Question of the Month: Tariffs and Construction Costs

To what extent have increased materials costs and new tariffs changed your approach to development?

A healthy challenge

By Jesse Marinko

CEO and Founder

Phoenix Senior Living

As a developer, we have had to adjust our expectations regarding financial returns and building costs, tighten our scope and place projects through more sensitivity analysis. Basically, the wiggle room evaporates much more quickly and fewer projects will get developed. 

It also places heavy constraints on the high-end developer that historically differentiated itself through upgrades and amenities. These constraints present a challenge when analyzing which differentiators truly create the greatest impact on projects. 

This process is healthy for developers to go through as it challenges our norms and pushes us to grow and adapt to the ever-
changing landscape.

 

Mitigate with careful planning

By James A. Taylor, Jr.

Chief Investment Officer 

Omega Communities

The cost increases relative to materials and tariffs are exacerbated by the scarcity of vendors, service providers and actual labor. This is due to the recent development explosion, as well as immigration issues affecting the labor supply.

We have approached the increases in overall construction costs holistically. Very simply, there is a number, for most projects, beyond which the community is unlikely to be successful financially. Adjustments must be made during the pre-construction and development process to unit mixes, amenities offered, level of finishes and market rates without affecting quality of care. This requires additional time and analysis during the pre-construction phase but is time most well spent.

 

Timing is key to any process

By Frank R. Muraca

President

ARCH Consultants

While our perspective on process has not altered given the increases in material costs, ownership’s project teams are assessing opportunities to contain inflation. Our consulting approach starts with establishing schedule assumptions.

Whether the sales duration, regulatory environment, or ease of securing construction prices for financing, all relate to the timing of milestone dates. An abrupt shift of any factor of the schedule creates challenges to overcome. The recent tariffs are one example. 

If there are dramatic shifts of any development discipline you’d better have a dedicated team to continually monitor and react in real time.

 

Demand exists; rents must align

By Dana Wollschlager 

Practice Leader, Senior Living

Plante Moran
Living Forward

The overall tariff situation and consequent material pricing impact is something we are watching fairly closely, as well as rising interest rates, labor rates and subcontractor margins. 

The bottom line is seniors housing is a pro forma-driven product type based upon need and affordability; thus if we assume the demand is there, then it is extremely critical to make sure the project’s rents are obtainable.

Ideas to consider include involving contractors early, more stringent site selection, increased unit density, leveraging subcontractor and vendor relationships, and locking in pricing by awarding bids early.

 

Eyes turn to acquisitions

By Blanding Beatty

Chief Investment Officer

Traditions Senior Living

The increase to development costs from labor, material costs and tariffs, specifically to steel and metals, has impacted the bottom line of construction budgets in the last 12 months. Because these cost increases do not translate to any added value to residents, coupled with the softness of operating fundamentals, there is limited ability to preserve yield through raising rents.

With the resulting tightening of the spread between stabilized yields on cost and cap rates, the risk profile of new development has increased. This result tilts our appetite toward acquiring existing assets.

 

Labor struggles trickle down

By Bill Pettit

President

R.D. Merrill Co.

Interest rates are on the rise, along with material costs and the looming threat of tariffs on lumber, aluminum and steel. We are starting to see costs that make it more difficult for projects to pencil than at any other time over the last decade.

As challenging as materials costs have been, the larger cost concern remains the labor markets. The shortage in critical skills at the subcontractor level has introduced concerns about the quality of work and timely project completion. 

 On a project-by-project basis, when a development no longer makes financial sense, we are more likely to hold onto the site and wait for more rational markets.

 

Value-add is more enticing

By Josh Rosen

Principal

McFarlin Group

Rising material costs have sharply impacted our company’s development costs in numerous ways over the better part of the last decade. During that time, our construction costs per square foot have increased nearly 40 percent. Most problematic among these rising costs have been the prices of lumber and labor, as our developments are entirely wood-frame projects. 

 Given such rising costs, our focus has shifted to the acquisition of value-add communities. These communities can be acquired for much less than replacement cost. They simply require new capital for renovations, which is becoming much more attractive under the circumstances of the current market. 

 

Long-term effects raise concern

By Allan R. Brown Jr.

Owner

Prevarian Cos.

Construction cost increases are normal in a growing economy; it’s supply and demand, not a surprise. Current costs are already challenging, but the band plays on. 

Now — surprise! Tariffs and tweets and trade, oh my! 

The first cost of tariffs is bad, but the longer-term concern is the tendency for cost increases to artificially sustain themselves after the storm passes. Our current development deals are fine, but our pro forma cost assumptions for future projects are less certain. While we will continue to pursue development, construction cost risk will be one of the first tests for viability.

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