January 31, 2024

JF3436: How to Combat Rising Material Costs ft. Andy McQuade




Welcome to the Best Ever midweek news brief, a new series where we will highlight the top headlines CRE investors should be paying attention to this week, followed by a deep dive on a larger news topic or trend alongside a CRE expert.

Today’s Headlines:

  • Retail is Back, Baby: Retail vacancy has hit a 17-year low, prompting landlords to withdraw the rent discounts and concessions they’ve been offering struggling tenants since the pandemic. This signals intensifying competition, meaning that retail may officially be back.

  • PHX Leads in Q4 Apartment Demand: Apartment demand in Q4 outpaced pre-COVID norms in some key markets, with Phoenix leading the way with an absorption of nearly 4,300 units in Q4 — close to 3,500 more than the annual average in the decade leading up to the pandemic.

  • Rental Fraud on the Rise: According to a new survey from the National Multifamily Housing Council and the National Apartment Association, more than 70% of major apartment landlords say they have seen an increase in fraudulent rental applications over the past 12 months. With this report, it appears that this problem is here to stay. (Here’s our previous episode on how renters are using TikTok to defraud landlords.)


Today’s Guest: Andy McQuade is the principal of The ARM Companies, which provides procurement and management consulting to clients in the real estate industry. Andy joins host Paul Mueller to discuss recent JLL reports which suggest that material costs are expected to increase in 2024 by anywhere from 2-6%, but electrical and related switchgear costs could be higher as companies continue to face labor and availability issues. Meanwhile, HVAC manufacturers and suppliers have also announced price hikes as high as 10% in some cases.

Andy McQuade | Real Estate Background


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Paul (00:07.278)
All right, how you doing today, Andy?

Andy McQuade (00:09.331)
I am good Paul, how are you?

Paul (00:11.338)
I'm doing well also, so I think the best place to start would be for you to tell the best ever listeners a little bit more about your background and what you're focused on now.

Andy McQuade (00:19.432)
Sure. So the first 20 something years of my career, I was on the supply side of the building materials industry. I did kind of both sides of it. I did the new construction, working with GC's lumber yard type of roles for the first 11 years in leadership. And then I was a district manager over B2B Pro commercial sales, whatever you want to call it at the Home Depot.

I had as many as 18 stores and I worked primarily with large multifamily operators spending anywhere from a half a million to $7 million a year with the Home Depot. I used to fly all over the country and do that. And I ran some building products, a manufacturing sales team in Japan, Canada, and across the U S for a year, uh, working with places like Harvard and Facebook, Amazon, Microsoft, you name it.

We had, we had product in some of their projects and that's sort of my background on that side of it is supply. So what I've been doing for the last almost five years now is working with large multifamily operators to help them with their purchasing and procurement. Anything from outsourced negotiation to actually writing specifications, working with their architects and designers, setting up their, their standards for their businesses and, and that's what I do now full time.

Paul (01:45.058)
So you're talking to operators and investors on a large scale on a daily basis.

Andy McQuade (01:50.244)
Absolutely. That's the only thing. It feels like sometimes that's the only thing I do, but I do some other stuff too. I record a podcast and do all that stuff. But, you know, for the, for the most part I make my money just working with larger commercial multifamily operators.

Paul (02:04.706)
All right. And Andy, I think we're all familiar with what happened regarding operational costs in 2023 in the Wild West that turned out to be. From your perspective, tell me where we're at right now in terms of the state of operational costs, particularly in multifamily.

Andy McQuade (02:21.024)
So I think that 2023, especially towards the tail end, we actually started to see a lot of the craziness taper off, right? During the pandemic, everything was nuts. And 2023 was like the reset year. We were able to go from complete chaos, it was costing companies $30,000 to get a container over from China in 2022. And that cost is like 2000 bucks now. So things are way better. We've seen a lot of stabilization, but I don't think we're done yet with the
overall growth impact that we saw in costs. But I think it's normalizing. Traditional price increases year over year for building materials, whether it was for new construction, remodeling, interiors, electrical, switchgear, HVAC, all of that stuff, it's always been somewhere between 2% and 5% annually is what you could pretty much bake into your projections.

