Multifamily Construction Costs: The Basics
For multifamily investors and developers, construction costs remain one of the biggest expenses, and it looks like costs are only continuing to increase. Unfortunately, these climbing costs could be having a negative impact on the industry as a whole. In fact, in a 2018 report, the National Association of Home Builders linked construction cost increases to multifamily developers’ lack of confidence in the overall market. Due to these ballooning costs, it’s more important than ever for developers and investors to understand the exact nature of multifamily construction budgets, and why they keep rising so quickly.
Why Multifamily Construction Costs Are Rising
According to the National Multifamily Housing Council (NMHC), regulatory compliance is one of the biggest reasons for the increase in multifamily development costs, counting for a staggering 32% of overall costs. While some of these rules and ordinances are clearly necessary (i.e. basic fire safety regulations), others are often needlessly complex. However, compliance costs isn’t the only area where construction expenses are rising. In fact, from September 2017 to September 2018, U.S. construction materials prices shot up by a sizable 7.4%-- enough to put a dent in any development budget. In addition to compliance and materials costs, labor costs have also recently increased, along with tariffs for imported goods, putting added upward pressure on construction prices.
How Construction and Development Costs Are Estimated
In the initial stages of a project, multifamily and commercial developers will typically utilize historical data from previous development projects, attempting to account for similarities and differences in their estimate (much like an appraiser might look at other properties using the sales comparison approach). However, due to constantly changing economic factors, it can be difficult to determine an exact budget, at least at first.
This is partially because, in the early stages of a development project, developers, contractors, and architects often rely on simplified, DIY cost estimation methods. In fact, simple “plug and play” excel construction cost estimate templates can easily be found online. These can usually give developers a good ballpark cost estimate, provided they input accurate information. While DIY spreadsheets are great for estimation, the vast majority of larger projects will bring in a professional construction cost estimator later on in the process. Though this can be expensive, getting an accurate budget estimation before breaking ground can often save developers thousands of dollars in the long run.
Hard vs. Soft Costs for Multifamily Construction
If you’re trying to estimate or analyze multifamily construction costs, it’s essential to understand the difference between hard and soft costs. Hard costs include all costs related to the physical construction of a building, including laying foundations, roofing, landscaping, appliances, and the like. Soft costs are typically intangibles, and include expenses such as permit fees, architectural costs, legal fees, construction loan interest and fees, and other similar expenses. On average, about 37% of a property’s development costs are hard construction costs, 24% are soft costs, and 19% can be attributed to land acquisition costs (and demolition costs, if necessary). The remaining 25% goes the investors in the form of equity returns.
In many cases, developers manage apartment and condo construction projects for a certain fee, but do not provide the majority of the capital. Instead, they usually partner with a group of investors who finance much of the development. Developer fees can vary significantly, but they are often set at 5% of soft and hard development costs. If the developer also acquired the land for the project, they might charge an additional acquisition fee of 1-2% of the purchase price.
How Much Does Multifamily Development Actually Cost?
According to the most recent cost estimates, multifamily apartment construction currently costs between $64,500 to $86,000 per unit. This estimate uses contractor fees of between $85 and $200 per square foot (psf) to provide a reasonable range between the most and least expensive markets, as the average contractor fee in the U.S. is about $125. The estimate also calculates mason, excavator, and carpenter fees at $70/hour, painters at $20 to $35/hour, plumbers at $45 to $65/hour and electricians a $65 to $85/hour. However, these numbers go out the window in the nation’s largest and hottest markets; for instance, in San Francisco, apartment construction costs currently sit around $330/psf, while in Los Angeles, they currently clock in at a staggering $500/psf.
In addition to direct construction costs, architects are also an essential part of the construction and development process, and will typically account for about 10% to 15% of the entire construction and development budget. Commercial architecture firms generally charge between $125 and $250/hour, though costs may be significantly higher in major markets.
When calculating apartment and multifamily construction costs, it’s also important to factor unusable and inaccessible space. On average, about 15% of the square footage of multifamily property consists of unusable space such as elevator shafts, building lobbies, and common areas. For instance, a 2,000 square feet of construction, would, in practice, only result in 1,700 feet of usable apartment space. This increase is nearly always passed onto the future renters, or owners, if the building is a condo.
Architects’ Role in Multifamily Development
While contractors are responsible for supervising and hiring workers to physically build out a property, architects are responsible for creating detailed plans for the entire development. In many ways, a building is only as good as its plan, so choosing a quality architect is of the utmost importance. The responsibilities of an architectural firm include:
Create an initial plan and budget for the project
Create a work list and plan outline
Draft schematic designs and floor plans
Help developer review contractor bids and select a contractor
Review architectural plans with relevant agencies, and obtain needed permits, including general construction permits (some permits may later become the responsibility of the contractor)
Collaborate with structural engineers and planning agencies
Monitor the contractor’s progress and payment requests
Contractors’ Role in Multifamily Development
Choosing the right contractor is essential, as they’re responsible for the day-to-day management of the construction site. Choose a good contractor and your project will likely go smoothly, and, assuming your initial construction cost estimate was accurate, within budget. Choose poorly, and you may find yourself well behind schedule and over budget-- which can be disastrous, especially since most multifamily development projects are financed with construction loans, which must generally be repaid within a limited timeline.
Overall, the responsibilities of a contractor generally include:
Sourcing and purchasing all materials and services to build the property, start to finish
Obtaining all relevant construction and utility permits
Advising the owner/developer and the architect on the best ways to decrease costs and reduce project timelines (while maintaining or improving quality)
Selecting, hiring, and supervising subcontractors
Cleaning the entire property after construction is complete
Contractors are typically responsible for sourcing and installing all building elements, as well as taking care of certain administrative functions. These responsibilities generally include:
Bath fixtures, plumbing fixtures, plumbing rough-in and connection
Cabinets, countertops, and built-in appliances
HVAC and insulation for building and individual units
Carpets and flooring
Exterior finishes and trim
Insurance and site/property cleanup
Permits, utility work, providing plans and specs for permitting
Lighting fixtures, painting, interior wall finish
Doors, windows, roofing and wiring
Rough/finish carpentry and hardware
Property excavation, foundation, piers, and flatwork
The Importance of Understanding Multifamily Construction Costs
Whether you want to get your hands dirty with a massive real estate development project, or you simply want to passively invest in apartment construction or rehabilitation, understanding multifamily construction costs is essential. Though costs vary significantly by area, understanding national and local cost averages for contractors, subcontractors, architects, materials, and other expenses can help you ensure that you aren’t grossly overpaying for any part of your project. Perhaps just as importantly, you can make sure you aren’t investing with a developer who doesn’t place a priority on effective budgeting.