“Better to remain silent and be thought a fool than to speak out and remove all doubt.”-Abraham Lincoln “
Diana Bell Aug 25, 2016
Commercial developers have been busy in 2016. Construction starts saw a hearty boost this year, fueled by multifamily, office and lodging sectors. But analysts expect rates of new construction to taper off through 2020.
Private non-residential construction increased 7.0 percent year-over-year, according to research and ratings firm Moody’s Investor Service. Cincinnati-based construction data firm ConstructConnect, formerly CMD Group, meanwhile tabulated year-over-year growth of 8.1 percent across all commercial property types.
Low interest rates here and abroad, coupled with softened global economic conditions, mean foreign investors are increasingly looking to invest in new construction projects in the United States.
“Among the effects of this capital influx are extremely low cap rates associated with multiple product types, including office, multifamily and lodging. With the price of commercial real estate having been bid higher, construction activity has been triggered,” says Anbir Basu, chief economist for Associated Builders & Contractors, Inc., a national construction industry trade association.
“Generally speaking, the construction sector is gradually improving. But the sector has not revived to the degree expected to have on previous recovery,” says Alex Carrick, chief economist at ConstructConnect. “The whole sector is changing as we are seeing the effects of technology on building decisions.”
Evolving technologies present a significant catalyst for the development industry, affecting decisions on what to build. The impact of technology on construction is greater than people realize and is happening faster than anticipated, Carrick says, adding that “Retail is the first category whereby technology is impacting construction.”
The most visible effect seen this year involves brick-and-mortar retailers investing in warehouse properties and supply chain infrastructure necessitated by their e-commerce needs.
“In retail, the story is recovery by abstinence. There is almost no supply growth. The biggest success in development has been with infill stores in wealthier locations,” says Hans G. Nordby, managing director at research firm CoStar Portfolio Strategy.
Office construction spending has increased 16 percent year-over-year, according to Basu. “This demand is partially fueled by strong employment, with the nation adding more than 2.4 million jobs over the past 12 months,” he says.
Research firms estimate new office space added to the market in 2016 at between 70 and 72 million sq. ft. ConstructConnect tabulates 70.2 million sq. ft. of new office supply this year, while CoStar data shows new deliveries at approximately 72.8 million sq. ft.
For many developers in this cycle, high-end office construction has been the name of the game.
“There is a growing gap between the most successful businesses and everyone else. The most successful businesses are targeting class-A+ and class-A buildings, including for purposes of recruitment. Correspondingly, in select markets, we are observing significant new construction of office space despite elevated vacancy rates,” Basu says.
Meanwhile, multifamily construction doesn’t appear to be abating either, in spite of significant levels of new supply already coming on the market.
Through the end of this year, approximately 400,000 multifamily units are expected to be delivered, representing construction growth of about 1.0 to 1.5 percent, according to Tiina Siilaberg, vice president-senior analyst at Moody’s. Next year, Siilaberg says multifamily developers will add another 400,000 units.
Newport Beach, Calif-based real estate research firm Green Street Advisors forecasts that 385,000 multifamily units will be completed in 2017.
In order to deliver returns high enough for banks to feel comfortable lending money in this restrained financing environment, developers of multifamily properties must concentrate on luxury properties with high rents. The higher cost of construction labor is another variable developers must account for in their pro forma. Thus most new multifamily development built over the past year has fallen into the luxury bucket.
As multifamily construction has picked up this year, so too has industrial, a trend brought forward by Nordby.
“There is an almost direct correlation between multifamily construction and light industrial demand nationally.” Some very obvious examples include Denver, Orange County, Calif. and Inland Empire, he says. That’s because although warehouse automation is a target for investors, manpower still mostly fuels warehouses along a supply chain. High population centers with well-developed infrastructure are target requirements for site location.
Over the past three years, demand for industrial properties has been increasing. In addition to space demand generated by e-commerce operations, manufacturing is contributing to the resurgence in industrial construction. BLS data released Aug. 5 signals a gradual recovery in manufacturing employment, which bodes well for this sector. “In the last six months, manufacturing has stabilized, contributing to industrial demand growth,” says Nordby.
ConstructConnect anticipates a total of $11.7 billion in industrial construction projects for 2016, tracking 136.6 million sq. ft. in new warehouse properties. CoStar forecasts a total 185.3 million sq. ft. in new industrial supply by the end of the year, broken up as approximately 169.3 million sq. ft. in logistics centers and about 16 million sq. ft. in light industrial manufacturing facilities. Performance of industrial as a property type is very market-specific, however, and certain metros are driving growth while others remain stagnant.
“Industrial construction in energy-intensive markets, such as North Dakota and Alaska, is down. But there are high levels of industrial construction in states such as Oregon, Utah, Maryland, and California,” Basu says. “There is a large amount of flex space being constructed nationally as well.”
One area of significant growth has been in the light industrial sub-sector. For this property type, Nordby says, “construction went from near-zero three years ago to 18 million sq. ft. nationally this year.”
Lodging construction is also up. There are approximately 103,000 hotel rooms under construction in the United States. Lodging-related construction spending is up 16 percent on a year-over-year basis, Basu says.
The healthcare industry has been another bright spot for developers, with hospital construction up. The seniors housing sector, on the other hand, is now treading into oversupply territory. “Healthcare facility construction is suddenly taking off this year. In 2010-14, with uncertainty over the Affordable Care Act, nothing happened. Hospital construction is now improving, as is construction of seniors care facilities,” Basu says. “But we got a bit ahead of ourselves with seniors housing. Baby boomers won’t need that level of care until they are in their 80s.”
Looking ahead, Moody’s forecasts 5.0 percent supply growth across all private non-residential property types in the first two quarters of 2017. ConstructConnect forecasts 5.4 percent growth for all of 2017, but by 2020, growth will moderate to 3.2 percent.
“2017 is poised to be a transitional year. The 2018-19 construction outlook looks murky. Economic dynamics will not be as they have been,” Basu says. “Price adjustments over the next few years will likely translate into diminished construction.”
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