We're not really seeing anything that says, oh my God, the world is on fire. We're going to see a 30% price increase on the raw materials that it takes to make, you know, vinyl products, steel, copper, aluminum, all of those components. There's nothing on the radar right now saying things are going to spike. Yeah. There's a lot of uncertainty in the global world. You know, if world war three breaks out, all bets are off, but assuming that nothing stupid and insane is going to happen in the next 12 months.

We should see a pretty traditional, you know, two to 5%, maybe a little bit more for certain categories in price increases. And I think a lot of that is just, we're still catching up on the impact of labor problems, right? People don't wanna go to work. They don't wanna do dirty work. They don't wanna get their hands dirty. They don't wanna do factory work. Factories are traditionally understaffed. Lumber mills and logging operations have been understaffed by 20 to 30% for the last 15 or 20 years.

It's hard, thankless work, a lot of it. And people just don't want to do it for long. So we're going to see cost increases as people have to basically bribe employees to show up to work every day and produce a good quality product. I don't think we're seeing the end of that. And we're going to see that tail into costs for manufacturing and shipping and all the other parts as we get through the rest of this year. But I don't see 20%, 30% increases on the horizon pretty much anywhere.

Paul (04:41.614)
Well, the reason you're here today, Andy, is because what's been in the news recently is the these HVAC companies that I mean, there's a major shift going on right now with these big manufacturers. I think Lennox, Trane, Allied and a few others have announced significant rises in prices, some as high as 10%. And these changes, a lot of these changes took effect just now in January. That's obviously going to have a huge impact now and throughout 2024 and beyond. Tell me about what's happening there and why particularly multifamily operators need to be paying attention to this.

Andy McQuade (05:16.04)
So the HVAC thing is tricky. It's a little bit like what's going on with electrical switch gear and stuff, right? We're seeing a lot of delays and extended lead times through production channels, right? Pricing doesn't seem to be accelerating as much as it did the last couple of years. We're still going to see that, like you said, 10%, maybe 12% to 16% on certain line items.

And those price increases that they announced, they are hitting, I think the last set goes through and is effective like February 1st. So, and that's just for now, we could see more later. It wouldn't be the first time they're like, hey, in 60 days, 90 days, 120 days, we're gonna have another 5% bump or we're gonna have another 10% bump. So HVAC, a lot of it is supply constraint, again, through manufacturing, a lot of it is labor related, but the material cost increases from like Train and Allied and those manufacturers largely comes down to they're still, again, getting caught up and stabilizing from the end of last year and adjusting all of their production stuff.

So a lot of these manufacturers, when they go in and they start dealing with big distribution houses, the big national change, they sign contracts that basically say, hey, we can only increase prices once every 120 days, 180 days, once a year, twice a year, whatever. And it's very specific on what they can do. So it's like, you can do a 5% price increase X, you can do a 10% X. So this time of year, like that January to like March window is when a lot of these big manufacturers renegotiate their contracts and they look at their profit margins, they look at their operations, they forecast out what they think the market's gonna do for their costs and then they do that price bump.

So, if things start to get crazy six months down the line, they're not selling everything below their cost. So it's kind of expected. Again, this time of year, we usually see that like 2% to 5% bump. For stuff like HVAC and electrical, given all of the headwinds that they've been facing as an industry for the last two or three years, I'm not really shocked that we're still seeing 10% and 12% and 15% increases.

Hopefully we don't see more come June, July. It's just keeping an eye on the news and really having that relationship with your suppliers and your vendors that deal with those products. Whatever the brand is that you're loyal to, it's going to be an important thing to make sure that you're booking it into your CapEx projections, into your operational projections. We're only a couple of months away from the Northeast and most of the country from going in and reordering seasonal stuff like P-TAC and V-TAC units, through the wall air conditioners, all those things. That's usually, once the cold is gone, then we start worrying about the air conditioners working. Well, you're going to take an increase again this year, and you may have lead time and supply chain constraints that are increasing that cost even more.

Remember, these increases are just from the manufacturers to their middlemen, their distributors and warehouses. Most of the guys out there doing HVAC do not have the volume to go direct to these companies and make it affordable. So they're using a two-stepper like a Ferguson or an electrical supply house like a Westco to get that product to your jobs if you're operating in any kind of real estate. So they can, because of their own labor issues, you could see even more of an increase.

