In a time of continued construction growth, with new development popping up seemingly everywhere, it’s no surprise construction costs in the market have been increasing. Global brokerage group CBRE debuted a multi-part series on the state of the construction industry that examines cost and trends across the United States. And the conclusion is definitive – construction is only getting more costly as demand for multifamily housing units grows, the cost of materials continues to rise, and the supply of labor tightens.
Unofficially dubbed as the city of cranes, with 62 currently piercing the skyline, Seattle is booming with construction. Yet, the pace at which the construction costs are increasing in this market is actually lower than the national average. The report found that over the past five years, from 2011 to 2016, Seattle had an increase in construction costs of 9.9 percent, surprisingly lower than the national average of 11.8 percent.
Given significant expansion in the technology sector in this cycle, these markets have been among the leaders in terms of both rent growth and construction activity
These measures excluded the cost of land as well as compliance and regulatory requirements that will likely differ greatly between markets.
Looking at Seattle’s year-over-year change in construction costs, the city had a 1.7 percent increase from January 2015 compared to January 2016, which again, was lower than the national average of 1.8 percent during the same time period. But other major markets such as Atlanta (3.8 percent), Los Angeles (3.5 percent), San Francisco (2.6 percent), Chicago (2.5 percent), Portland (2.4 percent) and Houston (2.3 percent) all had outpaced Seattle’s growth in construction costs.
While the report indicated that the price of some construction materials had decreased, it pointed out that materials is just one driver of overall construction costs. Labor tends to have a larger impact on overall cost trends over time, according to the study.
This was perhaps the report’s biggest takeaway; the size of the construction workforce is below pre-recession levels, which has led to labor shortages in major markets. The report stated, “In addition to the impact of metro-level variation in cost of living, minimum wage, union representation and other factors, metro-level differences in local construction labor rates stem largely from the current supply-demand dynamics within a given market.” Nationwide, the number of workers employed in construction-related jobs declined by 15.8 percent, or about 985,000 between 2005 and 2015. Consequently, many markets have faced considerable labor shortages as new construction has picked up during the current economic cycle.
Looking at new trends affecting the office construction industry, researchers found that office construction has been largely concentrated in gateway markets as well as those with tech or energy driven economics. The amount of space under construction is highest in those tech epicenters, especially in Seattle and California markets such as San Jose and San Francisco. Other locations with increased construction activity are energy driven markets as well as those with strong or emerging live, work and play environments.
The report also notes that the relationship between rent growth and construction is likely to shift in several markets. As we approach the later stages of market expansion, it is likely that construction may subside given that some of these rents cannot be sustained forever and fewer projects may break ground.
“Given significant expansion in the technology sector in this cycle, these markets have been among the leaders in terms of both rent growth and construction activity,” according to the report. “However, a pullback in venture capital funding, lower valuations for tech company IPOs and rising sublease space could all weigh on rent growth and new construction going forward.”
While rent growth has constrained development activity, overall rent growth has been slow to recover due to the densification trend and backfilling of space vacated during the Great Recession. Finally, the report found that “Office construction is occurring but on a more limited scale than in prior cycles, both in terms of the total square feet delivered and the number of markets with new development activity.”
Though the report found that the pace of rent growth in the office market has helped shape development patterns, other factors are at play. “Development is being driven by other factors, such as a shortage of large blocks, tenant requirements for more efficient and adaptable space, the emergence of new submarkets and local economic incentives.”
Overall, rental rates are approaching replacement costs in a growing number of markets, especially in CBDs. “As replacement costs increase at a faster pace than market rents, development activity is expected to cool,” according to the report.