CREJ

Page 28 — Office & Industrial Quarterly — June 2021 www.crej.com INDUSTRIAL — MARKET OUTLOOK S ince the beginning of the pandemic in March 2020, experts across various disci- plines have too often relied on the word “unprecedent- ed” when discussing COVID-19’s disruption of modern life. While this could be considered an accu- rate – if somewhat reductive – way to describe many of the challenges the Denver commercial real estate industry has faced over the past year, one challenge, at least, isn’t new: rising construction costs. According to Rider Levett Buck- nall’s Quarterly Cost Report, pub- lished in January, nonresidential construction costs were up 1.29% in Denver year over year. Denver-based construction firm Alcorn Construc- tion also predicted prices may rise an additional 5-6% throughout the balance of the year, translating to a $1 to $3 per-square-foot increase in ground-up construction costs. Though current pricing increases cannot accurately be described as “unprecedented,” considering Denver experienced similar price- percentage increases in 2018 and 2019, the most recent uptick in costs is nevertheless a result of the pandemic. Supply chain disruptions and transportation issues caused by the pandemic – including short- age of shipping containers – caused a surge in the cost of raw materi- als, particularly steel, in the early part of 2021. The United States also drastically slowed its domestic steel production at the start of the pan- demic in response to plummeting economic activity and an antici- pated global recession, creating a further shortage in supply when demand rebound- ed more quickly than anticipated. Unfortunately, though the threat of the COVID-19 virus has begun a slow but steady retreat in 2021, the pandemic’s eco- nomic aftershocks are slower to fade. The price of domestic hot-rolled coil – the type of steel most often used in weld- ing and construction – has risen 210% since August 2020, with the Bureau of Labor Statistics reporting that U.S. steel prices are currently 70% higher than the global average. Given predictions that it may take 12 months or more for global steel supply to catch up to the backlog of demand, it is unlikely there will be much – if any – decrease in cost of raw materials in the foreseeable future. With these factors in mind, the question for the Denver industrial sector becomes: How will construc- tion costs affect the market’s devel- opment pipeline? Even before the onset of the pandemic, there was some debate in Denver over wheth- er the supply of new industrial development was beginning to out- pace demand. Despite strong leas- ing activity both before and during the pandemic, vacancy in Denver has been on a slow but consistent rise since the third quarter of 2019, due in large part to speculative projects delivering vacant. Given decreased preleasing activi- ty over the last several quarters and the current construction pricing outlook, one might have expected to see projects being scaled back or delayed indefinitely as 2021 pro- gresses, but, thus far, that has not been the case. Far from a wait-and- see approach, many developers in Denver seem keen to finalize plans and order the necessary materials to avoid further price increases or delays. “Our clients are pushing forward and doing everything possible to expedite their development sched- ules,” said Bryan Fry, a director of industrial at Cushman & Wakefield. “Between the delays that currently exist throughout the supply chain and uncertainty over where con- struction pricing may go, the over- whelming sentiment in the Denver market is that now is the time to strike.” Far from a slowdown in con- struction activity, the Denver mar- ket actually may experience an uptick in land sales as developers and build-to-suit tenants race to secure sites and procure the neces- sary materials to compensate for extended project timelines. With dwindling land supply in the north- east submarket and redevelopment sites pushing toward $40 per sf in the urban core, development activ- ity likely will begin shifting north- ward along the Interstate 25 corri- dor toward Fort Collins. Furthermore, while industrial vacancy has increased over the last several quarters, the market’s over- all vacancy rate remains at a lean 6.3%, an indication that the mar- ket’s pent-up demand has yet to be fully depleted. In fact, the extended construction timelines for cur- rent projects likely will provide an opportunity for some of the specu- lative space that delivered vacant in 2019 and 2020 to be absorbed, driv- ing vacancy down and maintaining the need for a robust development pipeline into 2022 and beyond. Finally, it is worth noting that the cost for existing space build-outs/ improvements – while still less expensive than ground-up develop- ment on a per sf basis – also have increased as a result of supply chain disruptions. Similar to steel, materials like lumber, gypsum, cop- per and aluminum also have been subject to price increases and order backlogs in recent months, lowering the margin on existing space com- pared to new construction. Much like the virus itself, it is impossible to know precisely how long the pandemic’s supply chain disruptions will last, making it dif- ficult to predict how construction costs may be affected long term. However, it is clear – at least in the short term – that material short- ages, delays and increased pricing aren’t going away. While this may translate to a severe drop-off in development activity in some of the less active industrial markets, developers and tenants in Denver seem determined to forge ahead. s cara.stamp@cushwake.com Will rising construction costs impede development? Cara Stamp Senior research analyst, Cushman & Wakefield