If Trane is raising it 10%, and they've taken an increase on their labor costs and insurance and workers comp and all of the other things that go into their operations, you're going to see more than 10%. So just be prepared that your budgets are going to be a little screwy and you're going to need to have those conversations with whoever handles your account relationship there. If you don't have somebody handling your account relationship, you really need to get one.

Paul (09:14.198)
Yeah, so it sounds like operators and investors really need to be paying attention three, six months down the road, what they're going to face in the spring and the summer and really be taking on those preparations now instead of waiting.

Andy McQuade (09:25.884)
Absolutely. That's half the battle in anything when it comes to building materials and supply is labor and timing are always two of the biggest issues that you're going to have in the industry. So the more notice you can give to your suppliers, the better off you're going to be.

Paul (09:46.786)
So obviously we're focused on HVAC here because of what's happening in the news right now with some of these big companies, but how are these same factors that you're talking about impacting plumbing, roofing, solar, electrical, as you mentioned?

Andy McQuade (10:00.56)
So a lot of it comes down to again, the labor cost going up. So they're going to pass that on. Nobody's going to take a loss because they're paying more for anything. Right. And it's and nobody should. That's just part of business. And you have to kind of to bank around it. The the other products that are out there, electricals still facing headwinds on the production manufacturing side, which is driving up costs. A lot of the stuff that they ship is extremely heavy.

So when we see shipping cost acceleration, which was in the news a few weeks ago, that we're starting to see some price increases on the actual trucking and shipping services for train and ocean. It's not anything like it was in 2021. Like people shouldn't be panicking that they're gonna have to, you know, double their cost projections for product. But what they should be doing is building in that buffer of time for anything that even has a hint of a supply constraint.

So stuff like solar panels and stuff like that, the supply is really kind of eased. But the electrical connections in the switch gear to actually make the panels work with the buildings that they're going into has not. Same thing if you're doing like EV prep, EV chargers, all of that that material that has to go into those buildings, all the switch gear that has to go, all the upgrades to the service that has to be done. That stuff all has very, very extended lead time still. And you have to work with your vendors and make sure you get your place in line. It is a first come, first serve and relationship thing.

So if they have a relationship with somebody and they know that they're going to be doing a big project, they may not have as much notice on when the material needs to be there but they will give their allocation, assuming that they're on allocation, they will give their allocation to the loyal customer as opposed to the Joe Blow who's shopping at five different places, just trying to get it as fast as possible because they didn't plan ahead far enough because they weren't paying attention. So like plumbing, duct work, anything metal, the biggest cost increase, like risks that we're gonna see going forward is, what does it take to actually produce those and get them on the road? So again, the shipping cost is one part.

Andy McQuade (12:12.264)
But anything that's used in actually turning those products from a raw material into the finished product, so any natural gas, coal fired electricity, like all of those things that go into running like a big smelter, right? Tons of energy, tons of heat, 24 hour operation, three shifts. They never shut those things down. All of that stuff has to be taken into account in that. And as labor costs continue to increase and people are less and less willing to show up, the better. And now that we've got all these layoffs and stuff.

Maybe we'll see some relief through this year, but I don't see a lot of tech people leaving tech and going to work in a factory, right? So there's a lot more to come, and I don't think it's gonna be resolved in 2024.

Paul (12:56.05)
Andy, I want to touch on this because you mentioned relationships in there and that if you have a relationship with a vendor that you should take advantage of that relationship because they're going to give whatever inventory they have to the people that are most loyal to them. It, it sounds like what you're saying is that it's going to be really easy to fall into the trap of chasing lower costs because costs are going to feel comparatively high to where they've been in the past. But it sounds like what you're saying is if you've got that relationship to leave that relationship in search of lower costs could be a detriment or at least something that you should carefully consider.

Andy McQuade (13:29.564)
Yeah, so there's a balance, right? You have to make sure that you're keeping your current vendors honest, right? But if they're delivering a level of service to you that adds more value to your business than exiting that relationship to chase the lower cost with no track record for that lower cost provider, you're participating in what I call the race to the bottom, right?

You're chasing things. You're stepping over dollars to pick up pennies. You see this shiny object. Everybody gets shiny object syndrome. I'm super guilty of it. I see that shiny object. Wow, I could save 5%, 10%. This is $100,000 package. That's a good amount of money, right? You're talking $5,000 to $10,000. That would be nice for me to put on a pad because nothing is running in budget right now. Everything's still going over budget at least a little bit.

