Non-Residential Construction Inflation
Monday, May 18th, 2009
% Change Year/Year
After several years of sharp increases, construction costs for commercial real estate are plunging, down by 4.3 percent in April compared with April 2008. Speculative construction starts have dried up along with the availability of credit, and demand for construction materials has plunged across the globe. Nevertheless, core inflation as measured by the Consumer Price Index, which excludes food and energy, increased by a comfortable 1.9 percent in the 12 months ending in April, which means that broad, economy-wide deflation is not in evidence. Some economists think that inflation, not deflation, poses a greater risk to the economy, spurred by growing federal debt and massive injections of liquidity by the Federal Reserve. While the conditions are present for inflation to catch fire, there is no match to light the fuse; wages are deflating, not inflating, as employers eliminate jobs, a trend that is likely to persist into 2010. Most analysts expect the recovery, when it comes, will be gradual at first, which should provide a window for the Fed to remove excess liquidity by selling off the Treasuries, mortgage-backed securities and other bond instruments it has been buying recently. The decline in construction costs is good news for landlords and tenants who need to refit their spaces. A moderate increase in inflation might be considered good news for commercial real estate owners and investors; in the 1970s and early 1980s, when inflation was high, real estate was viewed as an inflation hedge along with gold and commodities.
Source: U.S. Bureau of Labor Statistics, Grubb & Ellis
The current recession, already the longest of the 11 post-war downturns, is also among the unkindest to consumers and, by extension, retail tenants and shopping center landlords. Consumer spending has been clipped by the evaporation of trillions of dollars in stock market and home equity wealth and by the loss of 5.7 million payroll jobs, of which 2.7 million were eliminated in the first four months of 2009. Average asking rental rates fell by 11 percent for in-line shop space and by almost 14 percent for upscale urban retail space in 2008. For a one-acre pad site near a mall, the average sales price slipped by 15 percent. Fortunately, the recession appears to be nearing a bottom, and a slow recovery may take root as early as the fourth quarter. Expect rental rates and pad site prices to fall further in 2009 but at a diminishing pace. Many observers have referred to this period as a “reset,” by which they seem to mean a recalibration of personal, corporate and civic values. Part of this recalibration is an increase in the personal saving rate, which adds to the evidence that retail sales and demand for retail space may be slow to mount a sustained recovery. 
The Institute for Supply Management reported on Friday that the nation’s manufacturing sector contracted in April for a 15th consecutive month, but parts of the report indicated that the contraction was moderating. The April reading of 40.1, though still well below the equilibrium level of 50, was the fourth consecutive month of improvement. New orders increased six points to 47.2, while inventories remained near their lowest levels since the early 1980s. Rising new orders and depleted inventories suggest that production is likely to increase in the next few quarters. The manufacturing contraction is reflected in the industrial property market where the first quarter vacancy rate increased by 70 basis points to 9.5 percent, the sharpest rate of increase in the 22-year history of the Grubb & Ellis survey. While the worst of the manufacturing contraction seems to have passed, the recovery is likely to be sluggish, particularly in the Midwest where the automobile industry continues to restructure.