The industrial market has seen increasing demand for space and has shown no signs of slowing the pace of construction. All the while, supply chain shortages and delays have put pressure on construction and real estate across the world.
At the November 2021 NAIOP Chicago panel, When Will It Arrive? Industrial Supply Chain Update, moderated by Ryan Stoller (Principal, Venture One Real Estate), Joe Rook, Principal at ARCO/Murray discussed this hot topic alongside panelists Frederick Regnery (Principal, Colliers International) and Joe Dunlap (Managing Director, CBRE).
Below are 4 key questions answered from the panel.
1. Is the supply chain issue the new norm?
Coming off an unforeseen global pandemic, there isn’t an industry out there who hasn’t felt the ongoing effects of the disruption to the supply chain. While we can look at this as a moment in time, albeit a long moment, there are a series of connected challenges that will persist over the next couple of years. While material suppliers are adjusting to meet the demands of an ever-growing industrial market, Covid-19-induced supply chain bottlenecks have caused delays across the board. Despite these circumstances, additional challenges threaten to aggravate the problem.
The supply chain is a bit of a cause-and-effect cycle. Pre-Covid, we were transitioning from heavy distribution facilities that are about efficiency and capacity, to ‘just-in-time’ facilities that carry a lighter inventory. As we experienced this shift to ‘just-in-time’ inventory, it made our margins for stored inventory very thin. However, Covid put suppliers in a position where they were fearful of being with too much inventory or holding too many raw materials. As Covid progressed, it forced suppliers to exhaust their already thin stores of inventory for a variety of reasons, like plant shut-downs due to Covid exposure.
Our margin for error was thin. Then we experienced a boom in material demand, especially in the industrial market, as we emerged from global Covid shutdowns and lockdowns. Low supply stores, increasing demand, and labor shortages had a compounding effect that exacerbated many smaller supply chain issues. This affected everything from congestion at our ports, to limited supply of CONEX boxes, to labor, to trucking, to plant shutdowns, etc.
Now we find ourselves in the position of needing our trades to begin to increase their stores of raw materials and supplies. Trades across the board are scrambling to catch up and keep up with ever-increasing demands. It’s going to take time and patience while material suppliers work to decrease their backlogs. While we can’t say the current supply chain predicament is the “new norm,” we can certainly say that these supply chain constraints will continue over the next year at least, and that any new threats to the system, such as natural disasters or new pandemic complications, will only intensify the supply chain problems and delays.
2. How are the trades being affected?
While this is a big question and there is no easy answer, it’s important to understand that each trade is being uniquely affected. The top three trades that are being affected are structural steel, roofing, and precast, and they are fueling the fire on pricing.
If you look at the Construction Cost Index (a combined metric on material indexes and labor that the ENR has monitored over the last 40 years), it has never reported increases over 7%, but we are already seeing a 9% increase year-to-date. While this metric combines indexes for the general market, the industrial market is outpacing the general market by about 40% year-to-date. This is because industrial developments utilize more of the commodities that have experienced the some of the largest increases in costs such as the steel, lumber, and concrete trades.
3. Can costs be saved if construction timelines are delayed?
Owners and developers are seeing costs go up exponentially, and one of the big questions we hear today is, “if I wait nine months, are these price increases going to go away?”
The short answer is no. Suppliers won’t commit to any downward pricing pressure until they see lead times shrinking. In steel, for example, we’re seeing lead times around 11-12 months. Normally, steel suppliers would prefer to have 12-15 weeks in backlog. They don’t like long lead times, either. It only adds risk to their portfolio since they are responsible for all the raw materials and labor.
What’s really going to help drive down prices is the opportunity for suppliers to burn off their backlogs. Each trade is going to need time to build up their capacity. Short of an abrupt market event, it’s going to take time to let supply catch up to demand in full. What we can do now is spend more time during the due diligence and design processes to line up our procurement of materials. Working with a design-builder like ARCO/Murray can help developers lock in construction pricing early with subcontractors. In a lot of cases, we’re seeing capital partners put a lot of pressure on needing their GMP (guaranteed maximum price) ready to sign – which means we need to have a substantial amount of the job materials procured.
4. How is the labor shortage affecting the supply chain issue?
Right now, there is no clear solution to the labor shortage. In some ways, the local Chicago market has been protected by being a unionized market, so for many of our field trades, this has insulated them from the labor effects. In non-union markets, labor shortages are more widespread because sectors, such as the manufacturing space which has been predominately affected, are competing directly on labor wage rate with e-commerce companies, retail, hospitality, and other unskilled labor pools.
Automation is a clear solution to the labor shortage in both manufacturing and distribution industries, not to mention a variety of others. While there has been a longstanding fear that automation will decrease job availability, it’s now necessary to alleviate supply chain and labor shortage constraints.
Disclaimer: Any figures quoted here are estimates and reflect remarks made at the NAIOP Chicago Industrial Panel in November 2021.