Managing Construction Costs: Tips for Real Estate Investors

We’ve all heard the word “unprecedented” way too often this year, but it’s a fitting description for the surging price of lumber across the country.

The extreme spike in costs comes from a short supply and big demand. Real estate investors – particularly those in new residential construction – are finding that their projects are more expensive and taking longer than expected.

Prices for basic framing lumber have skyrocketed, costing up to twice as much as at the beginning of the year. Staples like two-by-fours are hard to find. Builders are lining up outside of lumber yards every morning, hoping to get whatever is in stock to keep their projects moving forward. It’s a situation that’s shocking even longtime lumber industry veterans who are used to somewhat erratic markets for their products.

While lumber is getting hit hardest, other construction materials are not immune. One retailer reported that window packages that usually take 10 days are now taking three weeks due to virus-related shutdowns at the factory.

What’s behind the spike

A perfect storm of factors is contributing to the shortages and resulting price hikes, all set in motion with the first signs of coronavirus earlier this year:

• As the economy began to falter in early March, lumber mills scaled back production. Some mills also faced shutdowns and reductions in staffing and output due to cases of COVID-19 at their facilities.
• As the lockdown continued, millions of Americans shifted to working from their homes, which inspired them to take on home improvement projects. Big box stores saw an increase in business and ordered more from mills that were already low on inventory.
• While demand for lumber continued, sawmills were understaffed. With furloughed employees collecting unemployment benefits, many mills struggled with finding workers. Now, as government unemployment benefits end, many tradesmen are returning to work, but even with increased labor, the current shortage isn’t expected to end soon. The situation could be further exacerbated by another stimulus plan.

These are some of the events affecting the supply of lumber and driving up prices. Despite it all, construction has continued as an essential industry in most places, and demand remains strong.

What’s next?

The situation has investors wondering whether they should wait to start new projects in the hopes that supply will catch up with demand and prices will return to more normal levels. Others suspect that this is the new normal.

While this is hopefully a temporary situation, it’s also possible that costs will remain high for the foreseeable future, as increased prices have not yet diminished demand. Unless there’s a decrease in demand and building slows down, it seems unlikely that prices will fall back to their previous levels anytime soon. Some analysts predict that the situation could continue throughout this year and into 2021.

  What it means for investors

If your project doesn’t require a lot of lumber and you can handle any delays, the shortages may not affect you much.

But if you’re moving forward on a new build, there are a few things to consider. First, budget more on your line item for lumber. Do your homework on prices in your area. Plan on spending 15 to 30% more than your original estimate, or add this amount to your contingency fund.

Next, plan on a longer timeline. Some hard money lenders only offer a 6-month loan. That may have been enough before COVID-19, but with the delays in acquiring framing packages and other materials, your project will take more time now. Consider shopping for longer-term loans, such as 9 to 12 months.

Do your best to secure any supplies you need well in advance. While lumber is the hardest hit, some are predicting shortages in other supplies, such as cabinets, roofing, drywall, and other manufactured items.

If you’re in the middle of a project and facing higher costs or delays, you may need to consider a loan extension. Your lender may offer this option. There are fees for this service, but it may buy you more time to complete your project and either sell or rent the property out.

It’s not an easy situation for investors, but being prepared and working with a trusted lending partner are a good start.