Source: Mary Ann Azevedo of San Francisco Business Times

There’s no question that Bay Area contractors and developers are feeling the crunch of the overheated construction market – to the point that some developments have been put on hold. The biggest problem, they say, is that demand for subcontractors far outweighs supply, which is driving costs to unsustainable levels.

Until those costs come down, contractors and developers are getting creative with their approaches to building – or simply putting projects on the backburner.

Kofi Bonner, regional president of FivePoints — a spinoff of Lennar Urban that is working on the San Francisco Shipyard, Candlestick Point and Treasure Island — said there’s definitely concern in the development community over construction costs.

At the San Francisco Shipyard, FivePoint now has 130 units under construction and plans to break ground on another 66 units at the end of this month. Early next year, it will begin work on another 140 or so as part of a different part of the Shipyard master plan project.

“We are experiencing significant appreciation on the construction costs side,” Bonner said. “The net impact is that projects get slowed down or delayed significantly.”

To address it in the short term, Bonner says his company is doing “a great deal of redesigning.”

In some cases, that might mean a total redesign in an effort to create greater efficiencies and to reduce costs, which delays the delivery of homes.

“Sometimes ... we go out to the market and find that a project might not be financeable based on the increased construction costs,” Bonner said.

Uncertainty is frowned on in the capital marketplace, he pointed out.

“The net effect is then that margins shrink,” Bonner said. “In these cases, we may have to put a project on hold.”

Some developers might try to reduce the land price to make up for the construction costs, but most property owners don’t go for it, he added.

Subcontractors driving increases?

Bonner believes profit margins for subcontractors have more than doubled to 20 to 25 percent compared with 8 percent to 12 percent in the past. Andy Ball, a construction industry expert, is finding that a number of projects “don’t make sense” at the current subcontractor pricing. Subcontractors are “raising prices to unsustainable levels – they’re so much higher than they were a few years ago. They are almost ridiculous,” he said.

Lou Vasquez, founder and principal of Build Inc., agreed that some “deals just don’t work right now” because of construction costs.

“We’ve seen projects put on hold or (sites) be put back on the market because it just doesn’t make economic sense to go forward,” he said.

Highrise projects typically command higher rents or sales prices than low-rise, so there is an offset to higher construction prices, but not always, Vasquez warned.

To deal with the problem, Vasquez is looking at different ways of building, such as modular housing.

He estimates that construction prices have escalated between 25 and 40 percent over the last two and a half years.

“This can’t continue,” Vasquez said. “It’s choking off the pipeline.”

Megaprojects finishing up

As Bay Area megaprojects such as Apple’s campus in Cupertino and the Transbay Transit Center in San Francisco wrap up, there’s light at the end of the tunnel, said Vasquez.

“The volume of work is going to start to shrink” so costs should drop, he said.

Those big projects sucked up huge numbers of workers. The pool of workers was decimated by the Great Recession when many people left the trades. The local labor force is now smaller.

“It’s kind of a perfect storm of a lot of demand and a lack of supply” of workers.

Tom Wagner, a partner with Harvest Properties, agreed that rising construction costs are making development tough to underwrite these days.

He estimates that about a year ago, Harvest could complete the tenant improvements that are part of most leasing deals for $60 to $70 a square foot. Today, he said, it’s $100 to $120.

Redesigning projects

Ball said he is looking at mechanical, electrical and plumbing systems and doing a comparative analysis with other previously completed projects.

“We’re looking if we can cut back on a lighting package, for example,” Ball said. “Or, if we can leave out a tub or instead of having two sinks just going with one.”

Still, he’s had a number of clients say they just can’t move forward with a project with current prices. Or, they will cut back and “value engineer” a project.

Until prices come down, there remains concern about the overall impact.

“There has to be a slowdown at some point,” Bonner said. “With less demand, pricing should ease, but when will that be and what are the repercussions on the housing market in the meantime?”