Navigating the Rising Tide: The Surge in Commercial Real Estate Construction Costs

Over the past three to four years, the commercial real estate sector has witnessed a substantial increase in construction costs for all real estate types including office, industrial, retail, clinical and other specialty uses. Fluctuating material costs, labor shortages and regulatory changes have combined to push the price of building skyward. This blog explores these trends, backed by specific data on material cost increases and their implications for developers, investors and end-users in the commercial real estate market.

Understanding the cost surge

Between 2019 and 2023, construction costs for commercial real estate projects escalated dramatically, with industry estimates suggesting an average increase of approximately 25-30% across various markets. Key factors contributing to this spike include:

• Material Costs: Prices for essential construction materials such as steel, concrete and lumber have surged significantly.
  
  • Steel: The price of steel, critical for structural frameworks, increased by up to 40% at certain points, influenced by global supply chain disruptions and tariffs.
  • Concrete: Concrete prices have risen by about 15-20%, impacted by supply chain issues and climbing energy costs that affect production.
  • Lumber: Perhaps the most volatile, lumber prices spiked by over 100% during the pandemic, driven by an unexpected surge in demand for housing and renovations, coupled with supply constraints.
• Labor Shortages: The construction industry has faced persistent labor shortages, exacerbated by an aging workforce and fewer young workers entering the field. This shortage has led to increased wages, contributing to higher overall project costs by approximately 10-15%.
• Regulatory Changes: Increased regulations and stricter building codes have also played a role in driving up costs, often requiring additional materials, technologies or processes that can significantly increase the overall expense of construction projects by an extra 5-10%.

Regional variations

The impact of these cost increases has not been uniform, varying significantly by region and city. Urban areas, particularly those experiencing high growth or stringent regulatory environments, have seen some of the steepest increases. For instance, cities like San Francisco, New York and Boston have reported higher-than-average cost hikes due to their unique market dynamics.

Implications for the market

These rising costs have several implications for the commercial real estate market:

• Project Feasibility: Increasing costs are affecting the feasibility of new projects, with some developments becoming financially unviable under current conditions.
• Rental Prices: To recoup higher construction costs, developers and owners may charge higher rents, impacting affordability for businesses.
• Investment Returns: Investors may see altered return profiles, with longer break-even periods and potentially lower yields on commercial real estate investments.
• Innovation and Efficiency: There is a growing incentive for innovation in construction techniques and materials that can help control costs, such as modular construction or sustainable materials

Looking ahead

Despite these challenges, the commercial real estate market continues to adapt. Stakeholders are exploring new strategies and technologies to mitigate rising costs and maintain project viability. As we move forward, navigating these cost dynamics will be crucial for success in the evolving commercial real estate landscape.

Conclusion

The last few years have marked an era of significant change for commercial real estate construction. Understanding cost drivers and their market implications are essential for companies planning to relocate or remodel their facilities. As companies adjust to these new realities, Site Selection Group’s construction managers can help you control your construction costs for your next project.