The latest Producer Price Index offers a clear warning for commercial real estate investors: building and operating properties is getting more expensive again.
Final-demand producer prices rose a seasonally adjusted 0.4% in August and 5.4% year-over-year. Excluding food, energy and trade services, prices increased 0.3% for the month and 4.7% from a year earlier.
For CRE, however, the more consequential numbers are in construction materials and property operations, according to Xander Snyder, principal commercial real estate economist at First American. Nonresidential construction inputs rose 1.3% in August and 8.9% year-over-year, while multifamily inputs increased 1.3% for the month and 7.5% annually.
Both annual increases were the fastest since November 2022, following two softer months, Snyder said. The rebound could complicate underwriting for projects that were already facing tighter margins and more expensive debt.
“The headline read is that inflation is still here, even if you exclude energy,” Snyder told GlobeSt.com. “On the construction material side, we have more significant inflation.”
Materials Add To Pressure
Energy is contributing to the increase, but it is not the whole story. Diesel prices, in particular, are becoming a larger cost factor for construction activity and moving materials.
National average diesel prices were $5.32 a gallon a month ago, according to AAA. By Sept. 11, the price had topped $6 a gallon, a record. Those increases are not yet reflected in the August PPI or CPI reports, suggesting the next rounds of inflation data could show additional pressure.
At the same time, several core construction commodities posted substantial gains in August. Copper prices rose 4.2% month-over-month and 27.2% year-over-year. Steel prices increased 1.7% during the month and 23.4% from a year earlier.
“The implications for commercial real estate are that it makes it more expensive to build,” Snyder said.
That matters not only for ground-up development, but also for renovation plans, tenant improvements and capital projects. Investors evaluating acquisitions may need to account for higher replacement and improvement costs even when a property does not have an immediate development component.
Operating Expenses Rise
The cost pressure is not limited to new construction. Repair and maintenance expenses also accelerated in August, potentially creating a more immediate problem for owners trying to protect property-level cash flow.
Nonresidential repair and maintenance costs rose 1.5% in August and 9.6% year-over-year. Residential repair and maintenance costs increased 1.2% for the month and 8% from a year earlier. Like construction inputs, those annual increases were the fastest since late 2022.
Together, these increases raise the risk of deferred maintenance, particularly for owners with limited flexibility in their operating budgets.
“It might cause a greater amount of deferred maintenance and pressure on net operating margins,” Snyder said. “It pressures the debt service line, too.”
That dynamic is especially important in a market where many owners are already managing refinancing risk and higher borrowing costs. Rising expenses can reduce cash flow available for debt service, while lenders scrutinize property performance more closely.
Active Management Matters
The latest cost data reinforce that commercial real estate investing is not passive, Snyder said. Owners who create the most value are often the ones who closely manage expenses, capital needs and opportunities to lock in savings.
“Many people think [CRE is] passive, and it’s not,” he said. “There’s a substantial operational component for most people in this business. The people creating most value are hands-on operators.”
Snyder advised owners to monitor expense categories closely and capture savings when they become available. Insurance is one current example: Rates are lower than they have been, he said, though he does not expect that relief to last.
The broader lesson for investors is that the assumptions behind a deal matter as much as the headline price. Some experienced investors and newer entrants have made different mistakes in recent years, Snyder said, but many stemmed from inaccurate assumptions about interest rates and financing costs.
Now, rising construction materials, diesel prices and maintenance expenses are adding another variable to an already demanding operating environment. For CRE investors, controlling costs where possible may be one of the few ways to preserve returns when both financing and physical asset expenses are moving higher.
Source: “Rising Construction Costs Put New Pressure On CRE Returns”
