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In the pipeline: These 4 construction conditions are cementing multifamily industry trends

Four factors in the construction industry are undergirding an expensive multifamily market

All signs point to a multifamily market that is cementing into stable growth. Rents are rising at a more sustainable rate than they have in recent years; capital is flowing into the industry; construction is tapering off to a sustainable level; and demand is strong.

These are great signs for investors and developers, but they also signal continued exacerbation of the affordability issue. While slowing rent growth should also slow the growth of the affordability issue, it won't do anything to solve the issue. 

In talks with industry professionals, it appears that the source of the affordability issue is a lack of affordable units, and the source of the dearth of affordable units is the cost of building an affordable project.

We did a little digging, and according to experts in the construction and multifamily industry there are four main factors pushing up the cost of construction and propping up rent growth:

  1. The focus on high-rise, urban-core product
  2. Natural and artificial growth in commodity prices
  3. Labor costs
  4. Inexperienced builders

Dominance of the urban core

For the last few years, the lion’s share of the increase in U.S. apartment units has been consolidated in urban cores (think San Francisco, New York, Chicago). Typically, these projects cost more because of their size, location and material makeup. According to Dodge Data and Analytics Chief Economist Bob Murray, this is the root cause of the overall increase in price per project.

“I think really the big element of the current multifamily upturn is that it has been dominated by activity in downtown metropolitan areas…What’s happening is a continuation of the focus as far as the activity being in downtown areas, means that the steel component within multifamily housing–typically because you’re talking about high-rise structures in many cases–is causing the overall cost of multifamily projects to rise,” Murray told HousingWire.

“The fact that multifamily housing, in this particular cyclical upturn, has been dominated by downtown high-rises, more so than in the prior decade, I think it makes it more vulnerable to increases in the price of steel,” Murray added.

Rising commodity prices

Now, some say that the threatened tariffs on steel are to blame for the rise in multifamily construction costs, but according to Murray, the cost of steel was on its way up long before the Trump administration started waving steel tariffs around.

“When you look at the producer price indexes for steel, back in 2016 it was down 4% whereas in 2017 it was up 13%, if I use a full-year to full-year basis, and there have been other increases that have taken place in 2018,” Murray said.

“The rise in metal prices…that price increase was already taking place prior to the announcement of tariff increase,” he added.

According to Murray, the tariff situation has actually been watered down, because some U.S. trade partners such as Canada and Mexico, have been exempted from the tariffs pending the renegotiation of NAFTA.

On top of that, Murray noted that the American Institute of Steel Construction says the U.S. has enough steel producing capacity to supply the estimated multifamily pipeline of roughly 600,000 units.

“Yes, I’d say tariffs may be having some of a contributing element to higher metal prices and higher steel prices, but it’s not the only thing,” Murray said.

However, within the last few days, global trade tensions have been building rapidly as the U.S. steel and aluminum tariffs begin to take effect. The EU announced it is triggering a dispute settlement case against the U.S. with the World Trade Organization over these tariffs.

Canada is crying foul; Mexico is promising retaliation; and the World Trade Organization is expressing "very real concern" over global trade tensions. The price of U.S. steel is bound to rise as these tariffs put a major chill on imports of steel and aluminum.

In the case of lumber, which affects the construction of mid-rise and low-rise apartment communities much more than high-rise communities, tariffs, namely the ones on Canadian lumber, have a much larger effect on the price of low to mid-rise product (i.e. suburban projects).

For Summit Contracting Group, a group that builds mostly low to mid-rise communities and the number one contractor in the nation by number of units started in 2017, according to the National Multifamily Housing Council, increases in the price of lumber take a big toll on their budgets.

According to Summit’s lumber supplier, the amount of lumber Summit purchases each year can be stretched from Florida to Oregon if converted into 2×4’s. That’s billions of board feet for just one builder out of the many in the U.S.

“That’s a lot of lumber,” Summit President and CEO Marc Padgett told HousingWire with a laugh. No kidding.

What those billions of board feet translate to in dollars for summit is roughly $1.5 million to $2 million per project in lumber costs. No labor, no concrete, no wiring, just lumber.

The tariff war between the U.S. and Canadian lumber industries has been going since the 1980s, and right now it is at a fever pitch, just below the all-time peak back in 1993.

Labor shortages

On top of climbing commodity prices, for reasons natural and otherwise, there has been a shortage of labor since the housing crash in 2008, and construction wages have been on the rise.

Now, the labor shortage is interesting in that it does not touch every developer equally. Construction wages have been going up, but contractors’ quotes for jobs vary greatly depending on the relationship they have with the developer.

“When the recession hit, a lot of the labor left the industry, and it’s been slowly coming back,” Padgett said. “We haven’t seen it that bad. We’ve done a lot of business with our relationships that we’ve had, 10, 15, 20 years, and their sub crews are pretty loyal to them, so we probably don’t see it as bad as some of the industry does."

For Summit, the formula for construction cost goes like this: experience + relationships + buying power = total cost.

Companies without the relationships and experience of buying power to leverage end up spending more on construction, which in turn leads to higher rents.

Inexperienced players in the market

Because the multifamily market has been on fire, newcomers of all sizes have tried to throw their hats in the multifamily ring to cash in on some units.

Padgett said the Summit team has been seeing an influx over the last few years of newcomers trying their hand in the multifamily space and making rookie mistakes that cost them. This could be anything from not knowing how to properly design a project to using the wrong materials.

One of the things that leads to a higher construction cost is not knowing exactly how long a project will take. This leads to higher quotes from contractors and subcontractors and more time spent on jobs where there are inefficient building methods in use. This leads to a larger construction budget than more experienced developers typically don’t suffer from.

Add these four factors together, and what you’ve got is continued added upward pressure on rents.

Going forward, it doesn’t look like anything will change since demand is strong and constraints on supply are significant.

“I just don’t see it slowing down much,” Padgett said. “Will there be a valley? Sure. But will there be a big, huge overnight drop like we saw in the recession? I don’t think so.”

Buckle up America, the multifamily market isn’t going anywhere but up…slowly.

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