Construction activity grows, and tenant improvement allowances follow suit

United States

Construction Perspective

Q2 2015

As construction costs continue to grow nationwide, many landlords are looking to redevelop existing stock in major markets. The focus on tenant improvements (TIs) is also gaining momentum due to the urban renewal trend, which is driven by millennial demand for city center, unique and open spaces.

As a large pipeline of new construction is delivered, office landlords will compete for tenants by offering more attractive TI packages. These offerings allow tenants to customize interiors without paying for a full redesign out of pocket and are a key piece of lease negotiations. The average TI allowance nationwide is $30.00 per square foot, and the average is up to just over $50.00 per square foot in central business districts (CBD).

This trend extends beyond the office market. Industrial occupiers need more custom e-commerce space, with higher shelving, specialized lighting, new technology and office space. Retailers, who often self fund TI projects, are using brick and mortar stores as an extension of their online presence. They are incorporating more technology into their stores to support an omni-channel sales strategy. Restaurant chains are doing similar work, as quick service restaurants redesign their interiors to better compete with fast casual concepts.

National economic trends

GDP growth slowed in 2015, mirroring similar Q1 declines since

recovery began in 2009.

-10.0%

-8.0%

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Con

trib

utio

ns to

per

cent

cha

nge

in r

eal G

DP

(S

AA

R)

4

Decline in real GDP reflected negative

contributions from exports, nonresidential fixed

investment and drops in government spending.

Source: JLL Research, Bureau of Economic Analysis

600

620

640

660

680

700

720

740

122,000

124,000

126,000

128,000

130,000

132,000

134,000

136,000

138,000

140,000

142,000

144,000

2010 2011 2012 2013 2014 2015

Construction

Overall

After a drop in the winter, construction employment is increasing

as starts rebound for the spring.

5

Source: JLL Research, Bureau of Labor Statistics

Con

stru

ctio

n em

ploy

men

t (n

umbe

r of

em

ploy

ees)

Overall em

ployment (num

ber of employees)

0.0

5.0

10.0

15.0

20.0

25.0

30.0

2008 2009 2010 2011 2012 2013 2014 2015

Overall

Construction

Construction unemployment has declined 20 percent year-over-

year since June 2014, as construction demand grows.

6

Source: JLL Research, Bureau of Labor Statistics

5.5% Overall unemployment rate

June 2015

6.3% Construction unemployment rate

June 2015

Une

mpl

oym

ent r

ate

(%)

20

25

30

35

40

45

50

55

60

The Architecture Billings Index (ABI) slipped in Q2, continuing

the cyclical trend since the recovery.

7

The ABI reflects the time between architecture billings and construction spending, and is a 9-12-month leading indicator.

These fluctuations occur due to

regional differences in recovery –

some markets are seeing

consistent construction growth,

while others see the occasional

dip in activity.

Source: JLL Research, American Institute of Architects, McGraw-Hill Dodge

Driven by weather in the Northeast and the West Coast port

slowdown, the Construction Backlog Indicator declined sharply.

8

This index still rests 4.4 percent higher than Q2 2014.

Source: JLL Research, Associated Builders and Contractors

-25.3% q-o-q

5.9% q-o-q C

BI

-10.2% q-o-q

CB

I

-0.7% q-o-q

CB

I

CB

I

National average

construction backlog

8.4mos

Cost trends: Labor and materials

Nationwide, TI packages are growing as landlords compete to

attract clients and more stock comes to the market.

10

Q2 2015 average TI allowance has eclipsed 2010 highs.

$10.00

$15.00

$20.00

$25.00

$30.00

$35.00

Q12010

Q22010

Q32010

Q42010

Q12011

Q22011

Q32011

Q42011

Q12012

Q22012

Q32012

Q42012

Q12013

Q22013

Q32013

Q42013

Q12014

Q22014

Q32014

Q42014

Q12015

Q22015

Average TI package (per square foot) 14.2 percent Growth in TI Allowance

from Q2 2013 lows

Source: JLL Research

The markets with the highest average TI package also have high

levels of construction activity.

11

Landlords offer higher dollar-value packages in active markets in order to stay competitive.

