How to Beat the High Cost of Construction

Hot off the presses from our friends at UC Berkeley’s Terner Center for Housing Innovation comes another installment of its “Cost of Building Housing Research” Series. Amid global pandemic and economic crisis, it may be difficult to see why construction costs matter, but as California (like most states) faces a fiscal cliff and a devastating recession, all the barriers to housing affordability remain in place — and may even get worse. 

One of the March 2020 papers, “The Hard Costs of Construction” by Raetz et al, makes a case for innovation and regulatory streamlining to balance out higher costs of labor and materials in residential construction. As Director Carol Galante notes in a recent blog post: “How we plan now for this long-term disruption will set the stage for the arc of the recovery, and who will benefit.”

Indeed, even as household incomes fall and unemployment rises, the cost of housing may continue to grow out of reach for working-class Californians. Here’s why:

• Hard construction costs per square foot rose by 25 percent over the past decade.
• Some of the reasons for these increased costs are good: For example, prevailing wages raise the cost of labor, but provide employment stability in a volatile industry.
• As certain fixed costs get more expensive, policymakers should focus on increased efficiency in the construction industry by streamlining the permitting process and supporting new construction technologies such as mass timber.

The methodology for this study offers a tradeoff between completeness and accuracy, and may generally be underestimating hard costs of construction by analyzing bid costs from initial estimates, rather than final construction costs. The best way to get an accurately itemized receipt, so to speak, is to stick to the initial estimates, even if projects go over their budget during construction. Since developers and contractors categorized different line-items differently, Raetz et al standardized the data using the Construction Specifications Institute MasterFormat categories. The data shows that hard costs accounted for roughly 63 percent of construction costs for residential buildings in California from 2009-2019.

On average, construction costs per square foot rose from $177 to $220, a 25% increase. But that’s all of California—these cost increases are magnified in the Bay Area and Los Angeles.

Notably, the line-items with greater cost increases consist of wood, plastics, composites, concrete, and finishes. There are several reasons why this may be happening, but the researchers are quick to rule out a shift in overall industry trends toward more expensive housing types, as these cost increases were most concentrated in type V (wood) construction. Another theory seems more plausible: “It could be that higher construction costs and a hotter housing market have increased spending on finer floor coverings and other finishes to build out more expensive units and meet the expectations of a higher rental or sale price point.” The price of metal and lumber, meanwhile, has remained relatively stable relative to inflation.

Labor presents a much more complicated policy puzzle. While employment has fallen greatly since the great recession, the construction labor pipeline has not kept pace with the economic recovery relative to new housing permits. Fear of deportation under the Trump administration has only made the labor market tighter in an industry heavily dependent on immigrants. As a highly cyclical industry, construction labor is particularly sensitive to demand shocks, but trained workers are still difficult to recruit as workplace safety and job security remain uncertain in good times. We refer to a 2019 proposal co-authored by California YIMBY’s own Darrell Owens for more on this particular issue.

Critically, though, some sectors of the construction industry have recovered better than others. For example, adjusted for inflation, construction workers overall saw a 2.1 percent reduction in wages from 2010-2019 (that’s very bad news during a time of economic expansion). However, while carpenters’ wages fell by 7 percent during this period, iron and steel workers saw a 4.9 percent increase in wages at the same time. The Terner Center researchers found that prevailing wage requirements can raise construction costs by up to $30 per square foot, but that doesn’t tell the whole story.

 “Ultimately,” the authors note, “prevailing wage requirements are a policy choice designed to provide public benefit by stabilizing employment and benefits in a high risk field”—something that the data on line-item construction budgets can’t capture. Understandably, with patterns like these, the possibility of higher construction worker wages may not be first on the chopping block:

 The Terner Center’s policy recommendations can be summed up under three categories: (1) streamline permitting; (2) build more efficiently; and (3) defeat Trump.

Notably, the researchers found that while nonprofit affordable housing projects may face higher hard costs, this effect is largely nullified when controlling for larger projects overall. While affordable projects typically deal with more bureaucratic hurdles and prevailing wage requirements, these projects are larger than the average market-rate project, so these costs balance out in the end. Because local permitting processes can be so length and uncertain, the pre-construction timeline “is sufficiently onerous that developers often hire private expeditors to move projects through review in a timely manner.” Surely, if you are reading this newsletter, you probably know some permit Sherpas out there, or you may even be one yourself! We know that this service doesn’t come cheap. But that’s not all: “Slowing any project in the pre-construction phase can increase the cost of carrying capital and imperil key funding deadlines, endangering the viability of projects,” the researchers argue. General contractors, in turn, may raise their prices to hedge for this uncertainty.

To improve the labor pipeline, the Terner Center urges state policymakers to support unions and apprenticeship programs to train tomorrow’s workforce. According to a 2019 survey, “47 percent of California contractors reported that they had added or increased their use of unions to provide workers in the past year,” the authors note.

Industrialized construction and mass timber can also reduce the costs of materials or shorten the construction timeline, but institutional barriers remain, namely that state building codes and code inspectors must be updated to account for new building methods. Additionally,  investing in new construction techniques is also riskier and depends on larger pools of private capital, leaving nonprofit developers last in line. To mitigate this, the authors propose “supplemental revolving construction loans for affordable housing developers that make use of offsite technology,” i.e. industrialized, “in effect seeding the industry to lower costs for subsidized development.”

Finally, immigration restrictions and tariffs have made materials more expensive and the supply of construction labor more uncertain. To make housing truly affordable and build a California for all, we will have to defeat Trump. Then the hard work begins.