Development Industry Coming To An End Due to Rising Construction Costs

How can any ground-up multifamily developer start a project in the next 3-9 months? Rents are not rising as fast as construction prices. The mills are not taking orders for lumber until Q3 22' so no trusses on a job until Q1' 23'? Concrete, steel and gypsum at all-time highs. Limited labor in key trades MEPF, glazing, and roofing. Conclusion...if demand does not continue to grow then property values drop 20%-30%...if demand continues existing inventory will increase in value 15%-20% because it is too expensive to build new. Thoughts?

Comments (21)

Jan 12, 2022 - 3:54pm

You're not wrong. Good 'ole US of A is so innovative and dynamic with low interest rates and flush investment funds that people are ploughing money into preexisting structures with obscene cap rate compression. Change? Yes. We. Can. 

Jan 12, 2022 - 4:26pm

MF construction estimates & preconstruction schedules are a disaster right now.  In addition to all of the issues you outlined (very accurately), the labor shortage will only get worse.  Due to 'rona boi, a lot of retirements within the trades are on an accelerated pace and the apprenticeship/junior pool of bodies can't keep up (this is the whole Mike Rowe soapbox speech).

The one caveat is that other "hot" asset classes in high barrier to entry markets continue to surge.  A great example is the life science / lab sector in the Northeast (especially Boston and Cambridge).  Major institutional capital continues to pour into the space and projects are still finding a way to break ground on spec.  Sure the price to build continues to climb, but the lease escalation continues to keep pace (for now)

  • Developer in RE - Comm
Jan 12, 2022 - 4:48pm

I was quoted $300K per door to build TH multifamily style development... two years ago we did a similar deal at 170K per door.  On an office deal, also saw cost go up abour 40% in 3 years.  You can also assume caprates will stay low and/or inflation is real!  It's not your f**king money, once you get over that, you will sleep better at night and enjoy the dance while you have a job.  Sadly, CRE can be a ruthless business.

  • Developer in RE - Comm
Jan 12, 2022 - 6:20pm

That shows up in timing of land contribution and preferred return if you get developer terms.  We are in a time value of money business.  If you buy land month ZERO and start to pay interest then overall deal costs go up.  If you have a pref and you buy all cash, even gets more expensive.  Reason why larger deals are sometimes more expensive from a financing perspective if you assume market absorption.  Longer time line and slower absorption as a percentage of total.  All about knowing where you can get aggressive or chill due to equity partners!

Most Helpful
Jan 13, 2022 - 10:52am

Right now it's sustainable. Rents are up big time in sunbelt markets, cap rates have compressed 100 bps or more over as short as a 2 year period, and the increase in construction costs points to future competitive supply tapering a bit. At a certain point, though, the YOY inflation we are seeing in construction costs of 5-10% will outpace the rent growth and compression, though. Hard cost inputs are like 70% of most development budgets so this is starting to smoke the numbers.

In our experience, development yields are definitely down ~25 bps because of this issue but we are still building to the same development spread because of cap rate compression. Once that balance is thrown out of whack, different story. 

Jan 13, 2022 - 3:15pm

Pretty much this.

Another big factor is your land basis. If you're getting the land at a steal then you can easily still make deals work in secondary/tertiary markets.

In primary markets and for high rise product it's definitely getting much harder, and pretty much impossible in some markets.

Jan 13, 2022 - 12:30pm

Or you need to build in locations where municipalities are willing to be very generous with subsidies. Surprisingly, when I talk to cities they understand the macro picture better than you would think. We've been able to offset a lot of the increases in construction costs through more public $'s. 

Jan 13, 2022 - 12:59pm

Where are you developing, and what are you building, that municipalities are subsidizing? We do conventionally financed multifamily in the Southeast and every year it feels more and more like the Northeast and West Coast types are infiltrating... it's knives and pitchforks out at zoning hearings.

Jan 13, 2022 - 3:27pm

Does anyone have any flex duct?

We just had the power company delay getting power to the site for 6 consecutive months. Generators are expensive...

Replace Cost is the real valuation metric. 

“Capitalism: God’s way of determining who is smart and who is poor.” Ron Swanson

Jan 14, 2022 - 10:50am

fromPhilly2Miami

How can any ground-up multifamily developer start a project in the next 3-9 months? Rents are not rising as fast as construction prices. The mills are not taking orders for lumber until Q3 22' so no trusses on a job until Q1' 23'? Concrete, steel and gypsum at all-time highs. Limited labor in key trades MEPF, glazing, and roofing. Conclusion...if demand does not continue to grow then property values drop 20%-30%...if demand continues existing inventory will increase in value 15%-20% because it is too expensive to build new. Thoughts?

All I hear is crying that it isn't as easy to hit home run deals as you want it to be.

No such thing as a free lunch.  Development is a high risk business, which is why developers get paid a lot.  If you want something safe, go work 100 hour weeks on Wall Street

Jan 14, 2022 - 4:34pm

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