Steel Prices Soar: Self-Storage Construction Takes a Hit But Stands Firm Despite Rising Costs

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It began with a few modest increases—10 percent here, 15 percent there. But by April, self-storage manufacturers who rely heavily on steel were feeling the pinch. In just three months, steel costs had risen more than 30 percent. And it’s not just steel, but also the raw materials that go into making the steel.

Several reasons for the increase have bounced around in the media and in company boardrooms—a weakened American dollar, surging ocean-freight costs, an increase in exports from domestic steel mills, and strong markets in foreign countries.

At the time of this writing in April 2008, manufacturers were bracing themselves for two more huge increases: one in June, followed quickly by another in July, bringing the total increase to about 50 percent in just seven months.

While the volatile steel market is reminiscent of what happened in 2003-04, there are some subtle differences. At that time, the sudden jump in price was attributed to supply and demand—there simply wasn’t enough steel to go around. Foreign countries like China were gobbling up steel at a rapid pace. Now there’s plenty of steel—so far—but at a higher price. Whether a shortage comes into play will be determined in the months to come.

However, there are also some similarities—the aforementioned ocean-freight costs to transport steel into the United States, the rising costs of energy, and a weak American dollar.

In the self-storage industry, builders, developers and suppliers of steel have been hit the hardest. During the ’04 crisis, many of them lost business and chunks of money. Some tried to absorb the increases rather than pass them on to the customer; others were locked into contracts and unable to raise prices. Some simply slowed or stopped production until steel prices leveled and were more affordable.

Despite the soaring costs this time around, most builders and developers remain optimistic, knowing rough waters are definitely ahead, but calmer seas will prevail by the end of ’08. Inside Self-Storage (ISS) caught up with a handful of builders and developers to get their perspectives on the explosive steel market. Our panel consists of (in alphabetical order):

  • John Baragona, vice president, Diamondback Metal Systems
  • Bob Boilini, systems sales manager, Components Plus Inc.
  • Vern Cannon, owner, Cannon Storage Systems
  • Chip Cordes, vice president, U.S. Door & Building Components
  • Scott McHugh, general manager/sales USA, MBCI
  • Buster Owens, president, Rabco Corp.
  • Mike Parham, CEO, NDS Construction
  • Phillip Wilkerson, vice president/manufacturing, components division, MBCI
  • Caesar Wright, president, Mako Steel Inc. 

ISS: What’s happening with steel prices?

Boilini: Until last January, 26 percent of the steel used in the U.S. was imported. But with the devaluation of the dollar, a lot of that foreign steel in going elsewhere. To compound that problem, the U.S. steel mills are selling a lot of steel overseas because they can get more money for it.

Cordes: Right now, they’re escalating monthly. The increases will peak around July or August, and I don’t see them coming down until November or December.

Parham: In the past, steel went up because a lot of it was going overseas to support China and that’s over with. If you take a look at production orders, they’re way down. If you’re talking about typical supply and demand, there shouldn’t be any reason for it going up right now. We have a lot more of it now than we did when it was going up over the last five years.

If you look across the country, construction is down 35 percent. Government spending as it relates to particular projects is down. Exporting is down. The million dollar question is, in a supply-and-demand economy, how could steel be going up?

Wilkerson: There are several well-publicized factors driving monthly increases from our steel suppliers. Limited supply of imported steel, raw-material cost increases, scrap escalating to all-time highs, rising fuel and energy costs, value of the U.S. dollar, etc. All of these have created an opportunity for domestic mills to continue the price escalations. Although non-residential construction is down in this country, the limited availability of imported steel forces U.S. consumers to purchase from the domestic mills. As a result, their order books are full and, as we all know, prices are driven by supply and demand.
 
ISS: How is it different from or the same as what happened in 2004?

Boilini: We went through this four years ago when prices doubled in six months. Then they fell 50 percent. Nobody seems to think things are going to fall now because the demand around the world. We’ll all bracing for a long period of this. Business is good because people are trying to get ahead of these price increases. It’s not quite the same because the increases aren’t as dramatic and we’re not allocating steel yet. But it has thrown things in a tailspin.

Owens: There’s not a big difference. A lot of the supply in 2004 was going to China. What happened was, at the time, there was a shortage of steel. We’re hearing the rumblings of there’s possible allocations coming, but we haven’t seen that happen yet. In ’04, the prices were going up because there was a shortage of steel. Now it’s not necessarily because there’s a shortage, but with the dollar being so weak—in conjunction with the increase of all the material costs—they can sell it offshore for more money than they can sell it in the United States.

So, basically, the demand in China is a little different because they have built there own mills. We can’t blame everything on China like we did before. Canada’s economy is booming, so is Mexico’s. It’s more the devaluation of the dollar that’s affected us.
 
ISS: In what ways has the increase in steel prices affected the self-storage industry?  

Baragona: That’s hard to say. The increases in the first quarter were not so dramatic. Everyone is concerned about what the next couple of quarters are going to hold. The increases we saw in the first quarter are probably tolerable to most companies and customers.