$0.00

$10.00

$20.00

$30.00

$40.00

$50.00

$60.00

$70.00

$80.00

Washington,DC

Atlanta New York -Midtown

New York -Downtown

Seattle Chicago Boston Denver FairfieldCounty -

Greenwich

Minneapolis

Average TI package CBD (per square foot)

CBD

Average:

$50.69

D.C. also saw the most

construction starts in Q2

– three starts at 439,394

square feet

Many of the most expensive markets for office construction also

lead the pack for tenant improvement cost.

12

Source: JLL Research, RS Means

0

20

40

60

80

100

120

140

2012

2013

2014

RS Means Cost Index based on weighted average

of 30 key markets. The index average is 100;

Greater than 100 indicates higher than average

costs. This is based on materials and installation

costs needed to build out an office space.

RS

Mea

ns C

ost I

ndex

Buildout costs per market

The increase in TI packages gives occupiers the opportunity for

more customized buildouts, despite high costs.

13

Source: JLL Research, RS Means

28%

15%

9% 7%

6%

6%

4%

3%

3%

3%

3%

2%

2% 1% 8%

Percentage of total materials cost

Electrical

HVAC

Drywall

Ceilings

Flooring

Millwork

Demolition

Fire Protection

Voice Data

Glass & Glazing

General Conditions

Paints & Coatings

Audio-Visual

General Clean Up

Other

$19.46 Electrical cost per square foot

0

5000

10000

15000

20000

25000

30000

0

1000

2000

3000

4000

5000

6000

7000

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

National Building ConstructionIndexMaterials Index

Labor Index

Construction costs continue to increase, despite slight dip in

materials cost year-over-year.

14

Labor cost grew 1.4 percent since December 2014.

Source: JLL Research, ENR

Com

mon labor index: U

nion wage plus fringe benefits

BC

I: 20

-city

labo

r an

d m

ater

ials

cos

t ave

rage

inde

x

The value of nonresidential construction put in place is over

$40,000 more than in May 2014.

15

$0

$50,000

$100,000

$150,000

$200,000

$250,000

$300,000

$350,000

$400,000

$450,000

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014r 2015r

Value construction put in place

Source: JLL Research, U.S. Census

Non

resi

dent

ial p

ut in

pla

ce (

$M)

The value of construction put in place continues to grow across

all major sectors, as project spend increases.

16

Source: JLL Research, U.S. Census

Total 2014 Total YTD 2015

Manufacturing $57.8 billion $90.3 billion

Education $79.7 billion $81.5 billion

Commercial $62.7 billion $66.5 billion

Office $46.1 billion $55.4 billion

Healthcare $38.4 billion $39.1 billion

Amusement/Recreation $16.6 billion $21.4 billion

Manufacturing spend

eclipsed education to take

the top spot nationwide.

0

5000

10000

15000

20000

25000

New York Boston SanFrancisco

Chicago Washington,DC

Los Angeles Seattle Portland Denver Phoenix

Apr-14

Apr-15

Costs have increased in all major markets, with the biggest cost

growth in San Francisco: 6 percent year-over-year.

17

Cost of construction in major markets

Source: JLL Research, RLB

RLB Comparative Cost Index

tracks the bid cost of

construction, including labor,

materials, contractor and

overhead costs.

RLB

Com

para

tive

Cos

t ind

ex

Rates of growth are increasing in many markets, though Boston,

NYC and Portland are seeing rate declines.

18

0.0%

0.2%

0.4%

0.6%

0.8%

1.0%

1.2%

1.4%

1.6%

1.8%

Boston Chicago Denver Los Angeles New York Phoenix Portland SanFrancisco

Seattle Washington,DC

Q2 2014

Q2 2015

Change in construction cost QOQ

Source: JLL Research, RLB

Materials prices are increasing, though rates of increase are

declining.

19

Source: JLL Research, ENR

ENR Materials Price Index tracks weight price movement of structural steel, Portland cement and 2x4 lumber.

Wei

ghte

d pr

ice

mov

emen

t of s

teel

, cem

ent a

nd lu

mbe

r

1500

1700

1900

2100

2300

2500

2700

2900

3100

3300

3500

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Materials Index

1.7 percent YOY growth in materials cost

Growth in materials prices is driven by gypsum board and other

lumber materials.

