For this month’s column, we continue our discussion with Mike, Neal, Jeff, Don and Susan about the challenges for the balance of 2021, and the hot topics of the market right now. Click here to view the first segment in this series.
We want to thank Mike Yungerman, Senior Vice President & General Manager of Opus Development Company; Neal Driscoll, Midwest Region Partner of Dermody Properties; Jeff Lanaghan, Senior Vice President & Partner, Midwest Region of CRG; Don Schoenheider, Senior Vice President & Market Leader, Midwest Region of Hillwood; Susan Bergdoll, Vice President of Leasing & Development of Duke Realty; Matt Goode, Principal of Venture One Real Estate; and Tony Pricco, President & Partner of Bridge for their perspectives on what the commercial real estate markets will look like this year and for the next 24 months.
Q: So, what’s hot and what’s not?
Mike Yungerman, Opus Development: The entire Industrial sector has been white hot for several years now. E-commerce demand has driven most of industrial sectors on bull run, but other sectors such as food and building supplies have been very strong as well. E-commerce occupiers have high labor demands that require an abundance of parking and proximity to the people that make up their labor force. This has put a major focus on infill sites throughout the city and suburbs.
On the not-so-hot side, except for southeast Wisconsin, spec development in the outlying growth markets have been slow to non-existent. This is largely due to cost of infrastructure and lack of labor. But, as rents continue to climb and sites become harder and harder to come by, these growth markets may start to gain developers attention again.
Neal Driscoll, Dermody Properties: Highly functional (not always new) and well-located industrial is, and will continue to be, hot. Functionally obsolete industrial is losing ground. Tenants continue to prove they’re willing to pay up for the space that best fits their needs. As an industry, we’ve talked for years about rent being far down the list of the cost of business operations, well behind labor, transportation, etc. I think we’re finally seeing that come to fruition as more businesses improve their supply chain and logistics expertise.
Jeff Lanaghan, CRG: Many of the same product types will continue to be in strong demand: super bulk product, cold storage and infill developments. Even in the lesser focused product, user and investor demand will keep them active.
Don Schoenheider, Hillwood: Everything seems to be attracting attention. Certainly logistics, e-commerce and food-related developments seem to be at the top of everyone’s list. Additionally, secondary markets are seeing rents and pricing we haven’t seen before.
Susan Bergdoll, Duke Realty: Our customers want speed to delivery. They are not waiting for buildings – they need facilities for immediate occupancy. We work against tight timelines to meet client demands on developments and retrofits. Additionally, the need to get more products to consumers in a 24- to 48-hour window is driving the need for larger, state-of-the-art facilities. And one of the biggest selling points on facilities for our customers is truck terminals and trailer parking. Our customers need the space to move inventory quickly and efficiently.
Matt Goode, Venture One: Well located, functional infill property continues to perform well within our portfolio. Across the board, industrial vacancies are low and leasing activity is strong, but we are seeing the greatest rental rate growth in smaller infill properties. Rents have quietly grown between 20-40% in these spaces over the last five years, even in the Chicago MSA. This product type is very hard and expensive to build, so we believe that supply will continue to be constrained in this sector of the market.
Tony Pricco, Bridge: Industrial is hot, especially modern, last mile warehouse/distribution in the top 20 MSAs. Office, hotel and brick and mortar retail will continue to struggle in 2021. The question is how long this will go on.
Q: What are the biggest challenges the industry faces in 2021?
Mike Yungerman, Opus Development: From a developer’s perspective, the biggest challenges are construction pricing and the fierce competition here in Chicago. By now, most everyone is aware of the volatility in the steel and lumber markets. We’ve seen steel material pricing more than double in the past three to four months alone. This is a challenge in pursuing sites for speculative developments and quoting build-to-suits as deal underwriting changes every few weeks forcing developers to make expensive long-term commitments sooner than we are typically comfortable. Finding opportunities has been as competitive as I can remember in my career. Most development sites coming to market bring in 5+ proposals that require underwriting to be at top of market exit caps and upward trending rents to be competitive, providing no room for error.
Neal Driscoll, Dermody Properties: Two things: First, construction cost escalations are out of control at the moment, driven by supply and demand constraints; and, second is the interesting dynamic presenting itself in many markets in how to satisfy everyone’s desire for e-commerce delivery and yet keep those delivery trucks invisible. There is a lot of anecdotal evidence that shows ecommerce delivery is more beneficial to communities in terms of traffic and air pollution than residents driving themselves from store-to-store. One home delivery vehicle makes one store or fulfillment center pickup and then delivers to 30, 40, 50 homes. If all those households go out and purchase goods for themselves, the relative impact in terms of additional vehicular pollution and traffic is evident.
Jeff Lanaghan, CRG: Material deliveries will be a major determinant on how well the industrial sector performs in 2021. Steel prices have spiked more than 200% over the last three months and deliveries are being quoted six to seven months from order placement. Precast is also quoting extended delivery dates. As a result, projects looking to break ground in Q2 will likely be delayed until late Q3 or later.
Don Schoenheider, Hillwood: The increasing rise in the price of commodities and the resultant increase in construction costs are already creating some headwinds. Finding land that is either entitled or could be entitled for industrial development will also continue to be a challenge.
Susan Bergdoll, Duke: We are seeing steel pricing and deliveries impact our projects. Extended deliveries, in some instances as much as eight weeks, negatively impact our construction schedules more than price increases. The lack of skilled labor has also been an issue for the last several years. Our clients are seeing labor shortages in many areas of the country. A large e-commerce facility could employ several thousand workers.
Matt Goode, Venture One: Inflation, rising interest rates, and distress related to the fallout from over a year of the pandemic are factors. While many industries are poised for growth as we push out of the pandemic, some will be at risk as government subsidies run out. We are also concerned about the health of some cities and local municipalities that have had significant expenses as a result of the pandemic and reduced income due to less sales tax and revenue. This could lead to increased property taxes. That said, we have a positive, not negative, outlook for 2021.
Tony Pricco, Bridge: Rising interest rates and inflation are causing continued increases in construction costs. Both can be overcome if we have associated economic growth (i.e. rent growth) to offset them.
We wish to extend a sincere thank you to all of the developers who took the time to provide their valuable insights for this month’s column. We’re all looking forward to a strong second half of 2021 and into next year. — Elise A. Couston