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No End In Sight: Construction Costs Causing Headaches For D.C. Contractors, Developers

The skyrocketing cost of construction has become one of the top impediments to new development across the country, and even as Washington, D.C., continues to build at a rapid pace, its contractors and developers are feeling the pain. 

A construction worker at Republic Properties' apartment project near the National Mall in 2018.

"There has not been a let up for quite a while now," said UIP General Contracting President Gerard Heiber, who will speak at Bisnow's DMV Construction Finance Summit Feb. 13. "It seems like it has been steady 5% inflation in construction costs per year for quite a while now, and there doesn't appear to be any let up in sight."

Clark Construction, the largest general contractor in the D.C. market, has seen annual growth in construction costs of 3% to 4% over the past five years, Clark Division President Lee DeLong said. 

The rising costs have not stopped D.C. developers from building. Over $17.8B worth of projects started construction in the D.C. region in 2018, a 22% increase from the prior year, according to Dodge Data & Analytics. But Heiber said he has seen some developments affected by rising costs. 

"I've seen projects put on hold because of it," Heiber said. "I've seen investors pull out of projects where owners had to find new investors."

DeLong said he has also seen construction costs play a role in the scrapping of multiple projects, but he sees it as the exception rather than the rule. 

"We have not experienced a slowdown in the residential market, but there have been a select few [projects] that have certainly slowed down or been put on the shelf," DeLong said. 

Bennett Group President LuAnn Bennett at a 2018 Bisnow event

The primary factor driving up construction costs has been the labor shortage, DeLong said. Northern Virginia's emergence as a global leader in data centers has led to soaring development in that sector, which DeLong said puts a strain on D.C.'s construction labor market that other regions do not have. 

Even projects that are able to break ground despite rising construction costs are often producing narrower returns for developers, giving them less capital to deploy into additional development, Bennett Group President LuAnn Bennett said. 

"In the multifamily sector, building is still going on and people are compressing their yields they're willing to take," Bennett said. "Ultimately it gets passed on to the client, the costs of doing projects is higher and at some point they'll just table projects and decide not to do them." 

Meridian's Gary Block, Rockefeller's Hilary Allard Goldfarb, Kettler's Bob Kettler, Foulger-Pratt's Cameron Pratt and Baker Tilly's Todd Stokes

The problem of rising construction costs is front of mind for many D.C. developers. When a panel including Meridian Group Chief Investment Officer Gary Block, Kettler CEO Bob Kettler and Foulger-Pratt CEO Cameron Pratt was asked at Bisnow's Tysons State of the Market Thursday about the largest challenge facing developers today, each of them discussed construction costs. 

"Costs have risen. It's tough to underwrite new office and residential development today," Block said. "It's important to create something uniquely different where tenants want to be, because rents are going to have to be very high to justify new development today." 

Pratt also said construction costs have made underwriting projects difficult, but he thinks the situation could improve. 

"You do have to be optimistic and look out to the future and project things are going to get better and construction prices are not always going to go up 7% a year, but rents might," Pratt said. 

Contractors say they are still projecting steady cost increases for projects coming up in the near-term pipeline, but they are seeing some new innovations that could help bring costs down. 

DeLong said Clark is using virtual modeling and design before breaking ground on a project in order to use materials more efficiently and reduce waste, which can bring down cost. It is also using prefabricated materials to reduce on-site work for some projects, especially in the healthcare sector. 

"That [healthcare] work is very mechanically and electrically intensive," DeLong said. "To the greater extent we can have components assembled off-site and then move them on-site, it helps with labor, quality and safety, and there can be cost benefits."

Heiber said he is seeing some prefabrication but it has not taken off yet. One partial prefab method he is seeing implemented more is using panels for the facades of buildings, allowing the exteriors to be built in pieces off-site and put together quickly. 

"It saves you labor in the field and saves you time," Heiber said. 

Heiber, DeLong and Bennett will speak Feb. 13 at Bisnow's DMV Construction Finance Summit, held at The Hamilton Live.