Material Percent change YOY

Aluminum Sheet -0.3%

Asphalt Paving 1.2%

Cement 0.4%

Concrete Block 2.2%

Copper Pipe -5.8%

Fabricated Steel 1.1%

Gypsum Board 25.8%

Lumber/Softwood 4.0%

Plywood 1.8%

PVC Water Pipe 5.2%

Ready-Mix Concrete 3.3%

Sheet Metal 1.1%

20

Source: JLL Research, ENR

• Though cement price growth

remains low, it still saw an overall

boost of 8.4 percent since last year.

This supports the overall cost

increase in the industry.

• Copper and aluminum continue to see price

declines, and steel has experienced very low-

level increases as the market struggles with

over saturation of supply.

0

5000

10000

15000

20000

25000

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Labor Index

Labor costs continue growth, though at a lower level than in

previous years.

21

Source: JLL Research, ENR

As employment in the construction sector

continues to grow, wages should stop rising and

stay steady in the future.

Com

mon

labo

r in

dex:

Uni

on w

age

plus

frin

ge b

enef

its

Costs remain low in Southern states, while states with a large

union presence remain pricier.

22

Source: JLL Research, ENR

0

5000

10000

15000

20000

25000

30000

35000

40000ENR labor cost index by city

Com

mon

labo

r in

dex:

Uni

on w

age

plus

frin

ge b

enef

its

Construction activity

Q2 2015 starts are at the highest point since the downturn, as the

economic recovery continues.

24

Source: JLL Research, CoStar, McGraw Hill

11.5 m.s.f. 14.1 m.s.f. 19.4 m.s.f.

Q2 2012

12.1 m.s.f.

Q2 2013 Q2 2014 Q2 2015

0

20,000,000

40,000,000

60,000,000

80,000,000

100,000,000

120,000,000

140,000,000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Com

plet

ions

(s.

f.)

Average completions

46.0 m.s.f.

Though office construction is rebounding from 2012 lows,

activity is still below historical norms.

25

Source: JLL Research

Historical construction completions

Despite a slowdown in the winter months, construction in office

and industrial is up year-over-year.

26

Source: JLL Research, CoStar Group

Industrial construction

Retail construction

122.3 m.s.f. under

construction

Q1 2014

Q2 2015 Q2 2014 Q2 2015

158.8 m.s.f under

construction

61.6 m.s.f. under

construction

45.3 m.s.f. under

construction

Q2 2014 Q2 2015

Office construction

Q2 2014

86.3 m.s.f. under

construction

65.4 m.s.f. under

construction

Growth in retail

construction of

2 m.s.f since

Q1 2015

Office vacancies are slowly declining, as companies begin to

renovate and occupy older stock buildings.

27

Source: JLL Research

30,000,000

130,000,000

230,000,000

330,000,000

430,000,000

530,000,000

630,000,000

730,000,000

2011 2012 2013 2014 2015

Vac

ancy

(sq

uare

feet

)

-10.2 percent since Q2 2011

The most available office space is in the Midwest and South, as

vacancy tightens nationwide.

28

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

Wes

ches

ter

Cou

nty

Pho

enix

Cle

vela

nd

Cin

cinn

ati

St.

Loui

s

San

Ant

onio

Dal

las

Indi

anap

olis

Atla

nta

Los

Ang

eles

Wes

t Pal

m B

each

Kan

sas

City

Jack

sonv

ille

Sili

con

Val

ley

Milw

auke

e

Mia

mi

Min

neap

olis

Sac

ram

ento

Det

roit

San

Die

go

Ric

hmon

d

Hou

ston

Col

umbu

s

Orla

ndo

Bal

timor

e

For

t Lau

derd

ale

Chi

cago

Tam

pa

Den

ver

Ral

eigh

/Dur

ham

Pitt

sbur

gh

Was

hing

ton

DC

Bos

ton

Phi

lade

lphi

a

Aus

tin

Sal

t Lak

e C

ity

San

Fra

ncis

co

New

Yor

k C

ity

Eas

t Bay

/Oak

land

Sea

ttle

Cha

rlotte

Por

tland

Vacancy rates by CBD

Source: JLL Research

Q2 2015 completions are up 60 percent from Q2 2014, despite the

winter building decline.

