Historic Construction Cost Jump Fuels ‘Most Volatile Issues of Our Time’ in Apartment Development

A shortage of construction materials such as steel and lumber has caused multifamily development costs to inflate to historic levels, pinching the pocketbooks of builders who are beginning to pass these added expenses on to renters and investors.

New data from Skender, a Chicago-based construction firm, lays out just how much the costs of materials used in every kind of commercial real estate construction have risen. The steepest hikes were measured in refined petroleum products, such as gasoline and asphalt. Between April 2020 and April 2021, those material costs rose a whopping 143.2%, according to the data. The cost of lumber rose 89.7% in that same time, and steel products are up around 70%.

“Everybody recognizes that what’s happening is kind of unprecedented,” Joe Pecoraro, a project executive on Skender’s multifamily team, told CoStar News in an interview.

The pandemic supercharged the cyclical nature of the cost of commodities used in the housing and construction market, leading to record-high pricing for materials such as softwood lumber and steel for multiple consecutive months this year, according to the National Association of Home Builders.

Pent-up demand for raw materials built up in 2020 as mills and factories shut down, stopping production and decreasing overall supply. Meanwhile, demand increased for larger homes as many remote employees no longer needed to stay in smaller apartments near offices and developers kicked off a flurry of construction projects to address housing shortages around the nation.

Now, home prices are skyrocketing to record highs and younger Americans are gravitating toward housing options with more flexibility and affordability, causing apartment demand in the United States to soar. Nationally, multifamily rents are growing at a pace that would equate to the strongest apartment rent gains this century if maintained throughout the year, a recent CoStar analysis shows. And the national apartment vacancy rate is roughly 6%, according to CoStar, which is stronger than the market’s pre-COVID levels.

But with construction costs having risen to high levels and the labor market struggling with both significant unemployment and an inability to fill jobs, it’s a tricky environment for apartment developers.

In April, the National Association of Home Builders, a group that represents people and businesses in the home development industry, found that the rising cost of lumber alone added nearly $13,000 to the market value of multifamily units, translating to renters paying an average of $119 per month more to rent a newly built apartment.

“One of them has to take the hit, and a developer wants to stay in business,” Mario Lopez, vice president of development and construction at Los Angeles-based real estate investment firm CGI+, said of developers passing on the costs to renters.

The report also found that the lumber shortage had caused the average single-family home price to rise by $35,872.

‘Huge Issue in Our Business’

The material shortages could have been caused by several things, including the backlog in material production brought about by the pandemic, as well as the flurry of home construction underway right now and how many raw materials are needed to build new homes. Steel mills were slow to ramp up to pre-pandemic production levels, and lumber flew off the shelves as consumers renovated homes.

Pecoraro said that, in some cases, materials that would have been quoted at a six-week delivery time a month ago are being quoted as taking as many as 18 weeks to arrive.

“The cost of construction is a huge, huge issue in our business,” Neil Schimmel, CEO of Los Angeles-based Investors Management Group, told CoStar News in an interview.

Investors Management Group is a multifamily investment and asset management firm that owns and manages more than 4,000 apartment units around the country. Schimmel, along with Karlin Conklin, co-president and principal at IMG, said that rising construction costs have dramatically affected the cost of a standard apartment unit renovation, a common practice for many multifamily investors looking to make a new property more profitable.

For example, an apartment unit renovation that might have cost $6,500 is now being quoted at as much as $8,500 or $9,000, Conklin said. But instead of, say, reducing the amount of investments or renovations IMG is making, Conklin said the firm is more or less communicating with investors to expect lower yields, as the industry works its way through the material and labor shortage.

Schimmel also said the firm is considering more new or recently built apartment properties. By buying new instead of buying a property that would require a significant upgrade, IMG can somewhat avoid having to be subject to the shortages of lumber, steel and other materials used in a major unit renovation.

“We’re not going to play into some of the most volatile issues of our time right now,” Schimmel said.

Lopez said that one way developers can keep their heads above water is by working with contractors who are willing to estimate how much certain material costs are going to rise, so the developer can at least try to order some materials early or lock in the cost of the labor.

“Every developer and contractor is trying to play the market and figure out when the right time is to purchase materials,” Lopez said in an interview with CoStar News.

There is some light at the end of the tunnel, though: The contractors that Lopez works with are predicting that these material costs will go down in about a year, he said. And with the nature of the challenge being tied to the supply chain, rather than to a certain kind of construction or development firm, executives can at least take some solace in the fact that, broadly speaking, nobody’s immune to the cost hikes.

“If anyone says, ‘It’s fine, there have been no issues,’ they’re blowing smoke,” Pecoraro said.

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