How rising construction costs impact affordability

Everyone knows LA is in a housing crisis and everyone is talking about up-zoning as a potential fix.

But, recently, a big part of the problem is that construction costs are skyrocketing… and that’s what I want to discuss today.

What’s going on?

  1. The wipeout of 2007-9 crushed a lot of subcontractors (plumbers, framers, roofers, etc.). Many of them left the business and have not come back.
  2. Many subs and GCs are baby-boomers who have reached retirement age… some are leaving the business every day.
  3. All of the major economies on earth are growing right now, dramatically increasing demand for, and therefore price of, commodities – things like wood, steel, etc. that you need to build
  4. Our national government has decided that now is the right time to start a trade-war, which is driving up the price of some imports (including Canadian lumber)
  5. Our our national government has also decided to try to chase undocumented immigrants, many of whom are in the construction trades, out of the country, leading to massive labor shortages
  6. Our state government continues to add complexity to the building code, increasing the energy efficiency and life-safety of buildings, but also the construction cost
  7. Our city government has decided to add a $12 / sq ft “linkage fee” to all new apartment construction (this is so painfully stupid, I have no words)

And, most important of all:

8. There is a TON of construction going on in LA, so those GCs and subs who remain have their pick of projects.

Why do increasing construction costs matter? Well, they have a huge impact on affordability.

Imagine I gave you the land for a 4,000 sq ft 4plex apartment building for free. But also imagine that construction costs (including design, permits, fees, etc.) are $300 / sq ft.

That means you need to spend $300 x 4,000 = $1.2MM to build your building, or $300,000 / unit.

Let’s say that, to get a satisfactory return, you’re willing to build into an 11x GRM (in other words, you’re willing to spend 11x the annual rent roll to build the building). $300k / 11 grm / 12 months = $2,272 / month.

In other words, even if I gave you the land FOR FREE, you would still have to charge rents which are unaffordable to most working people in LA.

So, while up-zoning (which is intended to reduce the land costs) is part of the solution, it’s not going to come close to getting us all the way out of the crisis.