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How Rising Construction Costs Impact Property Values

Rising construction costs were the No. 1 real estate and development concern for respondents that participated in ULI’s Emerging Trends in Real Estate 2019 survey.

Construction costs have seen a continual rise due to material costs and labor shortages. Those costs are having a significant impact on the value of not only new construction but existing buildings as well.

 

Factors that affect property value

Because the commercial real estate market is constantly in flux, ensuring that you get the best deal requires a full understanding of the factors that may contribute to fluctuations at any time. This understanding is just as important to those looking to buy or invest in commercial real estate as it is for those selling or leasing their properties.

It includes any property type, whether it be retail, a medical office building, an office, or a warehouse. Familiarizing yourself with the nuances of your market is crucial to secure the best deal. Consider these factors:

  • Location: We hear it all the time – location is everything. This is true with commercial real estate. Different locations will pose greater desirability within the market at different times. You will need to consider the location’s accessibility when it comes not only to the target market but also to potential employees. Ensuring that the desired space is zoned for your type of business is crucial.

  • Demographics: Demographics and location go hand in hand when it comes to the value of your commercial real estate property. Statistics such as age, race, gender, average income level, and projected growth of an area and its population will help to determine what types of properties are in demand. This affects how a property is priced.

  • Economy: The demand for commercial real estate property is directly affected by the current state of the economy. Depending on where consumers are spending the majority of their money, higher demand will be created for the types of properties where those products or services are being offered. This helps drive up the price.
    To a lesser degree, the value of a commercial real estate property can also be affected by motivation – or lack thereof – of the owner; comparable properties; or physical condition of the property.

 

The impact of construction costs

While there are a number of complex pieces that impact commercial property values, one of the most noteworthy in recent years is the rise of construction costs. Because it costs more to build, the replacement costs also increase. This makes existing buildings in the trade area more valuable. New buildings need more rent to pencil and the existing buildings can raise rents based on this information.

The cost of many products used in construction climbed 7.4 percent over the past year due to double-digit increases in commonly-used construction materials, according to an analysis by the Associated General Contractors of America (AGCA). Those cost increases come as many construction firms are already grappling with shortages of skilled labor but have limited ability to increase prices for their services.

Diesel fuel and construction materials such as steel pipe and tube, asphalt paving mixtures and aluminum products were among the diverse products that contributed to the large year-over-year cost increases, AGCA research showed. Additionally, the current White House administration imposed tariffs on Chinese imports, including goods important to the construction industry.

 

So, what’s next?

Where will we see property values in the next 12 to 16 months if construction costs continue to rise? While costs are seen as sector headwinds, are increases enough to slow development?

Two words can best sum up this potential conundrum: jobs and volume. From 2011 to 2018, the construction industry has seen spending and job growth at or near record highs. Construction requires about 5,000 workers for every added $1 billion in construction volume. In 2018, a spending increase of 6.6 percent translated into an increase of $83 billion in construction spending.

That’s a dollar value you can take to the bank.

Tags: Construction Trends Costs Property Values

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