29

Source: JLL Research

0

5,000,000

10,000,000

15,000,000

20,000,000

25,000,000

30,000,000

Q12010

Q22010

Q32010

Q42010

Q12011

Q22011

Q32011

Q42011

Q12012

Q22012

Q32012

Q42012

Q12013

Q22013

Q32013

Q42013

Q12014

Q22014

Q32014

Q42014

Q12015

Q22015

Ann

ual c

ompl

etio

ns (

squa

re fe

et)

New York, San Francisco and Chicago have a wide cost variance

in their submarkets, giving them wider cost ranges overall.

30

Source: JLL Research, Rider Levett Bucknell

$0

$50

$100

$150

$200

$250

$300

$350

$400

Boston Chicago Denver Los Angeles New York Phoenix Portland SanFrancisco

Seattle WashingtonDC

($ p.s.f.) Range of office construction costs in major markets

4.5 m.s.f.

Boston

The square footage of office space under construction declined

country-wide in Q2, due in part to severe springtime weather.

31

Source: JLL Research

8.5 m.s.f. Dallas

7.0 m.s.f.

Seattle

1.4 m.s.f.

Portland

3.1 m.s.f. San

Francisco 2.0

m.s.f. Cincinnati

3.66 m.s.f.

Phoenix

3.1 m.s.f.

Denver

11.1 m.s.f.

Houston

2.3 m.s.f.

Chicago

2.9 m.s.f. Austin

9.5 m.s.f. New

York City

2.13 m.s.f.

Washington,

DC

3.8 m.s.f.

Philadelphia

0.5 m.s.f.

Atlanta

Q2 2015 under construction

Despite the general decline in

square footage under

construction, New York saw

construction activity increase

by nearly 2 million square

feet.

Tenant improvements become more vital as occupiers customize

newly acquired space and attract millennial workers.

32

Source: JLL Research

36

percent

50

percent

The percentage of

millennials in the

workforce will increase by

almost 20 percent

between 2014 and 2020.

Companies must work

harder to attract and retain

top talent.

2014

2020

• Millennials seek unique office space design, supporting collaborative work that supports creative thinking. According to

a Deloitte survey, 78 percent of millennials are strongly influenced by how innovative a company is when

making a career decision.

• Tenant improvements can support this innovation in the office market, as companies fill vacant space. This

customization includes new public areas, more access to technology in meeting and collaboration rooms, and open,

mobile workspaces. Firms without these new finishes may find it more difficult to attract and retain younger talent.

• Companies spend millions on these renovations – this is especially true for high-technology firms. The highest-cost

buildout for San Francisco-based technology firms in 2014 was $12 million.

0

10,000,000

20,000,000

30,000,000

40,000,000

50,000,000

60,000,000

70,000,000

80,000,000

90,000,000

2010 2011 2012 2013 Q1 2014 Q2 2014 Q3 2014 Q4 2014 Q1 2015 Q2 2015

Industrial completions in Q2 2015 are up 13.9 percent year-over-

year, as many of the 2014 starts come onto the market.

33

Source: JLL Research, CoStar

Indu

stria

l Com

plet

ions

(sq

uare

feet

)

Industrial construction cost ranges are the largest in California,

with very little cost differential in the East Coast.

34

Source: JLL Research, Rider Levett Bucknell

$0.0

$20.0

$40.0

$60.0

$80.0

$100.0

$120.0

$140.0

$160.0

$180.0

Boston Chicago Denver Los Angeles New York Phoenix Portland SanFrancisco

Seattle WashingtonDC

($ p.s.f.) Range of warehouse construction costs in major markets

24.4 m.s.f. Inland Empire

6.7 m.s.f. Reno

3.0 m.s.f.

East Bay

Industrial square feet under construction is growing, especially in

the South and West.

35

Source: JLL Research

13.0 m.s.f. Dallas

3.1 m.s.f. Seattle

3.8 m.s.f. Los

Angeles

4.5 m.s.f.

Central valley

3.3 m.s.f.

Indianapolis

10.1 m.s.f.

Houston

8.9 m.s.f.

Chicago

4.2 m.s.f.

Kansas City

17.3 m.s.f. Atlanta

2.9 m.s.f.

Charlotte

14.6 m.s.f.

Philadelphia

Inland Empire under

construction increased 50

percent since Q4 2014. Q1 2015 under construction

3.0 m.s.f.

Cincinnati

Retail deliveries in 2015 are below 2014 totals, as smaller square-

footage stores increase in popularity.

