Hard and Soft Construction Costs in Multifamily Development
When it comes to investing in multifamily and commercial development projects, understanding and analyzing construction costs is key. Construction costs, which have been rising steadily for the last decade, have a significant impact on the overall profitability of an investment. They can generally be divided into two categories; hard costs and soft costs. Hard costs are those associated with physical building construction, while soft costs are intangible, and are typically associated with the planning, permitting, and financing of a construction project.
Defining Hard Costs in Multifamily and Commercial Construction
Hard costs, which may also be called “tangible costs” or “brick and mortar costs,” include all costs involved with physical building construction, with the exception of land acquisition and demolition costs, which are classified as site work expenses. Hard costs include:
Construction labor and materials: Wages for workers physically doing work on the property, and purchase costs for all relevant materials, including concrete, wood, steel, insulation, glass windows, and more.
Landscaping costs: Typically includes costs for trees, grass, mulch, fertilizer, flowers, bushes, and any other landscaping elements.
Site improvements: Paving/walkways, gazebos, permanent/fixed benches/outdoor furniture, and other exterior improvements.
Utility installation: Electrical installation, plumbing, water/sewer hook up, etc.
Interior finishes: Wallpaper, paint, trim, flooring, etc.
HVAC: Full installation of heating, ventilation, and air conditioning systems.
Life safety systems: Fire alarm systems, sprinkler systems, fire escapes, and other related systems.
Hard costs can vary, but are often more expensive in areas with colder climates, as buildings may require additional insulation and slightly different designs to accommodate potential snow and ice. Contingencies are also required; at the final estimation, these usually come out to around 5-10% of total costs (for new construction), or between 15-20% (for renovations).
Defining Soft Costs in Multifamily and Commercial Construction
Soft construction costs are all costs that do not involve the physical construction or alteration of the property. Some of the most common examples of soft costs include:
Architectural, planning, and engineering fees
Legal fees, permits, and taxes, property and construction insurance
Multifamily construction loan application fees/origination fees, interest payments, and other related financing fees
Moveable furniture and building equipment (i.e. lawn chairs, fire extinguishers)
Depending on how construction costs are calculated, some expenses that are incurred after building completion may also count as soft costs, including lease-up costs and marketing expenses, security, building maintenance, and other, similar costs. In general, soft costs can be seen to directly impact hard costs. For instance, having an effective architect and engineer can help reduce the amount of materials used to construct a building. Plus, spending more on soft costs now can also reduce future soft costs. For example, making sure to hire high quality legal counsel can reduce the chance that a development will incur additional legal fees or permitting expenses down the line.
How LEED Certifications Relate to Hard and Soft Construction Costs
Leadership in Energy and Environmental Design, or LEED, is perhaps the world’s most popular certification for sustainable buildings. LEED-certification is typically classified as a soft cost, like architectural planning and building inspection costs. Despite this, LEED requirements may lead to a building using more expensive construction materials-- generally adding about 2% to the hard costs of a development project. While they can cost substantially more upfront, LEED-certified buildings can save a significant amount of energy and can often quality for tax credits and other benefits. Plus, they can enhance the marketability of a multifamily development, particularly for upscale properties in major MSAs.
Hard and Soft Costs and Construction Cost Estimates
Since construction costs are so essential to the overall profitability of a development, the construction cost estimation process generally begins many months, if not years, before a building actually breaks ground. Construction cost estimates typically go through several stages, including:
Initial Cost Estimate: The cost estimation process often begins with an estimate that’s between 30% and 50% accurate.
Preliminary Budget Estimate: In this stage of the process, an initial budget is created, which should generally be between 15 and 30% accurate. Contingency levels now generally hover around 20%.
Preliminary Budget Estimate: At this point, which usually occurs when the building design is at least 70-80% complete, a professional estimator is brought in, who will re-work and refine the construction budget, bringing accuracy to between 5% and 15%.
Final Budget: As finished building plans and signed contracts are issued to the estimator, they can begin to fully lock in a finalized construction budget. At this point, the budget should be within a 5% accuracy level. Theoretical contingency is now at between 0-5%, but, in practice, a 5-10% contingency will still be accounted for (or 15-20% for renovations) in order to compensate for unexpected expenses.
Rough estimates can be made by developers and contractors by using pre-built spreadsheets and other tools, but nearly all large commercial projects will hire professional construction cost estimators, which will use engineering expertise and mathematical skills to develop the most accurate numbers possible. The only real question is when to bring in the estimator-- at the beginning, middle, or end of the planning process. In many cases, it can pay to bring them in earlier. While this can cost more upfront, it can save developers significant time and money later on in the development process.
Putting Hard and Soft Construction Costs Into Perspective
With multifamily construction costs on the rise, it’s never been more important for multifamily developers and investors to understand how construction costs are calculated. Otherwise, they could make costly mistakes, such as not getting a sufficiently-sized construction loan or overpaying during the commercial construction or architectural bid process. Like everything else in commercial real estate, knowledge is power, and those who understand more stand the best chance of maximizing the profitability of their investments.