Within one week, two trusted contractors called developer Brian McGeady with troubling news about a pair of his affordable housing projects. The messages were similar: We can’t pin down our subcontractors to give us a number they’re willing to stand behind.
The phone calls showed just how volatile construction costs have become in the last several months.
“Going back a year ago or even nine months ago, many of the increases were in lumber,” says McGeady, a managing partner at West Chester, Ohio-based MVAH Partners. “It wasn’t all lumber, but that was the vast majority. Now, it is literally every trade and their materials.”
Rising development costs aren’t new. Developers have been grappling with those for years. What’s different is how tumultuous the market has been, with prices increasing not only sharply but quickly, according to several developers.
“It’s moving fast,” says McGeady, who received construction cost estimates for two Ohio developments in November. Two months later, he was hit with revised costs that were $750,000 and $500,000 more, respectively, on top of increases that happened earlier.
This is not a singular developer, owner, or contractor issue but a widespread problem, he says.
LDG Development, one of the nation’s largest affordable housing developers, was about to close on the financing for a new project when building material increases wrecked the budget last year. The Louisville, Kentucky-based firm made changes to make the deal work. However, when it tried to get bonds, the financing was no longer available, says co-principal Chris Dischinger.
Other experienced and sure-footed developers also report sizable gaps in project budgets that penciled out just a few months earlier. One developer estimates that prices have shot up 20% to 30% in the last four months.
Skyrocketing Costs
Here’s a look at some of the trends. Building material prices soared 20.3% year over year and have risen 28.7% since January 2020, reported the National Home Builders Association (NAHB) in February. The costs were driven by a 25.4% jump in softwood lumber prices and 9% price increases for indoor and outdoor paint.
The NAHB has estimated that lumber prices have caused the price of an average new single-family home to increase by more than $18,600 this year. This lumber price hike has also added nearly $7,300 to the market value of the average new multifamily home.
Yes, lumber prices declined for a brief period last year, but they’re surging again. Officials cite several reasons for the high prices, including strong construction activity amid the demand for all types of housing, ongoing supply chain disruptions that go back to the start of the pandemic, and a doubling of tariffs on Canadian lumber imports to the U.S. market.
NAHB has urged lawmakers to suspend duties on imported building materials, from Canadian softwood lumber to Chinese steel and aluminum, and to seek solutions to the supply chain bottlenecks.
For affordable housing developers, the conditions today are unlike those seen in prior events. For example, it’s different than the Great Recession when developers saw low-income housing tax credit (LIHTC) prices plummet. Back then, the prices fell sharply, but then the market settled down for a period of time. Everyone was able to adjust to the new conditions before prices gradually climbed back up.
These days, it’s much more turbulent. Not only is it difficult to put together a budget, it’s challenging to even get materials.
Items that have been elusive have included cabinets, insulation, wood trim, and fiberglass tubs and showers, says R. Scott Ewing, partner, chief construction and architecture officer, and executive vice president at Plymouth, Minnesota-based Dominium.
In some cases, Dominium has helped contractors with deposits in order to hold down prices and to make sure they get needed products.
When the COVID-19 pandemic started two years ago, people were hit with delays in getting materials. It’s not getting easier, but builders are doing their best to adjust.
“They know that I can’t call in my order for my next 60 units of appliances four weeks out. It has to be six months out or eight months out,” Ewing says. “I have to be planning that way, and I need to take them when they come. There’s no turning around a truck to come back a week later if you are not quite ready. It will just go to some other project.”
Pennrose, another top affordable housing developer headquartered in Philadelphia, has a development that’s nearing completion, but it’s waiting for cabinets to arrive, which may delay the project opening for a month, says president Tim Henkel.
There are no silver bullets to these problems. When delays or budget gaps surface, developers have to look at both cutting costs and raising more money.
“You’re really looking at all kinds of different solutions,” McGeady says. “Almost everything is on the table to try to get across the finish line.”
Developers can revise their projects and cut items from the budget, but that’s difficult to do because plans may have been approved and certain building features are required.
They may also consider adjusting the debt-service coverage ratio and different cushions that were built into a budget, but that could potentially weaken the deal. “It doesn’t make them bad deals, but it could make them a little more vulnerable to whatever might come next,” Henkel says.
A development team can also go look for more soft money, but that’s also difficult and time consuming when the clock is ticking with deadlines to get projects moving. While states are working in all kinds of ways to provide new and different sources, those programs are heavily subscribed and many are not immediately available. The Build Back Better bill could have brought some new resources to the table, but that legislation has stalled in the Senate.
“Within the industry, some deals are going to slow down dramatically, some will close without the fiscal health you would like to see them have, and some deals may sit and wait,” Henkel says.
Housing Finance Agencies Take Steps
Some state housing finance agencies (HFAs), which award LIHTCs as well as other financing to affordable housing projects, have been taking action to help. Developers hope more agencies will soon follow because they fear that the problems will get worse before they get better.
Rising development costs have been on the radar screen of the agencies for several years, but it has emerged as a bigger problem in the last six months, says Stockton Williams, executive director of the National Council of State Housing Agencies.
“In the first quarter of this year, a number of states have seen costs go up significantly,” he says.
The agencies have taken a range of steps, including providing additional LIHTCs to developments with documented hard cost increases, allowing developers to access credits across multiple funding rounds, and tapping other sources such as housing trust funds, according to Williams.
For example, the Michigan State Housing Development Authority amended its LIHTC program to allocate additional credits to developments that had experienced extraordinary construction cost increases and supply chain issues.
The Ohio Housing Finance Agency (OHFA) also approved a policy last year that allows developers awarded credits in 2019 and 2020 to request up to $100,000 in additional tax credits and up to $1 million in additional housing development loan funding. The requests need to outline how specific cost overruns related directly to increased materials and supplies have negatively affected construction timelines.
For the 2019 and 2020 9% tax credit rounds, OHFA received approximately $2.83 million in additional tax credit requests from 33 projects. The cap for the additional tax credits was $4 million.
In addition, a second addendum to the 2020-2021 qualified allocation plan was approved in January, which allowed for projects funded in 2021 to apply for additional tax credits. So far, OHFA received 23 requests totaling approximately $2.26 million in additional credits, said officials in February.
The agency was not anticipating updating the policy for projects funded in 2022.
NCSHA is also working with a number of its members to try to find additional funds and not just move existing resources around. One opportunity is state and local fiscal recovery funds, says Williams, noting that the $1.9 trillion American Rescue Plan Act included $350 billion of state and local aid.
“These funds can be used pretty flexibly,” he says, but they can’t be used optimally with LIHTCs, so the affordable housing industry is working with the Treasury Department and Congress to make technical fixes to facilitate the use of the funds with the LIHTC program. Specifically, it’s inefficient if the relief funds come into a deal as a grant because federal grants reduce the “eligible basis” in a LIHTC development, essentially reducing the amount of credits that a project is eligible to receive. Industry leaders say this can be resolved if the federal relief funds can be used as long-term loans.
HFAs also have been interested in opportunities to drive down construction costs through improved processes and new technologies such as prefab design. Several agencies have pilots encouraging innovation. While that’s important for the long term, the trouble is the benefits of any new approaches aren’t going to show on a large scale anytime soon.
Meanwhile, today’s projects are becoming harder and harder to do.
