Throughout 2020 and into 2022, industrial construction was speeding down the proverbial freeway, rolling at 100 miles per hour with few obstacles in sight. Interest rates were at or near an all-time low, demand for industrial space was on the rise due to e-commerce and reshoring, and developers and end users were kicking off new projects at an unprecedented clip.
That is until the Fed began pumping the brakes in March 2022, initiating a series of interest rate increases totaling 500 basis point by the end of 2023
“The recent Fed rate hikes significantly impacted the availability of capital and lending for new speculative projects resulting in an abrupt deceleration in construction activity that has made it feel to most in the industry like we’re doing 45 in a 55,” says Howard Green, Executive Vice President of Rosemont, Illinois-based Meridian Design Build. “There’s still work out there, but everyone is adjusting to the fact that things are no longer moving at the rate that they were.”
For the first six months of 2023, Green explained, Meridian remained busy finishing and closing out projects that it had broken ground on the prior year. However, the latter half of 2023 witnessed a marked slowdown in speculative construction, attributed primarily to the interest rate hikes.
“It became significantly harder for developers to make the numbers pencil for new projects with higher financing costs. The capital markets and lending environment changed dramatically over a very short period,” Green explained.
As the market slowed in late 2023, Meridian Design Build remained active, focusing on build-to-suit projects and full-building tenant fit-outs within buildings that it had recently delivered for developer clients such as Logistics Property Company and Prologis. Green also noted that the general downturn in developer-driven construction activity provided the firm with an opportunity to catch its breath and look to the future. The company made several strategic hires, implemented new software systems and used the time to focus on existing and new client relationships.
The good news for most of the Chicago industrial market is that despite an uptick in vacancy rates, the decline in speculative construction starts this past year will ultimately lead to a need for more new space. Green anticipates that this pent-up demand will be what drives the next wave of speculative construction.
“There are quite a few projects in the planning stages that we’re being told may break ground in the spring, summer, or fall,” said Green while discussing his company’s emphasis on helping clients navigate current market challenges and position themselves for future opportunities. “We’re looking at new projects for several of our developer clients that they are excited about and interested in kicking off in 2024, provided economic conditions and the capital/lending climate allow for that.”
There is a cautious but growing sense of optimism with the Fed recently signaling potential interest rate decreases in 2024. Green expressed skepticism that rates will return to early 2022 levels, but a consensus that rates may have reached a peak is expected to have a positive impact on the market. Although the impact that recent interest rate increases will have on the overall economy is not fully known, sentiment is growing that the Fed might be able to pull off a “soft landing” and avoid a recession.
“Our bid schedule has been more active over the past three months than any time I can remember.” said Green, “In addition to helping developer clients budget for the next round of speculative projects, we’ve been busy responding to bid requests on quite a few user-driven deals.”
He indicated that Meridian’s national reach and ability to assist its clients in other geographic markets has also been a plus, noting that the company broke ground on two large build-to-suit projects outside of Illinois within the past 90 days that will deliver in third and fourth quarter of 2024.
“The expectation of most people who I’ve spoken with is that signs of stability in interest rates may start to instill confidence in lenders and make it a bit easier for developers to secure capital for projects that make financial sense,” said Green. “With the turn of the calendar, many capital sources and lenders reset their allocations and we’re hoping that will help move some projects forward that did not get approved last year.”
Addressing questions about escalating materials costs, Green noted a positive shift, with pricing for key materials such as structural steel, precast and roofing coming down in a meaningful way over the past several months and pricing related to other materials stabilizing. Meridian has also seen a more balanced availability of labor and subcontractor resources because of the decrease in construction activity.
“I feel like this is a very good time for a developer or user to buy construction services,” said Green. “I’m a bit concerned that if everyone waits to jump back in at the same time, we could potentially see a repeat of the material shortages and price escalation issues that we saw after the pandemic.”
“We’re exited about what’s ahead – we feel like we’re in a great position,” he added, highlighting Meridian Design Build’s strong client base, the resilience of the industrial sector and the company’s readiness to help its clients any way they can as they gear up to deal with the challenges and opportunities that 2024 will bring.