Two years ago, Orion Construction started work on a 430,000-square-foot warehouse in Surrey, B.C. By 2021, construction costs had risen so much that its bid for a second, similar-sized building in the same area was 20 per cent higher.
“If we had to bid for a similar project today, it would be 25 to 30 per cent higher [than in 2020],” says Josh Gaglardi, principal and founder of the Langley, B.C.-based design-build company. As costs of materials, labour, fuel and financing have soared in the past two years, he’s had to come up with creative strategies to stay profitable.
Because construction contracts are fixed price and there is typically only a small contingency margin, “any cost increases are generally on us, so we have to be very creative and pro-active, hedging costs where we can,” Mr. Gaglardi says.
Being forced to explore where we could get sources of supply, we realized that there were not a lot of materials that we use that are actually off the shelf or created locally.— Josh Gaglardi, founder and principal of Orion Construction
It’s a Canada-wide challenge as industrial building construction has seen unprecedented cost inflation since the start of the pandemic, says Susan Thompson, associate director of research for Colliers International Inc. in Vancouver.
“As interest rates rise, there’s the potential for an inflection point that could see developers hit pause,” she says. “A lot of developers are carefully thinking through the facts before they go into the ground because they want to make sure they can cover their costs.”
But a pause may not happen soon. “The industrial market is still just blisteringly hot,” she adds. So far, the low vacancy rates in Vancouver, Toronto, Montreal and Calgary have meant developers can cover the excess costs by just raising rents and still have buyers.
In addition, every project is unique, Ms. Thompson points out. “When did they buy the land; what price did they pay for it? Have they ordered materials that are still on a cargo ship somewhere and do they have labour already lined up?” And importantly, as interest rates rise: “Do they have a lot of cash on hand? If they don’t need to borrow, that changes the equation.”
Meanwhile, buyers are willing to pay more. Industrial and warehousing lease rates are expected to continue moving up because of pent-up demand and a potential shift of owner-occupied spaces to rental properties, commercial real estate firm JLL predicts in its recently released Q2 2022 Canadian Real Estate Outlook.
After five consecutive quarters of tightening vacancy rates, industrial and warehouse vacancy rose slightly in the three largest markets in the second quarter of 2022. But vacancies are still at historic lows of just 0.8 per cent, 0.9 per cent and 1.7 per cent in Vancouver, Toronto and Montreal, respectively. Calgary has seen a notable surge in demand and its vacancy rate now stands at 1 per cent. Under-construction space increased for the eighth consecutive quarter, as market conditions remain extremely tight. However, in most cities, the number of days industrial properties are on the market before they are leased has begun to increase notably, the JLL report notes.
Finding ways to control additional costs that have come in waves has become a constant challenge, Mr. Gaglardi says. “The initial shock was due to supply chain constraints, and we had to be very creative as materials were becoming harder and harder to get and prices kept rising.”
The company has been pushing forward engineering work on projects ahead of the entitlement and permitting process so that materials can be ordered quicker, because lead times on orders can be long, he adds.
“It opened our eyes to how dependent we are for building supplies from other countries,” he says. “In the past, we just ordered materials and they showed up and we didn’t pay too much attention. Being forced to explore where we could get sources of supply, we realized that there were not a lot of materials that we use that are actually off the shelf or created locally.”
For instance, most steel components and rebar come from South Korea or China, and as the price of container shipping from Asia soared during the pandemic, prices spiked and delivery times slowed.
“We could see the increases coming, and being in the warehouse business, we had space at our disposal where we could purchase our materials ahead of schedule and store them near the construction site,” Mr. Gaglardi says.
By doing so, he estimates it saved at least $1-million in extra costs for one project in Surrey, about 5 per cent of the project’s price. Even though supply chain issues have eased a bit, the substantial surge in gas prices has meant a 50-per-cent increase in the cost of running Orion’s equipment and fleet of vehicles, he says.
And the challenges keep coming. “To be able to get labour in a competitive building market, we have to pay more in salaries. And for suppliers, we have to guarantee payment within 30 days. We have been successful with ensuring that our partners are paid promptly and happy to work with us, because quite frankly if you’re not doing that, you’re not going to be the first person they call.
“It’s been exhausting to explore all possible options to make our clients successful with their projects,” Mr. Gaglardi says. “And with our contract structure, I am not able to get direct compensation from clients. So, businesses like ours are feeling those increases directly. It’s definitely not a sustainable option.”