Commercial Construction Costs, Demands Changing

The commercial construction sector is confronting a vastly different competitive climate since the coronavirus began sweeping across the country at the start of what had been shaping up to be a strong year.

The American Institute of Architect's Architecture Billings Index — an economic indicator for nonresidential construction activity — has been at an all-time low since March. With the backlog of projects sagging significantly, how will the market affect investors, owners and developers?

LoopNet connected with industry experts to explore the changing landscape of commercial construction costs and risks and understand the potential shift toward interior renovations.

High Levels of Uncertainty

“Contractors are reporting an increasing number of projects being deferred or canceled," says Ken Simonson, chief economist with Associated General Contractors of America. These stoppages, however, are attributable more to owner concerns than to government orders, he notes.

Owners are facing a loss of net worth or decreased access to funds, as well as a drop in current and expected revenues, which casts doubt on whether they will be able to finance a project, he explains.

Developers also face a number of project-level risks that weren't present five months ago, he adds. Jobsite risks include concerns that materials, equipment, parts or personal protective equipment won't be delivered on time. Workers may not be available because they are ill or because they need to care for a family member. And government offices and inspectors may not be as readily available to allow projects to proceed as scheduled. Because commercial construction timelines must operate on a strict daily rhythm, minor delays can often have long ripple effects on the project's overall schedule.

“There are so many categories of uncertainty that either didn't exist before or were a minor consideration," says Simonson.

Longer Work Days

When it comes to commercial construction costs, the big conversation right now is the cost of labor, says Paraic Morrissey, resident manager of the New York office of Rider Levett Bucknall, an international construction consultancy.

“A lot of clients are looking for labor costs to come down because of the market becoming more saturated," Morrissey explains.

However, it's taking subcontractors a lot longer to get into buildings because of COVID-19 safety precautions. The consequence, says Morrissey, is that clients are paying for a longer workday.

“If you're trying to get 100 workers on to a floor, and you can only put three of them into an elevator at a time — and they also have to line up and have their temperature taken — it can create a bit of a panic trying to get into the building," he says. “So you're going to be charged for maybe a 10-hour day per construction worker, rather than your usual 8-hour day, which will drive costs up significantly."

Flat Labor Pricing

On the other hand, Simonson notes that there has been a dramatic moderation of the producer price index for new nonresidential building construction, and also for subcontractors' pricing.

He explains that these prices are somewhat synthetic, based on contractors' responses to questions such as, “What would you charge to put up this building or to do this kind of roofing or electrical work?" The index compares that price to what the same respondent said a month or a year ago for the same type and size of project.

“After years of those prices going up at 3% to 5% a year, the latest one-month change has generally been flat, or a little bit negative," explains Simonson. “The prices look as if they're going to stay flat for quite some time as contractors get hungrier to do more work."

Shifts in Costs for Materials and Freight

In terms of materials, Simonson says costs should remain low for 2020. However, freight costs are climbing day by day, particularly for materials from Europe and China, says Morrissey.

“There's such a backlog of materials coming in that it's hard to get a freight plan," says Morrissey. “So people are trying to book a designated freight plan of their own, which is obviously driving costs up."

Because of this, says Simonson, the industry has shifted its attention to U.S. suppliers — though that will probably not be the case for the long term.

“I think that bit by bit, the supply chain will heal and the trade pipeline will open up again," says Simonson.

The Rise of Adaptive Construction

Going forward, contractors' business models will be focused on client expectations, says Morrissey. Presently, he says, clients are hiring change management specialists and surveying their employees to determine the type of workplace environment that will make them feel safe and comfortable.

“So many things that we took for granted in the past aren't considered safe anymore," says Morrissey, citing such common workplace features as busy elevators and face-to-face meetings.

To that end, Simonson believes that office renovation projects will be focused on increasing distance between workers — possibly returning to the era of partitioned cubicles and private offices as opposed to crowded conference rooms and bullpens. Developers will need to create areas for employees to be screened upon entering the building and designate pathways for safe entrance and egress.

“While it won't look strong because there won't be much new construction, I think the office market will be deceptively warm for the next year or two as these kinds of adaptive construction projects take place," says Simonson.

And according to Morrissey, whoever can come up with solutions to determine the optimal layout of post-pandemic office space will be ahead of the game.

“It can be a huge selling point to produce an efficient space where it's safe for workers to go every day," he says. “There are big opportunities for investors to get on board with firms that are trying to figure out how a successful change is going to be made to the commercial sector."

About the Author: Robyn Tellefsen
Robyn Tellefsen is a New York City-based freelance writer and editor with more than 18 years of experience and hundreds of bylined articles. Her work has appeared on sites such as American Express, Chase, SoFi.com, Beachside Rehab, A Place for Mom, The CollegeBound Network, and others.