If we see similar increases over the next two quarters, we’ll have a chance to see some significant impact to project viability. But I don’t think we’re at that point yet. Everyone is obviously quite nervous, and people that are in the process of getting their projects ready for construction that are still six months out, those people need to keep a close eye on it.

Boilini: It’s going to impact the smaller developers and owners more than the big guys. We’re starting to see some of the smaller developers—the ones who do one project at a time and are totally dependent on commercial lending—have some of these projects delayed through financing. Let’s face it, commercial lending at this moment is getting much more conservative. For the larger ones that have a lot of cash, this is a hiccup.

Cannon: We’re in for a slowdown. You’ll see a lot of the people that jumped in because they thought it was great try and get out of it. It’s not going to be: “At what price can you do it?” It’s going to be: “Can you get the steel? Do you have the manpower to do it?”

And the people that do have the money to build, they’re not going to take the guy who works out of the back of his pickup truck. This may even be good for the industry. It may get rid of some of the fly-by-nighters who give us a bad name. The ones who came in when times were good, we’ll be gone.

Cordes: There are two things affecting the storage industry right now. One is the cost of construction. Two is the equity market. It’s harder for people to borrow money today. Because of the residential market, the borrowing guidelines are getting much stricter. A year ago, you could have a million-dollar piece of property and borrow $5 million against it, and build a $6 million project with only a million dollars out of project. Today, for that same project, banks are asking that you put up $2 million.

What does that do? If a group of developers had $2 million, it could build two projects last year. The higher the equity you have to put in, the lower the return on your investment. The strict guidelines the banks are going by for financing is dropping the return on investment. And the steel prices are driving up the costs of construction, which further enhances the decrease on the return on investment.

What really hurts with the way the steel is increasing is, when a guy starts a project, he can’t lock in his pricing because he doesn’t know what that building is going to cost until he gets his permitting done, the site work done. Even if he goes ahead and contracts the metal building, if he doesn’t need it for five or six months, the price could go up.

McHugh: Managing existing backlogs and bidding new work is difficult in the current steel market. When you are developing a mini project, it’s typically not a quick turn. Domestic steel guidance is only giving us a 45- to 60-day picture with changes to that guidance being made every day. Trying to hit a moving target can be frustrating for not only the contractors but the owners of the projects as well.

Owens: It’s certainly slowing it down. We have more than one factor; it’s not just the cost of steel. Deals were tight to begin with, but when prices go up, tight deals are no longer tight, they’re not feasible.

Wright: We’re going to find that out very quickly. There’s definite concern among the developers right now. Not only is just my scope of work, but there’s many other aspects of the project, such as the rebar that goes in the concrete, the electrical conduit, the sprinkler pipes. When you take all these things into consideration with these increases, we don’t really have a strong solid number we can attribute to how it’s going to affect the industry.
 
ISS: How has your company been affected?

Baragona: It hasn’t really affected us at all. It’s pretty standard to have price escalators in your contracts. The price increase generally gets passed on to the customer and we try to minimalize that as much as we can. We have not seen any projects fall off the board yet because of the price increases, but we’re still in the first quarter of what has potential to be a volatile cycle.

The other point to keep in mind is, at the end of the day, the cost of steel in the overall development cost of self-storage is not necessarily the make-or-break figure in the financial viability. As long as the cost increases aren’t overly dramatic, I don’t anticipate it having a traumatic impact on the industry. But if we see 10 percent in May, 10 percent in June, 10 percent in July and 10 percent in August, all back to back, then there’s a story there. We’re advising our customers that they need to be aware of some significant increases.

Boilini: As a roll-form manufacturer, we’re caught in the middle. We have to continue to buy, but there’s no price protection. We’re getting increases even if we’ve had an established purchase order. In the Texas market, we’ve had a 35 percent increase. We’re seeing increases in May production 13 to 15 percent. 

Cannon: I have developers backing out of projects left and right. We had 800,000 feet under contract. We have 500,000 square feet that we put on hold indefinitely. They can’t get the appraisal values higher. The banks won’t lend them the money. Basically, it is the United States steel suppliers; they can sell it over seas for more money because the U.S. dollar is so low. A lot of these projects that I’m building right now—they borrowed the money, bought the land, signed the contract, and they can’t get anymore money. They’re prices have gone up 50 percent.

Cordes:On our backlog. A lot of our jobs that we contract, we may not ship for four or five months. So our costs are going up, but that doesn't mean our pricing does. When we go back to our customers and want to raise our price, they tell us they’re going to put it out to re-bid. Then I take the chance on losing the job. I’d rather lose it than sell it at a loss. It’s a very uncertain situation right now. And because of the slowdown in the industry, everything is competitive to begin with because there are fewer places being built.

Parham: We have people who have to go back and see if it works. Cross Metal Buildings [a Parham Group company] is doing good business. But this is not just affecting the metal buildings, it’s also the roll-up doors. Just buying the doors for hallways and outside is a gigantic increase. Forty percent of the costs of a project is going to be steel, whether it’s doors, rebar or the steel components that go into a building.

