New Construction Woes: Steel and Aluminum Tariffs Likely to Strain North American Commercial Real Estate Construction
In June 2018, the Trump Administration imposed a 25.0% tariff on steel imports and a 10.0% tariff on imported aluminum from Canada, as well as tariffs on all foreign steel and aluminum. In retaliation, the Canadian government implemented counter-tariffs of its own on steel, aluminum as well as select consumer products imported from the United States. These disputes will likely have an adverse effect on new construction on both sides of the border — particularly on new steel-majority construction in major cities. The aluminum tariffs, while not as influential on construction as steel, have added fuel to the emotional fire in this issue. DBRS considers that the increased global prices on steel imports, the resulting domestic price increases, related supply problems, as well as the unpredictability of the trade disruptions will result in increased construction costs for commercial property developers. In this environment, commercial real estate development is likely to become more complicated, expensive and uncertain.
Commercial real estate development is an expensive undertaking. The average cost is approximately $267.44 per square foot (psf ) across all property types in all major U.S. cities (figure sourced from calculating the average construction costs psf in office, hotel, retail and residential properties across all major U.S. cities in data collected from market data analyst source Statista). But this cost varies widely across the United States: At one end is the most expensive property type to construct — the hospitality property — particularly the five-star hotel ($413.64 psf average across major cities). At the other end is the least expensive — the retail strip mall property type ($167.50 psf average across major cities). Refer to the appendix for a comprehensive assessment on average construction costs across U.S. cities and property types.
Adding to the steep price is the record labor shortage in the construction sector. The Bureau of Labor Statistics (BLS) reported that the unemployment rate of the experienced construction industry was 3.4% as of August 2018, representing the lowest rate in ten years. This figure comes just after BLS reported 273,000 job openings in July 2018. These record numbers mean that cities will have to rely on a smaller, more expensive workforce, putting a strain on major cities attempting a construction boom.
New York City is the most consistently expensive U.S. city to develop new properties in. According to Turner and Townsend’s International Construction Market Survey 2018 report, New York City holds the top spot for construction costs across all world cities at a price of $3,900.00 per square meter (m2 ) of development (a square meter is about 10.7 square feet), which includes a 3.5% cost increase in 2017 and a projected cost increase of 3.5% in 2018. Data collected from Statista verifies this hefty price tag, as New York City proved to be the most costly city in 2017. It gets top billing in primary and secondary office markets ($475.00 psf and $350.00 psf, respectively), the three-star hotel market ($350.00 psf ), the shopping mall center market ($350.00 psf ) and the single-family residential market ($337.50 psf ).
Turner and Townsend’s report highlights the high and rising construction costs across other North American cities: San Francisco (currently at $3,736.70 per m2 at a 5.0% 2017 cost increase and a 5.0% projected increase in 2018), Seattle ($3,101.50 per m2 at a 5.0% 2017 cost increase and a 5.0% projected increase in 2018), Toronto ($2,495.80 per m2 at a 3.0% 2017 cost increase and a 2.5% projected increase in 2018) and Houston ($2,361.00 per m2 at a 4.0% 2017 cost increase and a 3.0% projected increase in 2018). The report particularly focuses on New York City, which may be the most vulnerable to the steel import tariff, as the report foresees a construction boom in the city, thereby exacerbating price increases and supply shortages.
There is little doubt that the U.S. market will be affected by steel tariffs that may also disrupt the steel and aluminum supply chain. New York City, which is already the most expensive city to build almost any property type (particularly office developments), will likely have issues meeting construction goals at a manageable cost. Based on New York loans rated by DBRS over all vintage origination years, 19.0% of construction types in the city are steel-majority buildings (including steel and glass buildings, steel and granite, etc.). While most of the buildings in New York City are concrete or brick-majority constructs (76.2%) based on buildings collected among DBRS-rated loans, these building types also require a significant amount of steel for rebar meshes and some structural interiors. Refer to Exhibit 1 for a complete breakdown of DBRS-rated New York City construction types. It should be noted that the wider New York City inventory may reflect somewhat different percentages.
There are 52 steel-majority buildings rated by DBRS available on the Viewpoint database (refer to Exhibit 2 below for a complete property table). Of these 52, 64.7% are office spaces, 11.8% are mixed-use, 2.0% are multifamily, 15.7% are retail and 5.9% are hotel properties. With New York City being the most expensive city for office property construction, adding a 25.0% steel tariff to an already pricey property type that is largely constructed of steel will likely increase construction costs significantly. But this 25.0% increase is likely to be only part of the problem. Construction in New York City and other major cities relies on a well-organized supply chain. This supply chain could be disrupted by trade uncertainty and may delay construction, thereby adding further costs. In this current trade war, it can become more difficult to determine where exactly the steel supply will come from, how to transport it and how to stay on schedule in the midst of any disruptions.
The Canadian Coalition for Construction Steel, an organization that has consistently urged the Canadian government to act with more caution before imposing retaliatory counter-tariffs, has expressed the biggest concern for how this trade war will affect Canadian steel markets. The organization has raised concerns that the government’s decisions will put the construction industry at risk, which currently employs 1.2 million Canadians, according to its figures. Furthermore, if Canadian contractors are unable to absorb the price increases, they will also need to source steel from other countries. Canada’s supply is only enough to cover 50.0% of domestic demand, the rest being sourced from the United States and other countries. As a result, the Residential Construction Council of Ontario has warned that the cost of the average condominium unit could increase by as much as $10,000 to $12,000, stemming directly from the increased cost of steel.
The numerous ripple effects that the Trump Administration’s tariffs will have on the construction industry on both sides of the border cannot be fully quantified yet, but the effects will be significant and could have materially negative impacts on construction activity. These tariffs are causing both domestic and global prices to increase and are creating disruptions in the supply chain, all of which will factor into increased construction costs and will especially pressure New York City. Counter-tariffs from Canada are also having adverse effects of their own on the country’s construction sector. When it comes to steel, future construction plans stand on an uncertain foundation.
A copy of this research is available on DBRS.com and on the Viewpoint blog.
Follow Stephanie Hughes on Twitter @StephHughes95.