGC showed that the overall cost of inputs for new non-residential construction had jumped 1.1% between May and June alone.

The report also noted that the cost of supplies like concrete products, insulation material and some plastics had increased over the same period. In terms of other materials, however, there were bright spots, with lumber and plywood costs dropping 14.7%, while steel saw a more moderate 1.8 % retraction.

Lumber prices continue to tumble

Lumber has proved an interesting case overall, hitting record highs in 2021 that carried through into 2022. And while in March 2022 the lumber market was still showing a massive price spike, by July it had experienced a 50% decrease. At the time of writing, prices have dropped even further, adding an extra layer of complexity to forecasting and planning for new construction.

Outlook uncertain

Overall, the market remains in flux, with some prices still increasing rapidly. In a recent article covering AGC’s July Price Index analysis, Ken Simonson, Chief Economist for AGC stated:

“Since these prices were collected, producers of gypsum, concrete and other products have announced or implemented new increases. In addition, the supply chain remains fragile and persistent difficulties filling job openings mean construction costs are likely to remain elevated despite declines in some prices.”

In a separate post, Simonson pointed out that the Construction Industry Confidence Index (CICI) also dropped 17 points to a value of 44 in Q2 2022. The index, which measures sentiment amongst industry executives, only indicates a “growing market” if the value is over 50.

Heading into the rest of 2022 the situation remains uncertain, but some experts have predicted a drop-off in materials prices. Whether this translates into gains for the construction industry amid other pressures, only time will tell.

SOCIAL: How have fluctuating materials prices affected new development in your area?

Stabilizing employment rates good news for commercial real estate?

Employment numbers are up according to a recent news release from the Bureau of Labor Statistics (BLS). In their analysis, BLS announced that the unemployment rate had dropped to 3.5%, with 528,000 new jobs added over the course of the month.

These figures mean that, for the first time, unemployment measures have returned to their February 2020, pre-pandemic levels. BLS also noted that the gains were led by the leisure and hospitality industry.

Strong recovery in hospitality

Reporting on the figures, Real Deal pointed out that hiring at hotels, restaurants and bars was responsible for a large percentage of the 528 000 jobs created in July. Together with construction and healthcare, these sectors accounted for 43% of the overall job gains posted. Quoted in the article, Mortgage Bankers Association Chief Economist, Mike Fratantoni added: “This is not a picture of an economy in recession.”

Mixed results for other sectors

Though the construction industry was a strong performer, with an additional 32,000 employees hired, it’s worth noting that this figure would likely have been much higher if there were more workers available. The sector is still deep in the grips of a labor shortage that has put pressure on projects across the US, and led to a slow-down in new developments.

Meanwhile, the office sector also faced constraints, with the percentage of workers staying remote due to the pandemic remaining at 7.1%, exactly the same as in June.  As one of our NAI Offices recently reported, the future of offices has generated some strong dissenting opinions among those in the know, and exactly how the situation is going to pan out remains unclear.

Shifting sands

Though some of these figures certainly seem to indicate an upturn, it’s worth bearing in mind that there are still many indicators of a possible recession. As recently as a month before these figures were posted, there were announcements of cutbacks in the residential sector, and some experts were predicting a drop-off in employment rates.

For other experts, the picture is more nuanced. Lawrence Yun, Chief Economist at the National Association of Realtors (NAR) puts it like this:

“It would be one of the most unusual recessions — if it [the economy] does technically reach it — in that there are worker shortages. Some industries will lay off workers, but there could still be more job openings than the number unemployed throughout the recession.”

Long-term prospects

How the current job situation plays out, and how this affects Commercial Real Estate professionals, remains to be seen. We do know that the employment numbers we are seeing now exceed predictions that were made just a few months ago. If the positive trend in hospitality and construction continues, there could be a lot of new projects, and prospects, on the cards.

SOCIAL: How have hiring trends impacted commercial rentals and development projects in your area?

Report says CRE leaders expect post covid resurgence

In May, law firm DLA Piper released the 2022 edition of their Annual State of the Market Survey report, highlighting that “optimism about the future of commercial real estate (CRE)” remains strong despite the headwinds the industry faces.

The survey on which the report is built was conducted in February and March of 2022, by collating and analyzing input from CRE leaders and professionals in the US – specifically their take on matters including “pandemic recovery, economic outlook, attractiveness of investment markets and overall expectations over the next 12 months”. This input is further contextualized with additional research, presented the report.

Highlights

Overall, the report [PDF] shows “increased bullishness”, with “more respondents in 2022 [having] a higher level of confidence for the real estate industry’s next 12 months”.

Findings from the report also include that 73 percent of respondents are “expecting a bullish market”. This is consistent with 2021 expectations. “However,” they added, “this year, respondents reported feeling a higher level of confidence in a bull market over the next 12 months; 33 percent described their bullishness as an 8 or higher in 2022, compared to just 16 percent in 2021.”

Top contributing reasons include the apparent availability of capital in the market, with over half of the respondents citing this as the main source of their confidence.

Viewed per sector, Commercial Property Executive says in their analysis of the report, “Industrial (66 percent) and multifamily (57 percent) remain the property types that investors believe offer the best risk-adjusted returns over the next 12 months.”

Shaping CRE

Inflation and interest rate changes were ranked most likely to have an impact specifically in the CRE market in the coming year, but ecommerce, migration of workers out of city centers, and the “redesign/reimagining use of office and other commercial spaces” were also common responses.

Concerns remain

Top concerns included interest rate increases (cited by 26 percent of respondents), inflation (18 percent), as well as the Russian invasion of Ukraine.

US gains and advice

Finally, respondents to the survey said they felt the US would be seen as a safe and stable option, attracting non-US investment. “During times of uncertainty – like the pandemic or the conflict in Ukraine — investors often flock to safe havens,” the report reads, adding “a well-defined legal system, transparency and proven economic resiliency” are among the US’s assets.  

In the face of global uncertainty though, the report authors caution that CRE professionals and firms must “remain agile and prioritize adaption, with an eye towards staying ahead of the curve”.

SOCIAL: Do you see the US CRE market as a safe haven in times of global uncertainty? How do you expect inflation to make itself known in your CRE specialty?