How Rising Costs Are Affecting New Construction
By Carrie Rossenfeld
Published: August 18, 2017
NEWPORT BEACH, CA—Increased construction costs and the elongation of entitlements may lead to slower construction starts in the near future and possibly impact land pricing, CapRock Partners’ co-founder and president Jon Pharris tells GlobeSt.com. We sat down with the developer to discuss rising construction costs and how new construction is being affected.
GlobeSt.com: What is causing construction costs to rise?
Pharris: There are a number of factors contributing to rising costs: one component is that during the downturn, many subcontractors left the industry—and in some cases, the state—and many have not returned. There is a shortage of high-quality subcontractors for many trades today. Another component is simply supply and demand—Econ 101. There is strong construction activity with limited subcontractors and therefore increased pricing on the margin
GlobeSt.com: How are the rising costs affecting new construction?
Pharris: Construction starts in Southern California are still robust given the strong tenant activity. The last two years have had the highest amount of net-square-footage absorption in the history of the Inland Empire. This robust tenant demand across all industries is pushing up rental rates, which are offsetting to a limited degree the increased construction costs. However, the increased construction costs and the elongation of entitlements may lead to slower construction starts in the near future and possibly impact land pricing.
GlobeSt.com: What can be done to mitigate these costs?
Pharris: Every deal we are underwriting today includes significant construction-cost increases of more than 6% per annum. As such, the potential for increased construction costs can significantly impact he land value for complicated entitlement projects that may take three-plus years to obtain all city approvals.
GlobeSt.com: How do you see this situation playing out in months ahead?
Pharris: The increased construction costs may lead to a restriction on land value—especially coupled with the additional complications for getting projects entitled. The near term, as a result of the rental rates increase, will continue to make development deals pencil since they still offer attractive risk-adjusted returns. There is the possibility that if rental-rate increases do not maintain their same upward trajectory, then development deals several years out may not pencil, given the increase in construction costs. That scenario is a possibility we stress test in all of our underwriting today as we evaluate future development deals on land that is not currently in our pipeline.
There is the possibility that if rental-rate increases do not maintain their same upward trajectory, then development deals several years out may not pencil, given the increase in construction costs.
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