Bay Area Construction Costs Dip, And Affordable Housing Takes Notice

Bay Area construction cost growth may finally be slowing down as a result of the coronavirus pandemic after years of price escalation cooling development, especially for housing, some experts told Bisnow this week.  

Construction costs hampered many Bay Area development proposals in the last several years, including for residential projects, making even worse the region's and state's housing crisis. Last year, Turner & Townsend deemed San Francisco the most expensive place in the world to build. Now, costs in some segments of the construction industry have started to slow growth or even decline, with the potential for more of the same in 2021. 

“We were seeing somewhere, in 2019 to early 2020, around 4% to 6% escalation annually, and a lot of that was dictated just by the amount of work that was in the marketplace," Skyline Construction President Rene Olivo said. “Now that there isn’t the amount of work out there, we’re seeing a lot more competition, and we’re seeing the backlog, in particular in the [tenant improvement] marketplace, burn off.”

Through July, construction costs in San Francisco were still up from the beginning of the year, but the growth was limited. In Q2, construction costs in the S.F. market were up 0.65% quarter-over-quarter, down from the growth of 1% or more seen in previous periods, according to the latest quarterly Rider Levett Bucknall construction cost report. 

In another study looking at 14 major cities, RLB found S.F. to be one of five markets seeing a significant decrease (between 27% and 76%) in the number of operating tower cranes, signaling diminished activity. The other nine cities had an either stable or increased number of cranes.

Olivo, who leads Skyline's interior construction company, said the result is an approximately 3% decrease this year for that segment and likely a similar drop for Skyline's ground-up work. 

Olivo said what happens in the next year will largely depend on the path of the coronavirus, but Emerald Fund CEO Oz Erickson said he expects a 10% to 15% drop in construction costs next year, citing the developer's experience amid the last recession with its 326-unit Rincon Green project in SoMa.

Emerald Fund received a $69M bid for that project in 2007 and built it in 2011 for $60M, Erickson said. 

“During 2010 and 2011, [contractors] were basically pricing things to just cover their direct costs, just to stay in business, and I think something like that will happen," Erickson said. "It will be a very competitive market in about 10, 12 months.” 

Even so, a double-digit drop in costs wouldn't necessarily make housing development any more feasible in parts of the Bay Area, especially San Francisco, he said. Coming into this month, one-bedroom rents in the city were down more than 20% year-over-year, according to Zumper.

That situation is not conducive to housing development, even if rents drop, according to Erickson, a longtime S.F. residential developer. He said he doesn't expect the rent picture to get much better until the pandemic turns around.

“Until COVID-19 is solved, nothing happens," he said. "Once COVID-19 is solved, the rents have to come back in order to justify the cost of a project.”

In other parts of the construction industry, costs have yet to budge, and some don't think they will. 

McCarthy Building Cos. Vice President of Preconstruction Alice Nguyen said the design-builder is advising clients to continue planning on costs trending upward. There is still a high demand for skilled labor and a demanding state building code adopted last year, as well as hits to productivity because of coronavirus safety protocols. 

"We continue to see labor rates, safety and code requirements increase the overall cost of construction," Nguyen wrote Bisnow in an email. "Even though pricing may somewhat appear to be stabilized or flat in this next eight to 12 months and not see much initial escalation, we are advising clients to carry 3% to 5% per annum to account for the items above for all their future projects that don't start in the first half of 2021."

There is also a risk of many subcontractors not making it through the recession, according to Nguyen. A survey released last month by the Associated General Contractors of America and Autodesk found 32% of California general contractors think it will take more than six months for their volume to return to normal levels, or that it will never happen, while another 26% said they didn't know. 

Like Nguyen, Olivo said Skyline isn't seeing any relief on labor or materials costs, but he said he thinks there will be less work in the next year compared to 2019, making costs more competitive. 

"It’s really about sharpening the pencil on the profit margins right now," he said. "It’s a lot more competition and a lot fewer projects.”