Terner Center Finds Labor and Materials Drive Construction Costs in California, April 13

The Terner Center for Housing Innovation released two reports on rising construction costs in California. Both reports, one focused on the Low Income Housing Tax Credit (LIHTC) program and the other focused specifically on construction costs, provide evidence that the rising cost of materials and labor play a significant role in rising costs. The authors argue that California should trim legal costs and development hurdles where possible, promote innovative construction techniques that reduce costs, and invest in training programs that could expand the labor force.

The first paper, “The Costs of Affordable Housing Production: Insights from California’s 9% Low-Income Housing Tax Credit Program,” finds that the cost of materials and labor are the primary driver of significant increases in the cost of LIHTC projects. This study examined the tax credit applications for 678 new construction projects awarded 9% tax credits through the LIHTC program between 2008 and 2019. Applications contain developers’ estimates of project costs.

Between 2008 and 2019, the average inflation-adjusted per unit cost of 9% LIHTC new construction increased from $411,000 to $480,000, an increase of 17%. The cost per square foot increased by 55%, from $451 per square foot to $700 per square foot. Between 2016 and 2019 alone, per-unit costs increased 13%, and cost per square foot increased by 30%. While there was regional variation in total development costs, all regions of California have seen increases since 2013. Total development cost includes land acquisition costs, hard costs related to physical construction, and soft development costs for legal fees, appraisals, and insurance. While the reported costs of land acquisition have remained flat since the end of the recession, hard construction costs have increased by 40% since 2012. Rising construction costs lead to higher costs related to interest on construction loans, as well.

The authors suggest that increasingly complex financing and more supportive-housing projects may also explain some of the rise in costs. Only 11.5% of the LIHTC projects had fewer than four external sources of funding, and 80% of them had between four and eight sources. In interviews, developers claimed that the financing process had become more complicated and slower in recent years. An increasing share of California’s 9% LIHTC new construction projects are supportive housing, which provide services for individuals with special needs and have additional operating costs. The share of 9% LIHTC awards that went to supportive housing projects rose from under 5% to over 20% between 2008 and 2019. Supportive housing projects have more funding sources on average, which adds to development costs.

In “The Hard Costs of Construction: Recent Trends in Labor and Materials Costs for Apartment Buildings in California,” the authors compiled and analyzed a new dataset of line-item construction costs for 240 multifamily projects built in California between 2009 and 2018. Among the projects studied, 79% were affordable developments, 10% were mixed-affordability projects, and 10% were market-rate projects. Data were gathered by surveying developers, general contractors, and financial institutions.

According to their data, hard construction costs accounted for more than 60% of the total cost of producing a new residential building in California over the past decade. The per-square foot hard costs for multifamily construction increased 25% between 2009 and 2018. Cost increases have been highest for wood, plastics, and composites, which roughly doubled in price between 2014 and 2018. Wages in key construction occupations have risen in nominal terms, but after adjusting for inflation they have increased by only 3.4% since 2006, the height of the previous building boom. Even so, contractors reported a tight labor market with an insufficient pool of skilled construction workers.

Growth in the construction industry has not kept pace with an expansion in the amount of multifamily housing permitted each year. The total number of units included in each year’s permitted projects increased 430% between 2009 and 2018, but the number of construction workers has only expanded by 32%. Prevailing wage requirements are associated with higher hard costs: projects with such requirements cost an average of $30 more per square foot. Unsurprisingly, the authors found it was more expensive to build in the Bay Area or Los Angeles region than in the rest of the state, even for similar projects.

The authors make several policy recommendations to mitigate rising construction costs and facilitate more construction. Supporting industrialized construction methods could lower hard costs and speed construction schedules. Shortening permitting and approval timelines and cutting overlapping regulations could reduce other costs associated with construction. With regard to LIHTC projects in particular, the authors call for streamlining funding sources and reporting requirements, strengthening the Regional Housing Needs Assessment process to ensure all parts of the state are building affordable housing, and reassessing the costs and benefits of building code and environmental regulations.

The papers can be accessed at the following links:

The LIHTC report: https://bit.ly/2Xcg9Yj

The “Hard Costs of Construction” report: https://bit.ly/3dZnS28

Additional information about the Low Income Housing Tax Credit Program can be found on p.5-14 of NLIHC’s 2019 Advocates’ Guide: https://bit.ly/2JLt8s2