What is Driving Up the Cost of Construction in Seattle?
February 13, 2018
Hello, I’m here to crush your dreams.Jeff Pelletier, Dream Crusher.
That’s sadly the phrase I get to drop in most initial conversations with existing or potential clients. Mind you, I then offer to build the dreams back up as there’s still a lot of hopeful news out there, but the reality is that building anything in this market is going to cost a LOT more than you think and take a lot longer.
Here are my thoughts on what is going on with the cost of construction in Seattle and what you can do about it.
What is driving up the cost of building a new house or remodeling my home in Seattle?
Well, a lot, and there isn’t one thing to blame.
For simplicity sake, I’m going to focus on custom residential construction, although the same issues are impacting multi-family and commercial construction, as well. In particular, the costs of multi-family development are quickly reaching the point where I think we are going to see the market hit the brakes as rising rent is no longer covering the drastically increased cost of land and construction.
Here are some of the factors at play that are making construction more expensive:
- Supply and demand. Quite frankly, and this stinks to really think about too much, there are a lot of players right now aiming to make big profit because, a) they can, and b) the market is so hot that pretty much any price is acceptable as long as someone shows up on the job.
- Labor shortage. There’s certainly a labor shortage in the design industry. During the Great Recession, the design industry lost a ridiculous amount of talent to people either leaving the profession for good to pursue a more stable and lucrative career, or opting for early retirement. However, the shortage in the construction industry is far greater. On project after project, we are seeing schedules slip (even from the top-tier contractors) because there simply isn’t enough labor to get the job done.
- Permit requirements. While there is a lot of benefit to a thorough review of your project, we are seeing tremendous cost and schedule increases from local building departments. Where code reviewers would often ignore whole sections of a house not impacted by a remodel, they will now look at the entire house and insist upon requirements to bring that part of the house up to code. Certainly it is well-intentioned, but it drastically increases cost. Additionally, lengthy permit reviews means that contractors can’t lock in pricing, and costs often go up substantially between the Schematic Design and Construction phases just because of the change in market pricing.
- Sub-contractor costs. It must be said that we are not seeing unreasonable increases in profit or labor rates from general contractors. They’re still targeting 15% to 20% profit/overhead (although we’re seeing it more and more creeping to 18% to 23%), which isn’t that different from the recession. (Interesting to note that it is still much higher than the typical targeted profit margin for design firms.) What we are seeing, though, is drastically increased rates from their sub-contractors. They’re in such high demand and have so many other general contractors competing for their work that they can pretty much charge what they want. They’re burning bridges with established relationships, going for the quick profit, and dropping their level of service. Out of all of these reasons, this one has me concerned the most, as I think it has the biggest risk to artificially weaken demand.
- Cost of materials. Material costs have just gone up. Nationally, there isn’t some big reason for this, but it mainly follows the supply and demand model of the local economy. People charge more because they can and because their rent for their business has gone up, their labor costs have gone up, etc., and they need to charge more to pay for it.
Ironically, in all of this I have heard from numerous general contractors, architects, and designers in other firms, and they have all had a hard time generating the kinds of profit you would expect in such a boom time. We’re all seeing our costs rise, as well (especially salaries to attract top talent), yet are still feeling the push to keep fees and profit lower. It is an interesting dilemma and I’m curious to see where it goes.
Is it worth it to remodel when the cost of construction is so high?
The flip side to all of this, is the fact that the value of what is built is rising equal to — or faster — than the cost of construction, still. Even with construction costs for a solid residential remodel rising to around $350 to $400 per square foot in Seattle (it can go much higher, but not much lower) from around $250 just a few years back, it still pencils out.
A client who purchased a house for $750,000 two years ago now has a house worth approximately $900,000. If they want to increase the square footage and remodel it to get what they want (say add on 500 square feet and do some remodeling work), let’s say they’re looking at a realistic budget of $400,000. They’d be into the whole project $1,150,000, but their house would likely be worth $1,300,000 or above. They’d likely have to also buy a house for $1,300,000 or more to get what they want. So, no one is moving and everyone is swallowing the enormous costs (or trying to) and doubling down on remodeling a house they just bought a couple years ago.
How long will it stay this expensive to build in Seattle?
I get asked all the time how long I think this insanity will last. I still have no idea. We’re seeing no signs of a slow-down, although we have heard that firms doing more medium and larger sized multi-family work are slowing a little (fueled primarily by the lack of available sites and the rising costs of construction outpacing the rental income). The reality is, this city has fundamentally changed.
Things will certainly slow at some point, but there are some undeniable market realities in Seattle:
- Space. There is only so much land in the Seattle metro area.
- Lack of condominiums. Building condos is challenging and expensive in the state of Washington and so the ‘for sale’ market is largely limited to homes or older condos. It puts tremendous pressure on the Seattle single-family housing market.
- The awesome city factor. There are a LOT of people moving here. Some is speculative because they just want to live here, some is for a job and maybe they won’t stay here forever, but the vast majority is for the sweet combination of people who desperately want to move to Seattle and found a dream job. They’re going to be permanent residents of the Northwest and are going to keep changing this city.
Plus, there is one other thing: Seattle — and I’ll say this as a superfan — is freaking awesome. I have, and I would, happily pay more money to live here, and that’s fueling the market, as well.
How do you plan for the cost of construction being so high, or for changing during your project?
From our perspective, we try to do the best we can to help steer the conversation to what is a realistic budget early on.
Quite frankly, it is hard and it’s a moving target, but here is how we approach it:
- Use data. We keep an extensive database of past projects and what they cost. When we look at new projects we analyze those projects and usually add a hefty increase to reflect our thoughts on where the market is going. Historically, we had a solid track record of being above or at the final construction number (although certainly not perfect). Lately, however, it is getting far more challenging. Even when throwing very large increases to our historical averages (we have been using 30% lately) we are still finding some estimates below construction costs. So, we keep pushing our numbers up. It’s better to plan for more and be pleasantly surprised than the other way around.
- Bring in a contractor early. We pretty much uniformly select a general contractor either during, or at the end of, the Schematic Design phase to help with real-world pricing before a we get too far into a design direction. A contractor’s estimate is the best indicator of your project construction costs, not our historical database.
- Look at the whole picture. We also advise all of our clients to look at construction costs as only part of the project budget. So, what should you do to budget for your project? Take our early estimates for construction and add 25% for soft costs (design fees, permitting, reprographic costs, and other miscellaneous expenses) and then add in another 10% contingency. Heck, add in a 15% contingency to be safe. The market is silly, and while the numbers still pencil out in terms of value we advise you to go into this with eyes wide open.
And then, once you’ve had the hard conversations around budget and your dream has been crushed a little, remember that you still can get some amazing things for that hard-earned money, and it is our job to help guide you through what that is and build you a new and realistic dream that will turn into your new house.