SPECIAL FOCUS >> RISING CONSTRUCTION COSTS

Construction Still a Pain in the Wallet

BY BENDIX ANDERSON

AFFORDABLE HOUSING FINANCE • OCTOBER 2007

As the single-family housing market began to tank last year, many developers expected construction costs for apartments to drop. But prices for labor and materials are still rising faster than inflation, and that pace of growth shows no signs of letting up, experts say.

“It’s killing us,” said Mike Costa, president of Simpson Housing Solutions, an affordable housing developer based in Long Beach, Calif. Several of Simpson’s projects ran as much as 15 percent over their construction budgets. The company now budgets for cost increases of 10 percent or more a year.

Rising construction costs are especially hard on affordable housing developers like Simpson. Many market-rate rental developers benefited this year and last from rising rents that helped them cover higher construction costs.

But the rents at affordable housing projects are limited by the local area median income, Costa said. And the major sources of these developers’ capital budgets, like the amount of equity generated by the sale of low-income housing tax credits, have often been set years in advance. When construction costs rise, there is often little room to bring in new money.

The construction cost increases are a bit counter-intuitive. As the housing bubble burst, housing starts dove to reach a seasonally adjusted annual rate of 1.4 million in July, down from 2 million in 2005. That decline represents a decrease in demand for construction materials and labor that would seem likely to dampen prices.

Instead, the cost of new multifamily construction rose 2.7 percent over the 12 months that ended in July, according to information from the U.S. Bureau of Labor Statistics. The increase isn’t as bad as last year’s 8.5 percent jump, but it’s still above inflation as measured by the overall consumer price index, and it’s a huge disappointment to developers who hoped prices would fall.

The problem is that even as demand from the housing industry for materials and labor has shrunk, commercial developers and builders overseas have picked up the slack.

An appetite for metal

The rapid transformation of China into an industrial superpower has fed an insatiable appetite in the world’s most populous country for concrete, steel, and other metals. That’s pushed up prices here in the U.S.—especially for metals like copper, according to developers like Walter Zisette, vice president for Mercy Housing, based in Denver, Colo.

Meantime, U.S. developers spent $346.6 billion to construct non-residential projects in June 2007, a 17.4 percent increase from the prior year, according to the most recent numbers from the Commerce Department.

Prevailing Wage Laws May Spread

The New York State Association for Affordable Housing (NYSAFAH) warned its members in May that labor advocates are beginning to pressure state legislators to apply prevailing wage regulations to affordable housing projects.

The regulations dictate that builders of public works who receive certain kinds of subsidy must pay construction workers prevailing wages set by government officials. The wages are often close to local union wages.

Affordable developers, who often do not use union workers, say that prevailing wage laws add up to 30 percent to the cost to develop affordable housing.

The Davis-Bacon Act, the federal prevailing wage law, doesn’t affect developers who use indirect subsidies like low-income housing tax credits.

In California, many affordable housing developers like Simpson Housing Solutions avoid programs like the state housing tax credit, which would trigger the state’s prevailing wage law. Since 2005, California projects that receive federal housing tax credits do not trigger the state law.

In the New York Legislature, no bills pertaining to prevailing wage have yet been proposed, although housing advocates like NYSAFAH are already mobilizing to oppose them if they appear.