Les J. Cranmer, Senior Managing Director, Studley, Inc. (Aug/Sep 07)
With all the press over the last few years concerning the skyrocketing cost of construction materials and record building sale prices, it is logical for this factor to rank highly among those who were surveyed. These results are consistent with previous years' surveys, with facility-oriented costs always somewhere in the top third. But there is a curious anomaly which needs to be examined more closely; that is, if one were to view only those who ranked this factor "very important" (as compared to a combined "very important" and "important" rating), occupancy or construction costs would rank 17 out of the list of 25. Two dimensions should be examined to possibly further explain this issue: cost trends and the new/existing building decision.
Overall construction costs have increased 5 percent per year over each of the previous five years. While the labor component has increased more in line with inflation, the material costs have increased by 9-10 percent, more than double the increase of the previous five-year period. Some would attribute this to the tremendous demands being made by China. Looking closely at the survey responses, 42 percent of all new foreign facilities are being planned for Asia - and more than half of these for China, which is obviously focusing the attention of the respondents.
In the United States, the geographic variance of construction costs is still apparent. In the RSMeans 2006 cost guide, you will find that in Clarksdale, Miss., construction costs are one third less than the national index, while it comes as no surprise that in New York City they are one third higher than the national index. Each area, though, has been consistent with the national trend of 5 percent per year increases. Currently, this trend is forecast to continue, which puts pressure on new construction prices.
Rental costs have been on a similar pace. According to the Studley Effective Rent Index (SERI2007), the National Net Rent Index has increased at an average annual rate of 4.7 percent since 1996. This is reflective of both the increase in construction costs as well as the tightening of many desirable markets. (As a side note, it is a positive that most of the respondents were focusing on industrial properties; the same SERI2007 showed midtown Manhattan rents increasing by 22.8 percent last year). When a new facility is brought on line, the rent is directly related to the construction costs. Only the recent low-interest environment has kept rental prices slightly in check.
What is driving the decision to locate new facilities and the decision of whether to find existing facilities or build new? Overall business investments are up 8 percent and manufacturing exports are up 6.2 percent - this is double the general economy. Most of the respondents mentioned that new sales and products have caused the decision for new investment.
Traditionally, this speed to market would demand a search for existing buildings followed by a "fatal flaw" analysis of issues such as labor availability/cost, utility cost, and tax environment. The problem is most of the existing facilities have outlived their usefulness given the advances in manufacturing technology and warehousing. Luckily, expedited construction techniques and management have decreased the delivery time, with many a schedule in the six-month timeframe for "big box" warehousing. But this speed comes at a price.
The standard delivery method of design/bid/construct requires a longer time frame that conflicts with delivering new products or satisfying new sales demand. Organizations are partnering with design/build companies to deliver facilities around the country but at the cost of the traditional bid process, which held cost somewhat in check. In addition, wisely timed speculative construction has satisfied some of the demand.
Which brings us back to our anomaly: Why do most respondents rank this factor in the top third in terms of the "very important" or "important" ratings combined, but in the bottom third when evaluated in terms of just being "very important"? While there will always be concern over the cost of the facility and controlling this issue, labor and tax issues will always rank higher in the critical success of a new operation. Everyone in the industry is familiar with the metric that the facility cost is less than 10 percent of the overall operating cost of a facility, surpassed by taxes and, overwhelmingly, by the labor component. So in future surveys, it is to be anticipated that occupancy or construction costs will continue to be important but not of a critical nature in comparison to other factors.
Les Cranmer and Art Wegfahrt bring a combined 63 years of experience in facility and location consulting to their consulting practice at Studley, Inc.