Owens: We’ve had a slowdown in sales. We have a great backlog for a while. But the volume of quotes has dropped off significantly.

Wilkerson: Unlike in 2004 when non-residential construction was trending upward, attempting to get these types of increases in a down market has been extremely difficult. As steel continues to increase, conventional products like wood become an alternative construction product. In some of our markets, this definitely impacts our customer’s ability to close work. This, coupled with our customers trying to bid work several months out with no idea what impact the increases will have to their bottom line, makes it difficult at best.

Wright: Margins. It strictly comes to margins. We’ve priced these projects some time ago. Banks have approved these loans. We can’t sometimes—and don’t want to sometimes—go back and ask customers for more money. We’ve made the decision as a company to eat most of these price increases. It’s affecting our margins significantly. We’re hopeful that we’re strong enough that we will get through this.
 
ISS: What can builders and developers do?

Baragona: They need to try and anticipate some of those increases now. If you’re not building until summer or fall, you need to be aware these increases are coming and be sure you’re project is still viable financially. For example, you need to determine if there is a 50 percent increase in the costs of the steel buildings, does the project still work? So that if that moment in time arrives—and you hope that it doesn’t—you can still proceed with the project. If that’s not the case, you need to take a hard look at what you have going on.

Cannon: Absolutely nothing. If I keep raising my prices to reflect the price increases, it takes the developers longer to get a return on their investment because they can’t charge any more rents because of the way the economy is going. I’ve been in the business for 30 years and I’ve seen it before. Until the steel prices come back down, which they’re not going to, developers are going to stop building. It doesn’t make economic sense to continue to build mini-storages. It’s going to come quickly.

Cordes: Developers need to go into it realizing they need to put a contingency in their pro forma for escalating prices. Builders need to put it in the contract with the developer that prices could change from the contract based on raw material increases. However, they have to be documented. You have to put in an escalation cause, but you have to tie it to some kind of index that is believable.

McHugh: Open communication between the builders/contractors to the owners and from the owners to the banks as to the reality of the current market is crucial. We see a lot of folks gambling right now, hoping it will come back down quickly as some of the cycles have shown in the past. I think the market is finally realizing the magnitude of these increases.

Right now, the trends show the increases will continue. Today, most manufacturers are keyed in on the price and availability at the time of shipment, and not on giving numbers on bid day with extended “good-for” dates. It’s hard to hold a number when the target is moving as fast as the steel prices are moving today.

Contractors can only base their bids on the best forward-looking information they have at the time, and insert verbiage that gives them some opportunity to look at it again when a ship date is established. If they lock them down to a number with the current volatility in the steel market, it could create expectations that cannot be met at the time of shipment. In that situation, no one wins.

Owens: I try to paint the bright side as opposed to the dark side. The biggest consumer of steel in the United States is the automobile industry. A slowdown in new cars should bolster steel supply to other areas. The interest rates are very attractive. Construction money is cheap. The availability of low interest money is there. I’m hoping toward the end of the year, we’ll see land prices readjust; so if they come down some, that should help the tight project better.

Lastly, when you have the volatility in the financial markets like we’re seeing here today, people get nervous and start pulling their money out of the market. When they do that, they have to find someplace to put it. Typically, a good place to put it in a repressed real estate market is in real estate because there are some good buys out there. Self-storage is still a good investment. If we have some strengthening of the dollar and more availability of steel and little bit of luck, it still looks positive.

Wright: Educate themselves within the industry with contractors such as ourselves. Be somewhat conservative when they’re putting together their feasibility study and pro forma as far as the overall construction costs.
 
ISS: What’s expected in the next the months?

Cordes: Some of the smaller guys are going to have trouble riding this out. They’re going to have to cut back and hold on. And the people who can’t hold on are going to be bought by someone bigger or go by the wayside. It’s going to be very competitive. There’s going to be a lot of uncertainty.

McHugh: Current indications are that steel will continue to rise through mid-summer. After that, it is anyone’s guess. As domestic prices get more in line with the world market, hopefully prices will begin to stabilize. It looks like this trend is not going away anytime soon.

Parham: It’s going to have an impact and slow the industry down some. I hope the government will figure out that something is going on. I hope it will stabilize. Normally, the market will take care of itself. If it’s subsidized by the government, you’re taking that part of free enterprise out of the market. When you do that, that’s what causes these kinds of problems.

I have never seen a marketplace where there was free enterprise and free competition that failed. We’re going into a period of economics and the way the government is getting involved that I’ve never seen before. I see a big slowdown, which is already starting to happen, over the next to six to eight months.

Wright: What we think is going to happen is these steel companies will take full advantage of this current marketplace. They’ve created somewhat of a supply issue themselves. What I think will happen, come fourth quarter this year, hopefully fuel and oil will come down a bit and that offshore market will be one our vendors can seek again to keep our domestic suppliers honest.

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