NAREIM Architecture, Engineering & Development meeting. 

Key takeaways

September 11-12, 2024

Construction costs have come down from their pandemic peak however chronic labor shortages among GCs and subs will continue to be a major challenge for real estate investment managers - impacting construction budgeting and estimating and even the ability to secure GC bonds.

While real estate investment managers have little to no control over construction labor and skills training, members attending the NAREIM Architecture, Engineering & Development meeting in Austin this week were reminded of the risks they face – and the challenge they need to manage for – as the US struggles to attract and train a new generation of construction trades and GCs, and an aging construction workforce takes their skills out of commercial real estate for good.

NAREIM members were told the annual escalation of construction costs was now averaging 4%, back to its pre-pandemic levels, and away the peak of annual hikes of up to 25% during 2021 and 2022. However, a lack of labor was the most significant risk to the development projects – “a factor that was only going to grow” with time.

• “This is an existential issue we have to deal with,” the meeting was told, with the average age of a foreman in New York currently 58. Managers were strongly advised to take labor supply and local market skills capacity into account when penciling out all future projects.

Large developments by firms such as Intel and Amazon would have dramatic impacts on other commercial developments and deals, with the $20bn Intel semi-conductor fabrication plant in Ohio already resulting in drywaller costs increasing 40%.

Industry labor shortages were also the biggest risk behind GCs failing to secure surety bonds. Managers typically require general contractors to purchase a GC bond to guarantee the performance of projects. However, in 47% of GC failures seen recorded by one of the industry’s largest surety providers the common reason for failure was continuity. That is ownership, key personnel and labor shortages.

Labor shortages contributed to a median GC backlog of 8.75 months in 2023, compared to 5.7 months in 2005, with labor issues cited in the meeting as a key driver. 

A failure to deliver the project on time though means GCs don’t earn their profit as expected – and with 25% of GCs currently not having enough cash flow to pay their debts, cash flow issues could be exacerbated thanks to labor shortages.

• Also read the takeaways from the professional development workshop held as part of the NAREIM Architecture, Engineering & Development meeting.

• Addressing conflict before it becomes a war: EQ strategies for managers. Professional development workshop takeaways.

• To download the presentations from the NAREIM Architecture, Engineering & Development meeting, click here.

Highlights from the other discussions during the NAREIM Architecture, Engineering & Development meeting included:

Solar:

• Help asset managers get training to negotiate with solar providers and energy provider companies. And when negotiating make sure your expectations from the project are clear – and communicated early, upfront. Solar leases need to specify technical requirements with members recommending they should be proactive on lease reviews.

• Understand solar is not easy to execute. The number of stakeholders involved in any typical solar project and installation is 20 – involving the REIM teams, legal, accounting, roofing specialists, energy providers, utilities etc. “It’s not realistic to say that solar is easy and it can be done everywhere.”

• Lease review and understanding your roof rights is paramount, the meeting heard. Who has control of the roof space and who is responsible for roof protection, walk mats? What happens if a future tenant wants their own system or roof rights? What happens in the event of an incident and the solar system needs to be shut down – who has the right to do that?

• Members were told: “It is essential you know who is responsible for what on that roof.”

• Test the systems really well before buying an asset with existing solar arrays on the property. Members were advised to not just look at invertors but open them all up and conduct load testing as extensively as possible to ensure quality, no defects or no UV damage. “Test very well before you buy.”

• Key tip on due diligence for buying an asset with existing solar: Get the as built plans – and every change made to the roof and property since it was first built. Ensure you get roof warranty certificates and understand the existing energy efficiency of the building asap.

Batteries & fire risk:

The world is filled today with lithium-ion batteries – EV cars, scooters, power tools, laptops, construction equipment – but managing the risks of batteries, and the risk of fire, is highly complex with few solutions available to investment managers.

During the meeting, members heard the biggest risk to mitigate was a thermal runway event, where a chain reaction causes batteries to overheat, catch fire, and explode. Regulations for storage provide managers a standard toolkit of responses – including heat detection, fire suppression and fire walls/breaks.

But thermal runway events are intense, with the meeting hearing one fire in San Diego took 17 days to extinguish, 10m gallons of water, emitting toxic gases during the burn and endangering lives of not only local communities but also fire fighters. However, technology hasn’t caught up with battery fire intensity – and the best way to extinguish a fire is still water.

As a result, early design considerations for fire risk is critical for managers – especially in relation to accessibly parking stalls. The meeting was told ADA rules for private properties expected to change in the coming years, requiring bays to be 20ft long instead of 18ft – a rule that would apply to not just new properties, and existing properties as well when restriping or renovations take place.

More highlights from the meeting were:

• Skills is a critical challenge to the entire CRE industry, and for investment managers another risk is the need to know the people they are partnering with, not just the firms. As the industry faces change and consolidation owing to labor shortages,  members were advised to get to know the people inside the firms, GCs and subs executing your developments. “It’s not the company you’re interested in, it’s the team members themselves. That is absolutely key [to managing construction cost risk].”

• Switchgear delays have had a massive impact on the CRE industry with 16 to 18 month backlogs on supply the devices that control, protect and isolate power systems. Pre-purchasing was imperative, members were told, with managers advised to regularly review in-demand components that could create delays to project delivery.

• The labor situation could get worse, with an industry wide crackdown on firms who fraudulently claimed for Employee Retention Tax Credits from the government being required to pay back the credits. Sub-contractors were significant beneficiaries of the scheme, with one electrical sub firm wrongly claiming $30m in credits.

• The potential sunset of the Tax Cuts and Jobs Act could also see a wave of retirements and company sales in CRE. The tax cuts introduced under the law expire at the end of 2025 – with experts predicting increased turnover of skilled and experienced senior GCs and contractors as they sell their firms to take advantage of the reduced rates. Managers were once again advised in the meeting to get to know teams personally – not just firms – to avoid the risk of failed and delayed projects as skilled specialists exited CRE.

Also read the takeaways from the professional development workshop held as part of the NAREIM Architecture, Engineering & Development meeting.

• Addressing conflict before it becomes a war: EQ strategies for managers. Professional development workshop takeaways.

• To download the presentations from the NAREIM Architecture, Engineering & Development meeting, click here.