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Gaining an accurate snapshot of the current state of ground-up construction isn’t easy in today’s market. If developers were to simply look at demand fundamentals, there’s plenty of incentive to build in most commercial real estate asset classes. Multifamily in particular is undersupplied across the country, but industrial, data centers, life science and healthcare are all asset classes where the demand warrants new construction—and yet, developers are having a difficult time making deals work.
In the midyear construction update report, JLL said that ground-up construction was caught in between “a boom, business as usual and a sharp downturn,” and it all seems to hinge on outlying economic headwinds. Restrained capital markets, volatile material pricing and labor shortages have narrowed margins and stalled new construction starts, which are down and expected to decline further into 2024. The mismatch between demand-side strength and financial woes is a new normal that developers are still learning to navigate.
While the demand strength is reassuring, here are three things keeping developers up at night—and stopping them from putting shovel to dirt.
Financing, Margins and Economic Uncertainty
High interest rates are the chief culprit of the slowdown in ground-up construction activity. Since March 2022, the Federal Open Market Committee has increased rates 11 times, from 0% to a range of 5.25% to 5.5%. The aggressive push has substantially increased the cost of new development and constrained the availability of construction loans. According to Marcum’s 2023 Annual Construction Survey, 26% of developers are reporting more difficulty securing financing than last year and 70% report that financing struggles are about the same as they were in 2022, when rates began to climb.
Inflation is also contributing to higher development costs and thinning margins. This year, 43% of developers are expecting higher general and administrative costs due to inflation and overall, 55% of developers are concerned about inflation-induced project delays or even cancelation. Still, JLL researchers have said that the full impact on construction spending and new construction starts has not yet been realized. Due to a backlog of deals along with some federal incentives, construction spending will increase 6% for the year. It won’t last long, however. The report also forecasted a continued slowdown in new construction activity “well into 2024” as the industry navigates new financing costs and how they’re impacting margins and profitability.
Then, there are concerns over a recession. Last year, economists expected a recession in the first half of the year. By the first quarter, the forecast was pushed back, and by the midyear, many economists had either rescinded their recession predictions or delayed them until 2024. While the reforecasts have revealed economic resiliency, a looming recession is driving uncertainty and pushing developers to the sidelines. Until there is more clarity about a potential downturn, developers are likely to delay prospective projects.
Forecasting Material Prices
Over the last three years, developers have battled extreme material pricing volatility. Price growth began to temper in 2022, but this year most material costs have continued to exceed historical averages. On average, material prices have increased 4% this year, but some outlying materials are tracking much higher. Concrete and masonry, specifically, are expected to increase more than 10% this year.
While this remains a significant increase in costs, price growth in 2023 is trending well below the prior two years, according to research from JLL. The downward trend line shows that prices are stabilizing amid improvements in the supply chain—good news for developers. In addition, although some key materials are continuing to post double-digit increases, other material costs are declining. Overall, material pricing growth has returned to pre-pandemic averages. The stabilization has boosted developer confidence, with only 8% of developers reporting the costs of materials as a primary concern this year, behind financial constraints and labor shortages.
Yet, material costs are uniquely exposed to global events, and the pandemic revealed how supply chain disruption or a lack of diversified suppliers can drive up prices. The war in the Ukraine, US trade tensions with China and even geo-political events can impact material costs and destabilize the market. Amid uncertainty, developers continue to lack confidence in the trajectory of material price trends.
Combatting Labor Shortages
Labor remains the most significant challenge for developers. The construction industry unemployment rate trends near the national average with significant job openings—currently 374,000 open jobs. As a result, wages have increased nearly 20% since January 2020. Slowing new construction starts are unlikely to offset the labor shortage, even with fewer available jobs, JLL expects construction labor wages will increase 5% to 6% this year, a trend that is likely to continue. JLL’s midyear construction report says, “Construction activity per employee is anticipated to remain above pre-pandemic rates for the foreseeable future.”
Developers report that the labor shortage is the single biggest issue in ground-up construction. In Marcum’s 2023 Annual Construction Survey, 53% of developers cited difficulties securing skilled labor or labor costs as one of the top challenges this year, placing labor-related obstacles above financing and material prices. Labor-related challenges are stalling projects and stopping developers from pursuing opportunities, when they arise.
Public spending on infrastructure projects is contributing to the labor shortage and adding stress to an already constrained market. As a result, the labor shortage will also vary based on asset class and sector as well as geographic market.
Ground-up construction starts are expected to slow as developers navigate these ongoing challenges—but the savvy developers are adopting progressive solutions. Automation, machine learning and predictive analytics, available through software like Northspyre, are mitigating the impact of these headwinds. Automation reduces administrative and low-value tasks, easing labor shortages. Northspyre customers, for example, can reduce administrative work by up to 80%. Likewise, predictive analytics can help track material prices and availability, helping to cut costs and ensure availability of materials when you need them. Overall these technologies are helping developers reduce project budgets by 6% and overages by 66%. That has a big impact in a market with escalating costs.
Developers accept that they are playing in a high-risk field, but today, those risks have escalated. By understanding the market trends and investing in the right technologies, you can mitigate downside risk and move projects across the finish line.
Are tedious administrative tasks and market uncertainty making it difficult for your team to ensure complex projects finish on time and within budget? Discover how your team can effectively navigate today’s challenges by downloading our report The Biggest Challenges & Opportunities Facing Commercial Real Estate Project Managers in 2023.
Tag(s): Real Estate Development
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