Built Environment

Source: CoStar Group Inc.

Source: CoStar Group Inc.

Reflecting an improving economic picture, construction activity in the U.S. property markets is increasing, although in most cases it is less than half that of the long-term average. Industrial construction has shown greater activity than office and retail, with industrial in-process construction increasing by 63 percent since 2010, to more than 91 million square feet. That compares to a 32 percent increase for office, to 84 million square feet, and flat construction activity for retail, at 51 million square feet.

As a percentage of stock, industrial construction underway today measures about 40 basis points, which is just a fraction of the annual 1.5 percent built during the go-go years. However, industrial is just too easy to build, and developers have been idle for far too long. Since the beginning of 2011, 2,200 buildings have been proposed, totaling 369 million square feet. This matches the total space delivered in 2006 and 2007. Not all markets are equally active, but among the leaders with a high level of proposed space are Chicago (43 million square feet), the Inland Empire (32 million square feet), Atlanta (20 million square feet) and Dallas (18 million square feet). Despite this pipeline, we do not expect new supply to outpace demand this year or even next.

New in-process office construction is extremely bifurcated, with 44 percent concentrated in just five metros. For investors, the relative lack of new construction in the majority of metros means that for the most part office rents are below construction justification levels, which should allow for solid gains in occupancy and rent as the recovery matures. However, for the five markets with significant new construction—including Boston (7.2 million square feet), New York (14 million square feet), Washington, D.C. (6.8 million square feet), Houston (7.2 million square feet) and San Jose (2.3 million square feet)—the upside potential is likely to be constrained, especially in submarkets that have a large amount of new construction. The retail supply pipeline has had its spigot turned to the lowest flow in decades, and developers have closed up shop in most metros. Rather than the multi-anchor power centers and lifestyle centers that made up the bulk of the additions during the past few years, the little supply underway largely comprises big-box, single-tenant stores, often occupied by discount retailers like Wal-Mart, Target or Costco. As the desirable existing centers fill to capacity, don’t be surprised to see more retail projects proposed in the coming months. The first places with multi-tenant development should be urban cores, which are already seeing heady rent growth in a number of cities. However, the wave of development that swept over the retail landscape in the last cycle is not likely to happen again anytime soon.

—Walter G. Page is director of research for office at CoStar Group Inc.