Volatile Construction Costs Offer Windows of Opportunity

Developers would be wise to act before materials prices stabilize, writes Parkview Financial's Himanshu Tiwari.

Himanshu Tiwari

The ongoing disruption in the real estate market poses both challenges and opportunities. Amidst this landscape, a clear opportunity arises from the increased volatility in construction material costs, unprecedented over last three decades. Agile multifamily developers who collaborate with their capital partners and lenders, can forge success stories even within the current environment.

In order to implement a new construction project, a general contractor solicits bids from subcontractors. Contracts are awarded to subs offering the lowest quotes, often under guaranteed maximum price arrangements, meaning the developer will pay a locked-in amount irrespective of the actual costs incurred, thereby taking care of the volatility in pricing. Subs’ bids hinge on prevailing construction material and labor costs. Strategically timing sub buyouts, particularly during periods of lower construction material costs, enables developers to secure significantly lower project pricing and hedge against the volatile material costs, enhancing a project’s overall profitability. Given recent sporadic changes in material costs, it is essential that the developers track the movement closely, and move swiftly to tap on to this small window of opportunity.

For residential construction, the Producer Price Index: Net Inputs to Residential Construction, monitored by the Bureau of Labor Statistics, serves as a reliable gauge for construction material costs, tracking price movements for goods crucial to the residential construction industry. The below graphic shows the index value and percentage change month-on-month (an indication of volatility) post pandemic. A quick analysis suggests that a construction buyout in December 2023 (Index Value = 308) would have saved 5 percent in construction costs against the buyout that happened in Jun 2022 (Index Value = 322).

Source: Economic Research Division, Federal Reserve Bank of St. Louis

This savings is sufficient to make a deal pencil that otherwise wouldn’t make sense. The difference could be starker depending upon the type of construction. For instance, a mid-rise residential building that has a higher portion of cost attributed to lumber (prices declined by almost 50 percent during the same period) would experience a significantly higher savings. Recently, we concluded the buyout process for a similar project, and were able to lock into a construction budget that was 20 percent lower than what it was a year and a half ago.

While prices may exhibit an upward trend this year, as inflation is curbed, and supply chain disruptions continue to diminish, stability is anticipated later in the year. What this means for developers is that it is time to act before the opportunity no longer exists. Associating with a growth partner and lender that not only understands the intricacies, but also acts as an enabler for these opportunities is the need of the hour. As a specialized construction lender, our firm is able to leverage our construction team’s expertise to monitor trends through state-of-the-art construction databases and active market feedback. This in-house capability allows us to be a growth partner for developers as they navigate the current turbulent times.

Himanshu Tiwari is senior underwriter, Parkview Financial.

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