Thoughts On Construction Cost Increases


A lot of you will have heard about the steep rise in construction material costs over the past few weeks and months. What is causing this rise, is it a permanent thing, and where does that leave people wanting to do new construction? Let's look at some of these points.


Increase in construction costs are coming from a number of areas. Most notably:


- increase in existing home renovations as people stay home in the pandemic,

- movement from multi-family to single-family homes as these are seen as safer in a pandemic,

- requirement for people to have more room, as they stay at home, in the pandemic, resulting in sales of larger single-family homes,

- labor shortages, throughout the supply chain, again, caused by the pandemic,

- fear that interest rates are going up have pushed people sitting on the fence into the home buying market.


There are certainly causes for the increase in building material costs that aren't related to the pandemic, but a good portion of the increase is, mostly through increased demand. As such, we can anticipate that these increases should be temporary. While my crystal ball is no clearer than anyone else's, I have to think that a majority of the supply chain issues will get figured out as we approach the end of 2021. People will get their shots, people will get back to work, factories will get back to full capacity, ports will open.


The next question that arises relates to the increase in the price of new homes, the portion of the increase in home prices that relate to the pandemic. Assuming that building costs go down over the next few months, will new home sales prices go down as well. After all, you can afford to pay more to build a new house if you are confident that the eventual sales price will go up in lockstep. You don't want to be stuck paying more to build a home and then have sales prices go down just as you go to market.


I was in a very similar situation when I was building new homes back in 2006 - 2008. The economy went into a crazy boom in 2006. Everybody wanted to build a new home. You couldn't get building materials. Hurricane Katrina had just hit and everything from wood products to drywall was getting sucked down to rebuild New Orleans. Experienced workers were at a premium. Building was delayed 8 to 10 months in some cases. My costs went up 50% in a few months. Luckily, the sales price of my finished product continued to rise even faster. Then it all stopped suddenly with the sub-prime mortgage crisis of late 2007.


This has led me to invest with a couple of new golden rules:

- get in an out of your projects as quickly as you can. This helps you avoid booms & recessions & out of the ordinary price swings,

- try to work in jurisdictions that are friendly to developers / builders, where red tape is at a minimum, and permits are approved relatively quickly,

- build in jurisdictions where the underlying economy is strong, and scheduled to remain strong, where there is net in-migration into the area (i.e., people are moving in, not out), where jobs are plentiful, and where the underlying fundamentals are positive.


If you are building in places such as this, then you are in a much safer position as construction costs ease later in the year, that sales pricing on the newly built finished product has a better chance of staying high.


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