Construction Costs ‘Wreaking All Kinds Of Havoc’ On Silicon Valley Builders, With Per Day Losses Of $700K

The soaring construction costs weighing on projects across the Bay Area are showing no signs of relief in Silicon Valley, where developers continue looking for ways to adapt.

The Valley nearly quadrupled its apartment production last year, but there was a dwindling number of construction starts in Santa Clara County, CoStar San Francisco Bay Area Director of Market Analytics Jesse Gundersheim said at Bisnow’s Silicon Valley State of the Market event on Tuesday.

Look no further than Sand Hill Property Co.’s crack at redeveloping Cupertino’s dilapidated Vallco Shopping Mall into a mixed-use project including over 2,400 units. As it remains mired in City Council-led legal troubles, the $4B project is seeing projected construction costs shoot through the roof, Sand Hill Property Co. Chief Housing Officer and Managing Director Candice Gonzalez said at the event.

“We’re seeing $700K per day in hard cost escalation,” Gonzalez said. “And that’s being conservative.”

A report done last year by Turner & Townsend puts average construction cost in the Bay Area at $417 per SF, higher than anywhere else in the world, including New York City and its average of $368 per SF. As a result, developers new and old are changing what they build and how they build it in San Jose and neighboring cities.

Borelli Investment Co. Chairman Ralph Borelli, who is working on securing remaining entitlements for what will be an approximately 3,000-unit Market Park mixed-use project in San Jose, says project plans can change quickly with construction costs on the rise like they have been. He points to a 140-unit market-rate project in San Jose that recently fell apart, and which he is now trying to resuscitate as a 248-unit community.

“Units are getting smaller, parking ratios are going down and heights are going up, because we’re trying to get more density,” Borelli said.

One result of a need for density to get projects to pencil is San Jose starting to get co-living interest, which coincides with more development of studios and one-bedrooms than two- and three-bedrooms, Gundersheim said.

Another is more off-site construction, including the use of cross-laminated timber, which can more directly deal with the labor shortage driving the region’s exorbitant construction costs.

In addition to time savings, “there can be cost savings as well, especially in markets like this where the labor rates are so high,” Swinerton Project Manager Amory Shaffer said.

Construction of a CLT superstructure can likely be done with eight to 10 carpenters, much less than the 20 to 30 carpenters needed for traditional on-site building, according to Shaffer.

A big upfront downside to using off-site construction is the learning curve, which First Community Housing Director of Housing Development Regina Celestin Williams said the affordable housing developer experienced firsthand recently.

Working with modular construction company Guerdon Modular Buildings, First Community Housing used modular construction to develop its 135-unit Second Street Studios more quickly, but the steep learning curve delayed the San Jose project at certain points, Celestin Williams said.

“Cost of construction is wreaking all kinds of havoc for us and making us really have to adjust during construction,” she said.

But First Community will continue looking to do modular as a way to deal with construction costs. The developer is looking at doing a steel modular project with modular housing developer RAD Urban, Celestin Williams said. 

Even with costs stifling some supply needed to meet rental demand in San Jose, many units are under construction, and many multifamily developers are offering two months of free rent to stabilize their assets, Gundersheim said.

“If you look at the market as a whole and count under-construction apartment stock compared to existing stock, we’ve got 6% underway, which actually ranks as about the eighth-strongest growing metro across the country,” he said.

But the housing crisis still rages on, with the office portion of Google’s Downtown West project looming and poised to necessitate around 8,000 to 10,000 more units, Gundersheim estimates.

“I don’t think Google is going to be building that many units at their own site, so there is going to be increased pressure on infrastructure and housing nearby," he said.

Google's plan calls for up to 7.3M SF of office space and 5,900 units, 15 acres of parks, plazas and green space and 500K SF for other uses.

“Who in the room wouldn’t want more demand for multifamily housing?” Gundersheim said.