Commercial Investment Real Estate is the magazine of the CCIM Institute, the leading provider of commercial real estate education. CIRE covers market trends, current developments, and business strategies within the commercial real estate field.
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CCIM.COM January | February 2018 27 Nature's Disruptors by K.C. Conway Natural disasters can do more harm to commercial real estate markets than technology disruptors. Hurricanes Harvey and Irma devastated parts of Texas, with 28.3 million people, and Florida, with 21 million residents. These two populous states produce 14 percent of the nation's $18.9 trillion of annual gross domestic product, according to the Q1 2017 Bureau of Economic Analysis regional and state GDP statistics. On many fronts, Harvey and Irma were unprecedented. Not only was 2017 the first time that two category-4 hurri- canes struck the U.S. in one year, but combined, these two storms represent the cost of two hurricane Katrinas, accord- ing to the Insurance Information Institute. The bigger story to the U.S. commercial real estate industry, though, is that the disruption these two storms will have on both the U.S. commercial real estate properties will be material and lasting, extending into 2020. How? The impact will come from higher construction costs and likely double-digit inflation in both building materials and construction labor. Engineering News-Record tracks construction economics. A year ago in its Q3 2016 report, ENR reported 2- to 4-per- cent increases in its builder construction cost indexes due to residential housing costs up 5 percent and labor shortages in construction up 3.5 percent. ENR's 20-city construction cost index showed annual inflation of 2.7 percent — com- pared to hot real estate markets like Denver at 4.5 percent and Pittsburgh at 6.7 percent. The most recent Q3 2017 ENR report shows the hurricanes' damage boosting inflation and contributing to growing labor shortages. The construction cost of labor has already risen to 4.3 percent, and building cost inflation for materials, such as lumber and gypsum board, has climbed to 3.6 percent. Although it is too early to quantify the storms' impact on construction costs, industry experts that track construction economics warn that it will be significant. Construction cost increases in 2018 will likely be double those of 2017, and they were already under pressure from a recovering economy and growth in housing construction. Engineering and insurance economists refer back to storms like Katrina, Andrew, and Hugo as support for their fore- casts that it will take one to two years before the full ramifications show up in construction cost escalation. After Hurri- cane Katrina, the most noticeable spike in construction costs came a year after the storm. What does all this mean for the commercial real estate industry? Construction projects already underway will encoun- ter material cost overruns. Are lenders prepared to fund these? Are developers prepared to cough up more equity? They probably will, but some less essential projects may be deferred until material and labor costs come down in the second half of 2019 and 2020. The answer to all these questions is to expect a material and lasting impact into 2020. It is time to be thinking how hurricanes Harvey and Irma influence the broader commercial real estate industry. K.C. Conway, MAI, CRE, is the CCIM chief economist. * All cost estimates represent insured property losses adjusted to 2016 dollars. Source: Insurance Information Institute/Karl Gelles, USA Today Top Costliest Hurricanes in U.S. History* (in billions of dollars) $14.0 Ike Sept. 2008 $12.5 Wilma Oct. 2005 $9.3 Charley Aug. 2004 Katrina Aug. 2005 $49.8 Andrew Aug. 1992 $24.5 $19.9 Sandy Oct. 2012 $8.9 Ivan Sept. 2004