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The Trajectory Of Construction Costs Varies Depending On Where You Are And What You're Building

U.S. construction costs are expected to decline 2% to 5% on average in 2020, a major twist from the escalating prices recorded in the years leading up to the coronavirus pandemic, JLL said in its Q2 2020 Construction Outlook report. 

But prices are not declining everywhere, and there's a significant amount of divergent data in the market when it comes to the trajectory of construction prices. 

“It’s definitely not one story all across the country. It depends on where you are, what sector you are in and how that sector has been impacted by the pandemic,” JLL Construction Research Analyst Henry D’Esposito said. 

“Everything has been much more volatile in 2020 than anyone expected, so the story is playing out in a thousand different ways depending on exactly what you are working on.”

Prior to 2020 and the pandemic, construction costs remained on an inflationary and painful trajectory. 

An October 2018 report from CBRE found prices were rising exponentially for construction-related commodities that relied heavily on imports, with lumber up about 15% from the year before and iron and steel up 13%. 

In 2019, costs remained a primary concern for the industry, with ULI's Emerging Trends in Real Estate 2019 survey showing that on a scale of one to five, five being the important issue, construction costs ranked 4.59 in a survey of what issues were worrying the minds of the industry. 

Construction costs are affected by two things: materials and labor. Market reports say prices are falling as the construction labor workforce takes a haircut while workers who once observed a steady stream of projects face longer timelines and wait-and-see approaches by developers amid the pandemic. 

“Labor costs have been a bit volatile over the past six to nine months, [especially] since the pandemic started,” D’Esposito said. “Really, what we have seen is that the labor price quote has slowed down from where it was in 2018 and 2019 and even in the years prior.”

Construction employment fell 10.8% from the first quarter to the second quarter of 2020, while average hourly wages fell 1.1% for the same period, JLL said. 

But that isn't universal. Construction firm KWA anticipates reduced construction costs in the future given the national slowdown from the coronavirus pandemic, but so far, no such reductions have materialized.

“Due to supply chain issues, and other factors outside of [our] control, we have yet to see reduced labor costs in our market,” KWA President Brian Webster said in a statement to Bisnow

On the other side of the equation, raw material prices are volatile and don't tell a single story. Since the pandemic, lumber prices have been inflating, though prices for metals such as steel are down, according to JLL.

For many in CRE, that has resulted in an overall increase in construction costs over the last few months. A survey of commercial real estate professionals conducted by Bisnow in August found that 54% of the respondents have witnessed the coronavirus disruption pushing up the cost of construction materials, while 28% have yet to see increases but expect them at some point. 

“I think the difference of whether you see the costs going up or going down is completely dependent on what materials you are talking about, especially with the trade wars going on right now with China, the pandemic and a shortage in materials,” Dallas developer Scott Beck with Beck Ventures told Bisnow. 

Beck's commercial real estate projects generally use more steel and metal than wood, but his team sees the impact of escalating lumber prices when installing wood finishes within project interiors.

An executive with a national supplier of construction materials said lumber is being purchased and sold at off-the-chart, record rates. 

The executive blames escalating lumber prices on a sharp reduction in supply capacity after the coronavirus hit. When the virus first brought uncertainty to the market, mills and lumber suppliers began to cut back on production and capacity inventory, believing there would be a downturn in construction demand and supplies. Yet, just a few months later, pent-up demand for single-family homes pushed lumber demand back into overdrive, leading to inadequate supply.

Prices for raw lumber and plywood in June rose 4% from year-ago levels, while steel mill products, copper pipe and aluminum sheet were down 14%, 15% and 22%, respectively, JLL said. 

Beyond material selection, where a project is and what type of property it is can impact construction costs. 

“In some of the bigger, urban Northeast markets, for example, which are very highly dependent on public transportation or on people getting into the city via the metro, subway or bus, there is less demand for new work there as people come back to the office much more slowly in these markets,” JLL's D’Esposito said. 

The slowdown in these urban, hard-to-reach, dense markets tends to push local prices down, D’Esposito noted. 

Meanwhile, tertiary suburban markets in less dense areas that are now in vogue for the natural social distancing measures they provide are not seeing the same slowdowns. 

Construction prices edged up in several markets in Rider Levett Bucknall's Second Quarterly Cost Report for North America. The report shows Los Angeles construction prices growing 2.18% from Jan. 1 to April 1, while Boston, Seattle and San Francisco saw price increases of 1.26%, 1% and 0.9%, respectively, RLB noted. 

In Dallas-Fort Worth, Beck sees the prices on his projects remaining mostly flat, which is an improvement considering the market battled eight to 10 years of double-digit growth annually on lumber and labor along with escalating interest rates, he said.

“We have almost done a total 180,” Beck said. “Prices are now flat, and general contractors are now getting aggressive [with their pricing].”

But Beck sees the benefit of interest rates falling, with the federal funds interest rate now hovering around 0.25%, as the most significant cost reduction trend for developers since the virus outbreak. 

“The biggest single thing from a cost perspective on these projects is interest rates are at an all-time low right now.”