Apartment Market Surges, But So Do Construction Costs

Investor's Business Daily

Apartment developers are building to meet high demand. But they're running into rising costs for everything from workers and loans to drywall, lumber and concrete, hurting profits and project timing.

Construction materials prices are up as producers and distributors, who downsized after the housing bubble burst, now lack capacity to meet demand as the housing market recovers.

A shortage of skilled carpenters and other workers in some areas is contributing to higher labor costs. And rising interest rates are making it more expensive to finance projects, causing some delays.

The increases come amid heavy demand for multifamily developments. U.S. builders must deliver at least 400,000 new rental units a year to meet it and "we are nowhere near that," said Doug Bibby, president of the National Multi Housing Council. It projects just over 200,000 new units for 2013.

"The issue is, can you bring the property to the market profitably?" Bibby said. "If you are getting pinched on supply and labor costs, it makes it even more difficult.

In the NMHC's July Quarterly Survey of Apartment Market Conditions, more than two-thirds of apartment industry executives said construction costs are up more than 5% since last year. Another 29% said construction costs were above a year ago, but by less than 5%.

Framing lumber prices as of Aug. 9 were up 6% from a year ago and up 33% from two years ago, the National Association of Home Builders reports, citing data from Random Lengths. The price of gypsum, a key ingredient in drywall, has also risen sharply the past couple of years.

Lumber prices have risen as housing construction has started to come back from the doldrums, but a lot of lumber yards remain shuttered after closing in the housing bust amid slack demand, says Brian Turmail, spokesman for Associated General Contractors of America.

Like single-family homebuilders, multifamily housing developers cut back on building amid the credit crisis and recession, and as home values fell in the housing bust. With a better climate they're back at it and working to catch up after the pause.

Demand is swelling as the typical renter-age population grows, and as more people look to rent vs. own because they can't get a mortgage or decide they don't want a house.

"We're trying to meet demand but supply is still lagging," Bibby said.

Multifamily housing starts are volatile, the NAHB notes. The pace fell 26.2% in June to an annual 245,000 units after a 28.2% rise in May.

The problem in many markets is that developers can't fill supply needs due to financing difficulty.

"It's a little more costly and cumbersome to get loans right now," Bibby said. "Lenders are trying to guard against concentration risk. That means you must track down additional lenders, or go to lenders you don't know as well.

That can delay projects or make them more costly, he says.

Loans And Labor

Financing for projects has become more expensive in recent quarters, as NMHC chief economist Mark Obrinsky notes.

"In addition to the 90 basis-point increase in interest rates from the April survey, spreads over Treasuries have also gone up, likely dampening transactions somewhat," Obrinksy said in comments with the group's June survey results.

The shortage of skilled labor has its roots in the housing crisis, when many construction workers were laid off and either moved into new industries or relocated to new markets. It has left builders in many markets forced to pay top dollar for available talent in the housing rebound.

"There are not as many subcontractors in the mix now as there were a few years ago, so they have pricing power that they didn't have before," Bibby said. "They can charge more because the market can bear it. That's a significant factor in the short run.

However, builders have faced many pricing hurdles before.

Outside of major housing busts, "rising construction costs are always an issue," said Toby Bozzuto, president of The Bozzuto Group, a Washington, D.C.-based real estate firm that builds both multifamily and single-family homes.

"The one exception was 2008, when pricing was cheap but you couldn't get financing," he said.

Bozzuto says materials and labor prices began "creeping up" a couple years ago and continue to do so. But demand for new housing is so heavy in his market — Washington, D.C., northern Virginia, Maryland and parts of Pennsylvania — that higher costs have not been "a limiting factor" for his company.

"It hasn't made the feasibility of our deals impossible," he said. "We are cautiously optimistic and continuing to look for new opportunities. The Washington MSA (metro area) has been the beneficiary over the last several years of being a hot spot for multifamily. There is an enormous pipeline being built.

Room For Rents

One key to overcoming higher costs in business is to raise prices. But single-family builders have a rough time doing this because their prices are so contingent on those of comparable homes nearby.

Multifamily housing developers, however, have a little more flexibility. In this kind of high-demand market, they can factor in higher rents if necessary to help offset costs.

Some of the largest publicly traded apartment owners are Equity Residential (EQR), the seventh biggest U.S. apartment owner in NMHC's 2013 ranking with 117,322 units; and Camden Property Trust (CPT) and AvalonBay Communities (AVB), at Nos. 11 and 12, respectively.

UDR (UDR) and Mid-America Apartment Communities (MAA) are in the top 20. All are part of IBD's Finance-Property REIT industry group that ran up this year into May but has since fallen to a low rank.

Each of these REITs added apartments in the latest quarter, through acquisition, new building or both.

MAA's CEO Eric Bolton noted in the company's July 31 second quarter earnings report that "steady employment growth and favorable trends are driving higher demand" for apartments in Sun Belt states. He saw an outlook for "continued solid rent growth despite the uptick in new apartment deliveries.

During the quarter, MAA took delivery of 200 apartment units in Charlotte, N.C., and Charleston, S.C., and developed properties in Charleston and Jacksonville, Fla.

Camden built in several Texas and Florida cities, as well as in Denver, Atlanta, Glendale, Calif., Washington, D.C. and Charlotte.

AvalonBay developed in Massachusetts, Washington, New Jersey and California. UDR worked on Southern California redevelopments amid a $1.3 billion U.S. development/redevelopment pipeline.

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