So why wouldn't I want to pad my numbers? Well, the reality is that what can good is that five or 10 grand if what happens is you don't get the product when you need it and you have to stop work or you have to put those guys somewhere else or worse yet you have a really good quality installer. You're buying the product and that guy has to go off the job and go somewhere else to do something else for someone. Are you going to get them back or are you going to be scrambling looking for labor?

These are these are huge issues and you know how you run your business, whether you're vertically integrated, whether you use subs how far out your projects are being planned, how much of a pain in the butt the inspectors are. Like all of these things go into your costs and you have to build some cushion in there. But you have to be very, very careful when you're looking at breaking a good supplier relationship because the reality is that in the environment we are in right now, you need your good supplier more than your good supplier needs you because everybody's hungry and everybody's gonna be shopping.

So be aware that just because you've had a good relationship, if you break that relationship, don't assume that you're gonna be able to go back to them and say, hey, I screwed up, sorry, do you wanna do this job? They're not gonna play second fiddle. They're gonna take that allocation and they're gonna give it to the next guy who stayed loyal. So it's a very, very careful game you have to play. And people have long memories in this business. There's people I know still to this day that won't buy from certain companies, even though nothing about them is the same 20 years later.

Paul (15:53.33)
Andy, you mentioned earlier that you're talking to operators and investors on a daily basis about these topics. What are their biggest concerns? What are you hearing out on the ground that is really top of mind for all of these investors?

Andy McQuade (16:06.88)
So a lot of it is still, again, labor, right? So HVAC, electrical, plumbing, even some of the guys that have relationships with owners, with firms that do their work, those guys that are out in the field can't get employees to show up regularly. They can't get them. They're paying some of these techs $30, $35, $40 an hour to do this work and they show up one day and then they ghost for two days and nobody knows where they are. It's not like it was payday, they just don't go to work.

They don't answer their phone, they don't return texts and it sounds anecdotal, but it's across every single trade industry, right? In the industry right now, whether it's electrical plumbing, drywallers, framers, you name it, these skilled and unskilled laborers, right? Are having issues showing up to work, whether it's a motivation thing, whether it's their personal lives, whether it's whatever, no one can seem to fix the problem.

With operators, what they're seeing is they'll have these things booked sometimes two weeks, four weeks in advance, and they'll get a crew there that shows up and works for a week. And then one guy shows up. I've heard horror stories where it's just the owner shows up to finish these projects. Doesn't matter if it's unit turns, doesn't matter if it's a vacant building getting new HVAC install, doesn't matter if it's a huge project, that labor side is a massive issue.

Now, the relationship piece should be you're using people that deliver for you regularly. The best thing you can do for yourselves is to build a vendor scorecard, which whatever you want to consider it, whether it's supplier scorecard, vendor scorecard, the basic of it is is price, service, terms, and how are they performing on all three of those? And if they're not on the service side, maybe that's the time to start looking around if they're not fulfilling their end of these timelines. And make sure, you know, honestly, make sure that you're using a good contract, right? Like the AIA contracts, as much of a nightmare as they are, if you're doing any sort of commercial construction, it's a good template if, even if you're just bringing in a company to do work on a property.

Like some of those clauses in there as far as like non performance and, and liens and you know, you don't have to get into bonding and any other stuff, but there's things in there that can help you as an operator to prevent and avoid and mitigate some of the issues. If it does come to that, like business relationships are good. Contracts are just making sure that people understand what it is they're supposed to deliver on because there's a lot of the failures are from a lack of communication.

So communicating is really, really important. Like, I think we're past the point of, oh, make sure that they're going to give you a W-9 and have insurance. I don't think that's the kind of conversation we're having right now. I think that's a goes without saying type of thing. Make sure that your vendors are aware of the importance of the project to you and what your timelines are. Because the better you can communicate that, I think what we've seen and what we still see is that they will go out of their way to fix their problems without them becoming your problems. And that's the perfect answer is make sure that they have an incentive and they understand that they need to fix their problems before they become yours.

Paul (19:44.278)
You jumped the gun on my last question, which is obviously spinning that forward and seeing what operators and investors can do to mitigate some of these price hikes that they're seeing. Is there anything that you didn't mention that you've been talking to your investors about that they can do?

