No end in sight to rising construction prices
Last year ended on a high note for construction in Arizona, with a whopping 19.06 percent increase year-over-year (YOY) compared to 2019 statewide construction volume. Annual activity topped $17.7B according to the Arizona Department of Revenue’s tax data. 2020 marks the highest annual construction volume since 2008 when the market started to slip into the Great Recession. Since 2017 the market has seen yearly double-digit increases in activity.
Driving the market are economic forces of in-migration and demand for housing and industrial spaces. The market is delivering these in-demand products as fast as they can, but constraints of high construction prices combined with shortages of skilled labor and construction materials are having a real impact on the market’s ability to deliver projects on time and on budget. “I have not seen conditions like we are at now in the 31 years I’ve been in the market” stated Anthony Jeffers, Project Development Director of Hensel Phelps. Jeffers attributes the strong market conditions to years of efforts by economic development agencies such as GPEC and the ACA, along with business-friendly tax policies put in place by Governor Ducey and the State of Arizona.
Industrial Leads the Pack
Last week’s announcement of Intel’s $20B capital investment into two new fabrication facilities in Chandler comes on the heels of TSMC’s $12B capital investment into a new gigafab manufacturing plant in North Phoenix in May of 2020. These recent announcements join a long list of manufacturing facilities being built in Arizona such as Lucid and Nikola in Pinal County. While the construction costs do not make up the entire capital investment, even using a rough estimate of around 30-50 percent, these each will bring $B in construction activity to the state in the coming years.
In addition to the heavier industrial-type construction these manufacturing facilities represent, light industrial demand is exceptionally strong as well. Warehouses, distribution centers and smaller/lighter manufacturing facilities are all surging in demand. According to the latest CBRE vacancy report, all industrial is hovering at 6 percent while space under construction is topping 11.1MSF. Compare that to a retail vacancy of 7.8 percent with 571KSF under construction and office vacancy at 17.4 percent and 2.3MSF under construction. Conclusion – retail and office combined equals roughly 25 percent of the current industrial activity and volume.
Housing Not to be Outdone
All the forces driving housing construction – low inventory and mortgage interest rates combined with high population in-migration – have been well documented. Arizona multifamily construction has been on a tear since 2014 even leading some to speculate that there was a “bubble” of multifamily in 2016 and 2017. Those fears have given way to a sustained bullish outlook on all forms of housing. As presented in the annual Construction Activity Forecast event in January 2021, housing (both single-family and multifamily) makes up one-third of the Arizona construction market. Multifamily construction is at an all-time high in Arizona.
According to the U.S. Census Bureau, Arizona clocks in at number five in the nation for new housing permits since January of 2020 (data available through February 2021). Ahead of Arizona are fast-growing and/or states with very large population centers: Texas, California, Florida and North Carolina.
Construction Prices are Increasing Fast
With sharp increases in demand for housing and industrial spaces, prices for construction materials have skyrocketed. Lumber has increased anywhere from 60-100 percent YOY depending on the specific item and source of the material. Concrete has increased between 5-10 percent in the last six months according to Derek Wright, President of Suntec Concrete.
BEX researchers are starting to see individual projects that no longer pencil and are being delayed or canceled outright. The biggest consideration for these projects is the time delay of when a project was budgeted to the time it goes to contract. For example, with HUD financing, the project budget is set but then goes through a 60-day review process prior to the project moving forward. That 60-day delay is wreaking havoc on subcontractor pricing.
Subcontractors and vendors are holding their bid prices for only 7-14 days, which is putting enormous pressure on general contractors to buyout jobs early and fast in order to lock in pricing.
Several general contractors we spoke to stated that their best advice is to secure subcontractors early, but on the other hand, projects may have to go back to the drawing board and be completely redesigned to avoid a structural design that no longer makes sense due to the sharp materials price escalation.
Volatility in the Market Projected to Continue
For very large projects, institutional owners and developers, GC’s and subcontractors are (ever so) slightly insulated from major volatility in the market.
In general, the biggest projects draw the most interest from the market and will realize significant economies of scale. Negotiating a very large deal influences manufacturers so they become willing to lock in a lower unit price. Larger contractors and trade partners are able to sustain a higher pay scale for workers, in turn attracting the workforce they require for their large projects.
Owners such as TSMC and Intel are much less price conscious than a small developer and will happily pay a premium to secure the quality and schedule they demand for their project. In addition, larger firms typically have access to capital and will be able to secure favorable purchase deals as needed to execute the projects. These factors – availability to purchase early, negotiate better purchase agreements, pay higher wages, cashflow, etc. are not available to anyone but the largest and best capitalized players in the market.
The old adage of ‘Rising Tide Lifts All Boats’ may apply to the overall market, but it is possible we will see the lower end of the market struggle as these mega projects attract significant portions of the labor and materials in the market, continuing to drive construction prices higher than many projects can support.