Increase in Construction Prices Leads to Struggles in New Developments

Since 2021, various commercial real estate segments, such as multifamily, retail, and healthcare, have faced rising construction costs for new developments. The uptick in the price for materials, as well as labor shortages, have both contributed to making it difficult for new developments to pencil and also selling the development at a profit. 

Construction costs have surged by approximately 25-30% in many areas, with lumber prices doubling during the pandemic. This dramatic rise stemmed from a spike in housing demand and challenges in supply chains for new projects. Steel prices rose by about 40%, largely due to global supply chain disruptions affecting delivery to developers.

Labor shortages in the construction and logistics sectors have been exacerbated by an aging workforce and a decline in new entrants to the trades. As a result, wages have risen due to the limited availability of workers, making financing new construction more costly.

These upticks in pricing have created many struggles for construction activity in CRE. Developers must be able to adapt to these conditions in order to move forward with creating a new development and maintaining stability in their investment. 

Multifamily

Multifamily housing construction has reached levels not seen since 1988. However, the increase also led to higher vacancies and rising rents across the sector. The Northeast and Midwest regions have reported positive rent growth in the second half of 2024. These specific areas are outperforming because they did not fall into the oversupply trends that occurred in the Sunbelt during the pandemic period. This balanced supply is expected to sustain positive rent growth into 2025.

Conversely, some markets are experiencing significant declines in construction volume, such as Charlotte, where multifamily construction dropped 47% year-over-year by the end of Q2 2024. The first half of 2024 saw only 3,448 new units delivered, marking the slowest start for apartment construction in the metro since 2015. 

Many Southeastern markets are grappling with substantial construction delays, with a recent NMHC survey indicating that 47% of respondents believe this region is the hardest hit. Furthermore, 46% cited financing availability as a contributing factor to these delays, with lending being difficult to secure in a turbulent market. 

The average cost to build out a new apartment complex was recently noted at $350 per square foot across the country. For larger markets, like New York and San Francisco, this metric is brought up to $450 per square foot; meanwhile, secondary markets, such as Phoenix and Orlando, have noted lower rates that range from $300 to $350 per square foot.

Retail

Retail construction has slowed significantly, largely due to low national vacancy rates. Across the U.S., the restaurant segment noted the highest construction cost per square foot. The national average cost per square foot for a restaurant is $266.90, with New York noting the highest cost at $350.82 per square foot. 

Construction costs for the retail segment have skyrocketed because of higher rents for new build-to-suit properties. For example, retailers like Starbucks and Dollar General are paying around $150,000 in rent for a newly-constructed property, an increase of up to 50% compared to five years ago. This increase has prompted real estate investors to seek out older stores with more replaceable rent and healthier rent-to-sales metrics. 

Several retailers, such as 99 Cents Only, Bed Bath & Beyond, and Dollar General, have closed, opening up vacant space in the marketplace. For those looking to expand, these vacant spaces offer a less complicated route to securing construction permits, compared to starting from scratch. 

The redevelopment of a 50-year-old retail center in Houston is one example of investors using shutdown space for a new purpose. Grogan’s Mill Village Center opened in the 1970s, but its grocery tenant closed in early 2020. Since then, other tenants kept their operations here, but Howard Hughes Holdings sought to fill empty spaces in the center to bring in new tenants. The new tenants have yet to be announced, but president Jim Carman of Howard Hughes stated the redevelopment allows for “creating places and spaces that bring people together to meet, shop, learn, and connect as part of a revitalized village center in The Woodlands.” 

However, if a newly-constructed retail property is up for sale, sellers must strategize in order to ensure a successful transaction. One beneficial way to do so is by having tenants already in place for the sale. Curating a complimentary mix of tenants can boost foot traffic and consumer interest, ultimately enhancing the property’s sale price.  

Healthcare

Hospitals

In the healthcare sector, construction costs for hospitals have increased by 6% per square foot compared to 2023, reflecting a more than 20% rise over the past five years. Material costs for HVAC and plumbing have contributed the most to the increase. HVAC prices are currently high because of supply difficulties, and there are supply chain backlogs for electrical and plumbing maintenance. 

Medical Office

The cost to build a brand-new medical office facility has increased to around $150 to $300 per square foot. This uptick is due to the high cost of zoning permits and supply costs. In order to meet the goals of the final design for a medical office, the layout needs to be taken into consideration. The zoning process must be planned out carefully to ensure it meets this process correctly. Receiving approval for zoning permits can be one of the most time-consuming steps in the construction process, and rates for zoning have also increased to $100 to $500 for obtaining a zoning permit.

For materials needed to finalize the development, the highest costs are seen for plumbing work and cabinetry for the office. Installing plumbing ranges anywhere from $20 to $50 per square foot, while custom cabinetry can be $300 to $500+ per square foot. 

While costs increased the most from 2021-2022 to the current elevated levels, pricing has remained stagnant since then. Current construction costs are still high, making financing difficult, but understanding the uptick in cost levels is crucial to ensure success for different properties. By comprehending why construction has climbed, as well as the effects on the market, it can be beneficial to controlling properties now and in the future.