Andy McQuade (19:59.812)
Yeah, absolutely. So there's a lot of. Parts to this that go outside of just the labor piece, right? So for your building materials piece, it all it all eventually comes back to labor. But the reality is whether you're buying electrical switchgear, HVAC, preplanning stuff, the more notice you can give your vendors, right? Whether you're buying product directly, whether you're a two stepping product through your, you know, subcontract operations, however you're running that part of the business, the more notice you can give these companies as far as what you're gonna need, specific price list, or, let me start that over. Whatever you're gonna need, specific item lists, specifications, quantities, when you're gonna need them, why you're gonna need them, how they're gonna be used.

You give all that information to your vendors, right? Materials, labor, whatever it may be. And you're taking their job and actually making it easier, right? Cause you're number one, giving the opportunity for them to buy in bulk and pre-plan their ordering structure. They can reduce their costs because instead of dealing with your guys coming to the shop every day or every three days, or them doing deliveries once a week or twice a week or three times a week to the job site, you're giving them the ability to manage their side of the labor down, right?

We talked about the escalating labor costs on your middleman supplier side, mitigate those for them, give them the ability to reduce their overhead when they deal with you as a client, again, over communicate what you need to happen so they can pre plan and they can execute at a higher level and save themselves money. I don't know a single vendor who says I would love to bring these things in one at a time on a UPS truck every single day of the week and deal with packing it and moving it and doing this and that, as opposed to bringing in a tractor trailer load of product and dropping it in my warehouse and sitting on it until you're ready for the job.

I don't know anybody who says that I would guarantee you that they can secure better pricing, better lead times, better service from their suppliers and do them a favor as opposed to just having somebody have to deal with your stuff a couple of hours every single day.

Andy McQuade (22:20.604)
Is it the only thing they're doing? No, there's a lot of stuff that goes into it, but if you can make their job easier, you can save money.

Paul (22:27.858)
Andy, you've been really thorough in breaking down these issues and explaining how investors can adjust in both the short and the long term. Is there anything that we didn't discuss regarding this topic that you think we should touch

Andy McQuade (22:39.988)
Um, honestly, Make sure that when you're dealing with your vendors, if you're going to go in and negotiate, know what your buying power looks like. Know that your relationship with them has value, right? If you're going in and you're going to try to negotiate a better set of terms, a better set of pricing, and you're giving them five to $10,000 a year, they're probably actually losing money, just having a conversation with you.

Right. So don't negotiate from a point of weakness, because again, you need your vendors right now more than they need you. They will sell their stuff. If the economy suddenly tanks and all the construction dries up and these guys need to sell product to put food on the table, it's a different conversation, but we are not there. Everybody predicted we would be there. We are not there. And it doesn't look like we're going to be there in 2024.

So my advice is, make sure you understand where you're coming from when you're negotiating. If you're gonna do one project and it's the only project you're gonna do and it's worth whatever it is, they're still going to give preferential treatment and better terms and better pricing to that client that spends on every project, multiple projects a year, tens to hundreds of thousands of dollars a year.

They're going to get better stuff than you do. And you have to understand that. That's how business works. You're going to give preferential treatment, preferential pricing, preferential service to the guy that's keeping your doors open and the lights on, and not the guy that does one project a year or spends a very small amount of money in the grand scheme of things. A lot of these supply houses are doing $10, $20, $30 million a year. $5,000 sale isn't even going to light a candle in the window for them.

Paul (24:39.99)
Yeah, it sounds like that self-awareness is really going to be key when dealing with those vendors.

Andy McQuade (24:44.72)
It is. It is. I think we could all use a little more software and it's personally like, I'm right there. I get it. But I negotiate these things all the time. And a lot of times I just have to tell people I'm like, listen, you don't have buying power. I don't know how to help you get a rebate. Get get something like go take the time to file those 2% manufacturer rebates. Like, I don't I don't know what to tell you. That's not you. Just you can't do it. I'm sorry.

Paul (25:10.126)
Well, Andy, thanks a lot for joining us today to discuss this topic. I know people are really optimistic about 2024, but it seems like it's just more uncharted territory. However, that shakes out, I guess we'll all find out, especially in the face of these rising operational costs. I appreciate you coming on, sharing your wisdom with myself and the best ever audience. And yeah, well, I'm sure we'll talk again soon. In the meantime, have a best every day.

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