Although most industry experts expect demographic demand to support the increased level of new apartment development, rising construction costs are beginning to force developers to tap the brakes on some new construction.
The extent of cost inflation on both materials and labor varies widely by market and even region. Some of the increases trace directly to big jumps in materials prices; for example, one developer said lumber prices for his company jumped 45 percent in the past year. However, a lot of the increase is due to higher labor costs. Not only is a scarcity of high-quality labor driving up the costs, but growing demand is allowing subcontractors to put a premium on their services, helping recover margin lost during the lean days of the recession.
For example, Clyde Holland, CEO of Holland Partners, which builds in seven markets in the West region, said he’s seen construction costs over the past year rise by 1.0 percent to 1.5 percent a month-a growing concern given how little wiggle room today’s deals already have. Given this pace, he’s expecting an additional increase in construction costs of 5 percent to 9 percent across his portfolio from 2013 to 2014
And costs could get another boost as single-family construction ramps up, creating additional demand for materials and labor.
“What concerns us is that we’re seeing all this increase without single family really hitting the gas,” Holland said, noting that as AD&C financing for single-family construction began flowing freely again at the end of 2012, a lot of land has been moving through permitting and entitlement. He’s expecting single-family builders to have a significant number of lots ready for vertical construction this summer.
“We’re going to pull our production down 25 percent, and we think we could see a cost spike when single-family inventory hits,” he said.
Ron Witten, president of Witten Advisors LLC, said rising costs were one of the reasons his forecast for multifamily starts was a little below the industry’s historical benchmark of 300,000 new units annually.
“Our forecast shows starts running up again this year and stabilizing. Our model has replacement cost inflation built in,” Witten said. “It’s in the high single digits, so not as much as 1.0 percent or 1.5 percent a month. But that’s the reason starts stabilize. That’s the governor, the lid, if you will, that keeps us on the 250,000 starts pace.”
MPF Vice President of Research and Analysis Greg Willett agreed. “After this first wave of development, the second wave will be smaller just because you can’t make the deals work financially.”