Construction Cost Surge Delivers Benefits to Commercial Real Estate Owners

NEW YORK--(BUSINESS WIRE)--Clarion Partners LLC, a leading U.S. real estate investment manager and one of Franklin Templeton’s specialist investment managers, sees a potential silver lining in the impacts of surging construction costs on the commercial real estate (CRE) industry since the onset of the COVID-19 pandemic.

Clarion notes that, while commodity prices have slightly improved over recent months, overall building costs are up by approximately 35% from early 2020. Lumber and plywood have increased 26% from March to August 2021, while other building materials have seen greater increases – steel pipe and tube, copper and brass mill, and plastic construction prices have increased by 63%, 61% and 32%, respectively.

Several factors may be attributed to the rapid run-up in overall construction prices, including pandemic-induced supply chain disruptions, a synchronized global demand recovery, a housing and home improvement boom, commodity market speculation, labor shortages and higher construction wages.

“This unprecedented surge in construction costs is having profound impacts on both new development projects and existing CRE assets,” said Tim Wang, Managing Director and Head of Investment Research at Clarion. “On the positive side, rising replacement costs, and more moderate development pipelines partially as a result of that, may further boost appreciation of existing assets going forward, provided strong supply and demand fundamental conditions allow landlords to pass through inflationary increases to tenants in rents. We see the greatest investment opportunities in sectors with the highest demand and low vacancy, which includes rental housing, institutional-quality Class A logistics properties and life science facilities.”

It is also meaningful, noted Wang, that rent is a small portion of the total cost equation for tenants in the overall logistics chain, making it easier to pass through industrial rent increases, while housing is a necessity, which leads to the same dynamic for apartments when housing is at such a shortage.

Clarion noted that the higher construction prices along with significant increase in land costs are resulting in lower profit margins on new development and renovations, project budget overruns and delays, more moderate development pipelines, and more room for rent growth and appreciation at existing properties. Clarion expects that recent government initiatives, such as the passage of the Biden administration’s infrastructure plan, will likely also put upward pressure on construction costs going forward.

“Over the next five to seven years, the Biden administration’s $1.2 trillion infrastructure plan will direct billions of dollars toward clean air, water and transit infrastructure, which may impact both material and labor costs nationwide. Construction costs could moderate as production and supply chain disruptions ease, but we have not yet seen global production and supply chains universally improve. We will be monitoring these and other risks, such as new COVID variants, tariff and trade policy, the pace of Chinese economic growth, and new construction technologies, very closely,” said Wang.

Clarion’s new report, titled “Surging Construction Costs: Implications for Commercial Real Estate,” can be found here.

About Clarion Partners, LLC

Clarion Partners, LLC, has been a leading real estate investment manager for more than 39 years. Headquartered in New York, the firm maintains strategically located offices across the United States and Europe. With over $65 billion in total real estate and debt assets under management, Clarion Partners offers a broad range of real estate strategies across the risk/return spectrum to its more than 500 institutional investors across the globe. More information about the firm is available at www.clarionpartners.com.

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