Last week I had the pleasure of sharing some positive outlooks not only in the office market but also for construction while participating in a panel discussion at the REDnews 2023 Dallas Office Summit. Amidst concerns about inflation, rising interest rates and looming debt maturity, I discussed three trends that offered some good news such as construction costs stabilizing.
That’s not to say construction costs aren’t still rising; they are just starting to stabilize from 2021 and 2022’s unprecedented increases. After reaching estimated year-over-year cost increases as high as 20 to 25%, the increases are now moving to the more typical range of 3% to 6% as we head into the second half of 2023.
A few key things currently impacting construction pricing include the cost decrease of certain materials as well as our supply chain opening back up. We all recognize that commodity pricing changes often, and pricing for some materials—such as aluminum as well as concrete and cement—has moderated, helping steady overall construction material pricing.
Additionally, as we see some construction projects slowing down in light of interest rates going up and debt concerns, the backlog of the trade partners and the labor force is starting to slow. Previously, our trade partners’ backlog and pursuits were dictated by their work-in-progress calendar and available labor but as construction starts slow, we see more availability from our trade partners and their associated labor force. I believe this will have a positive effect as we are finally figuring out the industry’s post-pandemic labor supply chain.
Supply chain woes have also calmed down some. While there are still constrained numbers of construction materials and supplies, the effects are beginning to lessen as we see a reduction in air, rail and trucking shortages. For one thing, stats show air freight volumes decreased in nine of the last 10 months. It’s a trend we hope continues.
Ocean freight container costs skyrocketed in 2021. Costs began to decline sharply in the middle of 2022 from around $10k per container to $1,700 per container in March 2023. Over-the-road freight is doing better with declining fuel prices resulting from slowed demand and people stockpiling inventory as the supply chain was such an issue since 2020. While diesel fuel prices remain high, they are lower than 2022 fuel prices.
Economists anticipate diesel fuel prices will continue to soften in the coming months barring any major supply chain or geopolitical changes. We’re hopeful rates across the board from air and rail to trucking will also continue to move downward.
One key area that the supply chain seems to still be impacting is our MEP trades. Currently, it takes over a year from the time of placing an order to the delivery of electrical gear and panels. We are also seeing mechanical equipment such as RTUs (rooftop units) and chillers have a one-year plus lead time. So proper preconstruction planning is still needed to mitigate the impact of the long lead times associated with the MEP Systems.
Overall lead times to get materials are still longer than pre-pandemic, but the stabilization allows for better inventory management. One of the problem areas tends to be the MEP segments, where long lead times continue.
Adaptive reuse is a growing trend, and AP Gulf States is building almost 300 multifamily units across 14 floors of former office space in the 50-story Santander Tower (pictured below), located in Dallas’ historic Main Street District. Building owners have invested more than $40 million to update all of the building’s systems, refurbish common areas including the lobby and plaza, as well as create a true vertical mixed-use development with on-site dining options, a boutique hotel and residential transformation.
During the REDnews panel discussion, several commercial real estate brokers touched on the fact that office-to-multifamily conversions don’t necessarily increase the value of a tower in a lender’s eyes, calling it an unproven market.
However, the addition of multifamily uses is taking obsolete space out of the equation and adding vitality to the area with residents who want to live, work and play in Downtown Dallas. This creates tremendous value. Plus, not everyone enjoys commuting from the suburbs. Factor in the cost-savings and sustainability of converting a tower, and there is a win-win to consider.
And, not every building is prime for conversion, as the floor plans and bones must be right for it to work. For instance, adaptive reuse won’t work on a suburban Class-B building. At that point, a developer would rather just take the investment and build a garden-style apartment.
A lot of factors go into making adaptive reuse a profitable development. First and foremost, the purchase price and investment into the building must be on a basis that will allow for the development and construction cost of the demolition and conversion to multifamily. Also, there needs to be a long view on the returns as the developers of adaptive reuse projects are gambling a bit by anticipating that the residential demand will take root and increase the work/play opportunities in the same building or surrounding areas. Sometimes you may see the conversion is done to fill in an already vibrant work/play building such as Santander Tower.
To sum it up, whether you think we are heading into a recession or not, there is no better place to be than Texas, especially the DFW Metroplex. These trends indicate that the CRE market here is holding its own, far better than the rest of the country and much of the state. It’s never wise to bet against Texas, though.
The REDnews 2023 Dallas Office Summit Development, Investment and Finance panel featured (left to right) Cawley Partners Partner Jeremy Duggins, Colliers Fort Worth SVP Cody Payne, Ryan Companies Development Manager Hank Biddle, AP Gulf States Regional President Will Pender, Goodwin Advisors Managing Partner Evan Stone and McKinney Economic Development SVP Michael Talley.