CHICAGO — Building revenue and demand for new commercial construction may be rising fast, but so are costs. Profitability for new commercial building projects will be tricky in 2015, as soaring demand may not lead to soaring profits, according to a new JLL report on U.S. non-residential construction activity.
“Leasing momentum is boosting construction demand across multiple commercial property sectors — but raw material and labor costs are making it more expensive to get out of the ground than ever before,” says Todd Burns, president of JLL Project and Development Services for the Americas. “Demand is exploding, but demand isn’t everything. You have to consider the bottom line of every project to make sure it makes economic sense short- and long-term.”
Affirming rising demand, the consensus forecast of the American Institute of Architects calls for spending on non-residential construction to rise 7.7 percent in every commercial property sector this year. Likewise, the Construction Backlog Indicator, which tracks non-residential construction, hit a post-downturn high of 8.8 months in the third quarter of 2014.
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The JLL report highlights several trends to watch this year on the construction front:
• Recovery Continues, Backlog Builds — The overall value of buildings constructed has continued to grow since bottoming out in 2010. The Construction Backlog Index has grown in all but the Southeast region, indicating that 2015 will be a big year for construction.
Office vacancy rates across the country have declined from 14.1 percent in 2012 to 10.9 percent in the fourth quarter of 2014, further strengthening demand. That said, cities with high labor costs and limited land, such as New York and New Jersey, may see construction activity slow.
• Costs Climbing Higher — Although raw material costs are expected to stabilize in 2015, rising labor costs will force construction costs overall to continue growing. Cities such as New York and Chicago will feel the pain of cost hikes, and so will Minneapolis where a massive downtown refurbishment is underway.
Even Atlanta, one of the lowest-cost markets, saw a bump up in overall prices for the first time since 2008. This trend could be troublesome for the education sector, which reported the highest level of spending on construction in 2014 at $78.7 billion.
• The Construction Unemployment Paradox — Construction unemployment rates remain high, indicating a large potential employment pool for new construction. However, overall unemployment will drop quickly as construction activity accelerates. Though unemployment will drop, costs will continue to rise due to productivity issues; there is a lack of construction workers with the proper skills and training, frustrating employers and driving up overall labor costs.
Costs are also growing more quickly in union-centric markets. According to the U.S. Bureau of Labor Statistics, the lack of available workers with the right training will worsen even as 1.1 million construction jobs are added to the market by 2020. The construction industry grew every month in 2014, gaining 48,000 jobs in December to reach 290,000 total in 2014. However, overall construction employment is still 1.5 million lower than the peak year of 2007.
• It’s Cheaper to Build Than to Lease — With more demand for new construction in some markets like Chicago, West Los Angeles and Seattle, replacement costs have become lower than purchase prices so constructing new space is more cost-effective than leasing existing space.
But it’s not an even recovery. Construction of distribution facilities supporting e-commerce and retail supply chains will continue to expand, particularly in markets like Dallas and Miami, where new facilities are needed to support sophisticated logistics strategies.
Conversely, due to a high volume of office projects started in 2014, more than 16 million square feet of new office development is under construction in Houston. Approximately 44 percent of that space has not yet been leased, which may cause vacancy issues for the city down the road, especially if oil prices remain low.
“Vacancy rates for industrial properties have dropped in the last two years, and competition for big distribution centers has increased dramatically,” says Dana Westgren, research analyst with JLL. “Particularly in locations near ports and other key supply chain locations, new construction can replace older, now-obsolete facilities.”