"Sticker Shock" Hits Industrial Tenants

 

 

United Properties has been following the construction costs of a typical 30,000-sq.-ft., precast industrial shell with 20-foot clear height. The cost to construct this building, excluding land costs, was $1,908,600 in 2004. However, with rising costs in construction and raw materials, the price tag in 2006 is $2,239,500—a 16.7% increase. Within this increase, the shell building costs rose 16.1%, and tenant improvements (TIs) increased 15.5%.

 

"Shell and tenant improvement costs are up, and that certainly is having an impact on tenants' willingness to execute new deals," says Mark Sims, United Properties' vice president – Industrial Brokerage. "What used to be in the $40-per-square-foot range is now actually pricing at $50 a foot for standard office tenant improvements."

 

 

Shell Plus TI Costs Create Ripple Effect

"On top of rising hard costs, most cities are requiring users and developers to present new development plans that have a mixture of uses," Sims says. "It's a more complicated and time-consuming master-planning process, which equates to higher costs as well."

 

Tony DelDotto, senior associate – Industrial Brokerage at United Properties, says the most discussed and anticipated effect of rising construction costs is the upward pressure those costs continue to have on lease rates.

 

"Currently, we're working with a developer on a potential speculative project, and even with reasonable land cost, the construction numbers are demanding that we pro forma bulk warehouse rates in the neighborhood of $4.50 to $4.75 per square foot to even consider the project," he says. "These numbers leave very little wiggle room for error and put significant pressure on predicting the future. We're starting to see more and more warehouse lease comps over $4.50 per square foot, but it still requires tremendous faith that such rates can be consistently achieved in a new project."

 

DelDotto says in some cases, new construction costs are even putting downward pressure on inflated value expectations of land sellers.

 

"In a couple of cases, we've seen developers aggressively put sites under contract, but after determining construction costs they're forced to renegotiate with the land seller or even abandon the project altogether," he says. "The landowners are forced to either reduce their price or hold out to see if someone else can make the numbers work."

 

Despite the increased costs associated with new construction, most tenants will pay more for functional, state-of- the-art space in the right location, DelDotto points out.

 

"Older, less functional buildings continue to lose deals to these properties, regardless of significantly reduced rates. Eventually the cost savings delta will persuade tenants to accept less-efficient space in return for low rent. In many cases, however, almost no price can overcome a tenant's demand for functional space."

 

 

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