36

Source: JLL Research, CoStar

Ann

ual c

ompl

etio

ns (

squa

re fe

et)

0

2,000,000

4,000,000

6,000,000

8,000,000

10,000,000

12,000,000

14,000,000

16,000,000

18,000,000

20,000,000

Q1 2013 Q2 2013 Q3 2013 Q4 2013 Q1 2014 Q2 2014 Q3 2014 Q4 2014 Q1 2015 Q2 2015

Retail deliveries Smaller square-footage specialty

store deliveries are up 4.8 percent.

In order to compete, retailers are incorporating technology into

their build-outs.

37

Source: JLL Research

• New “omni-channel” retail outlets combine brick-and-mortar stores with online stores. Retailers often use

brick-and-mortar stores to fulfill online sales, which emphasizes convenience for the consumer.

• This new form of retail requires brick-and-mortar stores to bring in new technology, including interactive

screens in dressing rooms and the opportunity to shop in-store, yet order online.

• Textures, finishes and other unique touches also draw in today’s consumer – this includes exposed

beams and locally harvested materials.

• Flexible space that includes gathering places and outdoor seating is gaining in popularity as well, driven

by demand for unique shopping and dining experiences.

Retail costs have the largest price range, due to size and stock

quality variances.

38

Source: JLL Research

$0.0

$50.0

$100.0

$150.0

$200.0

$250.0

$300.0

Boston Chicago Denver Los Angeles New York Phoenix Portland SanFrancisco

Seattle WashingtonDC

($ p.s.f.) Range of retail construction costs in major markets

The majority of new retail space is focused in the Northeast and

Florida, with some Midwestern growth.

39

Source: JLL Research

0.5 m.s.f.

Broward Co.

0.5 m.s.f.

Minneapolis

0.4 m.s.f. Las

Vegas 0.4

m.s.f. Los

Angeles

0.4 m.s.f.

Indianapolis

0.6 m.s.f. SW

Florida

0.7 m.s.f.

St. Louis

0.8 m.s.f.

Chicago

0.7 m.s.f.

Washington,

DC

1.0 m.s.f. Long Island

0.4 m.s.f.

Northern NJ

0.7 m.s.f.

New York City

1.6 m.s.f. Boston

Q2 2015 under construction

Florida’s growth is driven by

increased consumer confidence,

growth in tourism and a

recovering housing market. 0.5 m.s.f. Miami

Overview and outlook

Key construction markets

41

Source: JLL Research

Houston continues to lead the pack, with 11.1 million square feet under construction in Q2 2015. However, this

represents a 12 percent decline of activity since Q1 2015, as the energy construction boom loses steam.

Boston and Long Island see retail growth. The Northeast and Florida represent the most retail construction

growth by square foot in Q2, as the economic engine boosts demand in these regions.

The Midwest and the Southwest lead in available office space. As companies scoop up vacant space in

primary markets, secondary markets still have higher vacancy rates, which provide opportunities for firms looking

for new space.

New York City remains the most expensive market, driven by high labor costs and land supply constraints,

while demand for NYC office space continues to grow.

Chicago had the biggest cost growth YOY, as land available declines while demand in the city increases.

1.

2.

3.

4.

5.

What’s next for construction?

42

Source: JLL Research, IBISWorld

Construction costs continue to grow, despite a brief slowdown in materials cost. Materials costs are projected

to rebound, however, further driving up costs.

Construction deliveries saw a dip in Q2 2015, due to winter weather and other supply factors, but starts are at

their highest point since the recession.

Labor costs see no reprieve from growth, and the cost differential between markets remain high, with

Southern states boasting consistently low labor costs.

Tenant improvement demand will stay high, as companies continue to scoop up vacant property in growing

primary and secondary markets and build out offices to fit shifting trends.

As construction activity grows, TI allowances increase as well as landlords battle to attract occupiers; now

is a good time for occupiers to lease new space. Activity is still far below pre-recession highs, indicating growth

will continue over the next several years, and dollar value of TI allowances will as well.

The construction industry usually lags overall economic recovery by one to two years; the industry is

still in the early stages of its recovery and will continue to grow in response to overall economic growth.

1.

2.

3.

4.

5.

COPYRIGHT © JONES LANG LASALLE IP, INC. 2015

Thank you

Dana Westgren

Research Analyst

Project and Development Services

+1 (312)-228-2867

Dana.Westgren@am.jll.com

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