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INCREASING LABOR COSTS SQUEEZING MULTIFAMILY DEVELOPMENT PIPELINE

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by Jim Boyle

A tightening labor market has forced developers of apartment properties across the country to push back or slow down the delivery of new supply. According to the Bureau of Labor and Statistics, unemployment in the construction sector declined from 4.1% in September to 3.6% in October. Construction unemployment was 4.5% at this point last year. Unemployment had tightened to 3.4% during the peak summer months of July and August but it remains at an almost historically low level.

The sector, which includes building construction, heavy and civil engineering, and specialty trades, had 7.3 million workers in October. That number is up 30,000 from the month before and is near its pre-recession peak of 7.5 million. The growth in demand for construction labor drove wages in the sector to a 10-year high of $30.21 per hour last month. Construction wages averaged just more than $29/hour one year ago.

Although low unemployment and increasing wage growth are indicators of a healthy and growing economy, apartment developers are getting pinched as the strong demand for workers continues to outpace supply. Roughly 260,000 units were added to the country’s inventory last year and a Ten-X study from earlier this year projected another 255,000 units will be added by the end of 2018. However, that supply which is due to come online might result in a slowing of rent growth and an increase in vacancies. Trepp’s most recent study of the apartment sector (Can Multifamily Continue to Outperform Other Property Types?) shows that the average NOI growth and occupancy rates for multifamily properties in CMBS outpaced the broader CRE segment.

Grand Openings on Hold

As a result of the growing multifamily supply, property owners have decided to hold off on making some of their units available. For instance, Essex Property Trust has pushed the delivery of about 8% of the units it had expected to complete this year (about 3,000) into 2019. It expects to withhold the delivery of a similar number of apartments from next year to 2020. The U.S. Census Bureau reports that the number of permits being pulled for new apartment units has declined from an annual average of 417,000 to 324,000 in September.

“For the next couple of years, we see little change in the number of apartments being built and the overall construction labor force,” said Michael Schall, Essex Property Trust’s President and CEO, who spoke with analysts on a conference call last week. “Therefore, there’s no reason to believe that the delays will abate…unless the construction labor force increases.”

Meanwhile, the Associated General Contractors of America (AGC) found that more than 80% of contractors were facing difficulties finding workers. “The pool of unemployed skilled workers is almost dried up,” explained Ken Simonson, Chief Economist for the Arlington, Virginia trade group.

Finding Workers Now a Laborious Task

In a recent survey of its members, the AGC found that 62% of construction firms reported increasing base pay rates for craft workers because of the difficulty in filling positions. Additionally, 24% improved employee benefits for craft workers, and 25% reported they were providing incentives and bonuses to attract workers.

The result is that nearly half of the companies the trade group surveyed had placed higher prices on their bids for construction contracts. Another 44% reported that projects that are underway are costing more to complete than planned because of the labor shortage. The lack of workers is also delaying projects which “suggests that contractors’ margins are being squeezed as they increase productivity,” Simonson said.

“This situation, along with construction-cost increases which are generally rising faster than rents, have led to compressing yields and increased risks related to apartment development,” Essex’ Schall said.

The potential construction slowdown is coming as homeownership levels are expected to decline further, thanks to increases in mortgage rates. Schall also noted that recent tax changes that limit the deductibility of property taxes and mortgage interest could further augment demand for apartments. That demand would be especially pronounced in high-cost markets, particularly in states like California and New York.

Travis Watson