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Another year, another look at what we might expect in the world of commercial real estate development. As the economy recovered, the commercial real estate sector followed suit, and 2018 is likely looking at a continuation of what 2017 provided.
Here are a few of the elements that will play a role in what 2018 has in store for the industry:
Impact of Tax Cuts
One of the most important issues facing the commercial real estate development sector in 2018, and one of the biggest challenges: determining the impact of tax cuts.
The bill includes deep tax cuts for corporations, reduces the tax rate, and provides a steep deduction for some businesses.
The question becomes: What cash is coming back to businesses and how will they use it?
The belief is that reduced corporate tax rates will free up money for many retailers and businesses to invest in increased wages, business expansion, or creation of upwards of 1.5 million new jobs.
As businesses figure out how to manage the money coming back to them, we’ll likely see a steady increase in some development activity as the year goes along.
Interest Rates and 10-Year Treasury
While we may see a continued uptick in development towards the end of the year, interest rate increases could put a damper on some of that activity.
Commercial real estate isn’t directly affected by interest rates of the federal reserve, but rate hikes will likely result in an increased 10-year treasury which will impact the industry. Add to that the reports of China ending its purchases of U.S. bonds, which has already bumped the 10-year yield up 3.1 basis points, and we could see increased borrowing costs and CAP rates.
These increases will likely make questionable projects slightly less profitable. An increase in higher-risk developments may result in a pullback on some projects, or at least a more in-depth look at many proposed developments in the pipeline.
Construction Costs and Labor Shortage
Construction costs continue to rise because of the ongoing skilled labor shortage within the industry, as well as a continuing rise in material costs.
Overall, the industry has seen a roughly 20 percent increase in costs, split fairly evenly between labor and materials.
As SimonCRE Director of Construction Jared Atkisson puts it, “The market is busy right now, so short-handed contractors are setting higher prices and taking more localized jobs. So, it’s getting very hard to get competitive bids for outlying areas which are driving up costs.”
Nationally, there are 11% fewer construction workers than prior to the Great Recession, and 381,000 job openings at the end of October, the largest October total since 2009.
According to a recent Associated General Contractors of America survey of 1,000 firms nationwide, 82 percent expect it will be either harder or just as difficult to find qualified workers in 2018.
As for materials, we continue to see higher material costs that have trickled into the new year. The industry has experienced a roughly 10% cost increase in materials over the last couple of years, costs expected to rise another 2 to 3% in 2018.
The issues facing the construction sector may result in slower activity, which could actually help prevent the real estate bubble from expanding too much.