Remember the days of Zach Morris cell phones, or when you had to do math in your head? The days when Pauly Shore was famous, or back when the Patriots were Super Bowl champs? (Too soon?) Or how about this one, the days when you could build an apartment community in Denver for less than $200,000 per unit? Man, those were the days.
OK, so maybe there are a few projects under construction that cost less than $200,000 per unit, but those projects are few and far between. Heck, we’ve even heard of garden-style projects down in Colorado Springs costing nearly $250,000 per unit. Replacement cost for apartments has been skyrocketing along the Front Range, and all signs point to continued rising costs.
One of the biggest challenges has been a severe shortage of skilled labor. We were once quick to point to Denver’s sub-3 percent unemployment rate as an indication of how great things were, but it’s becoming a real thorn in the side of developers. Framers who once made $20 an hour are making $40 an hour, and when subcontractors tell you they’ll be on site tomorrow with 20 workers, you’ll be lucky when they show up with 10.
Unfortunately, the problem isn’t going away any time soon. This summer, Denver International Airport is scheduled to break ground on its $1.8 billion Great Hall renovation. DIA also has 2018 plans to begin a 39-gate expansion that will cost $1.5 billion. Let’s not forget the Colorado Department of Transportation’s massive $1.2 billion central Interstate 70 expansion also is slated to begin in early 2018. The cherry on top? This past November, voters approved an additional $937 in the city’s bonding capacity to be used for 460 various projects ranging from road repairs to library renovations.
For those counting, that’s almost $5.5 billion in projects set to commence over the next year or so. These projects will tie up a lot of skilled labor and put further strain on the construction industry. And that’s just what is happening in Denver; massive hurricane rebuilding efforts across the country are already underway. Labor costs will continue to rise and apartment projects will continue to face delays.
We apologize to any developers reading this, but, so far, we’ve only mentioned labor costs. We also must remind you that the cost of materials is rising. Just over a month ago, the U.S. began to impose a 20.83 percent tariff on Canadian softwood lumber. Over the last decade, Canadian lumber has accounted for 28 percent of U.S. lumber consumption. According to Moody’s, benchmark lumber prices have increased almost 25 percent over the past year. And it’s not just lumber; gypsum wallboard is up 8 percent over the year, and steel, while beginning to moderate, is up nearly 7 percent.
Behind all of these increasing costs, however, are a few silver linings. For one, the majority of projects already out of the ground are being built below today’s (and tomorrow’s) replacement cost. That should provide developers with a little insulation. And investors who purchased newly built product a year or two ago appear to have scooped up quality assets at well below today’s replacement cost. It wasn’t too long ago when $300,000 used to sound like a hefty price to pay for an apartment unit, but today it sounds like a bargain when you consider current projects under construction at a cost of more than $750,000 per unit.
The other silver lining is that continued project delays resulting from the labor shortage may actually help keep Denver’s apartment market in equilibrium or, at least, close to it. There are approximately 25,000 market rate units under construction per Apartment Insights. Normally we would expect that supply to deliver over the next two years, but, today, we’re probably closer to a three-year delivery window. We’re currently absorbing approximately 7,000 market-rate units per year. If that pace holds (which we expect), then we’ll absorb 21,000 units over the next three years – not too far off from the 25,000 units currently under construction.
Behind those 25,000 units are another 19,000 market-rate units in planning and permitting. A number of those projects will have a tough time securing financing, and a number of those projects no longer pencil due to increased costs. It’s difficult to know exactly how many of those units will become part of inventory, but it’s easy to see Denver a few years from now in a situation where not enough apartments are being built.
At the end of the day, new residents continue to flock to Denver, we’re still seeing strong job growth (despite a shortage of labor), the for-sale market is extremely undersupplied, and homeownership rates continue a downward trend. Existing product should remain ripe for investment, and, in the right locations, multifamily development is still a solid play. Just be sure to pad that pro forma with contingencies.