Sticker shock has some Twin Cities apartment developers in retreat

With demand for rentals in the Twin Cities on the upswing this summer, the escalating cost of building apartments is delaying projects and forcing developers to put others on hold.

Lumber prices remain more than double last year's levels following a breathtaking run-up this spring before an easing in recent weeks. After a record setting 4.3% rise in May, overall construction costs are up more than 24% over year-ago levels, the Associated General Contractors of America said last week.

The price hit is being felt in all areas of residential construction, from DIY home improvements to apartment projects with eight-figure construction budgets.

"This is costing us millions and we can't afford that," said Kelly Doran, a Twin Cities-based developer who has built apartments throughout the metro. He recently shelved projects in Shakopee and Maple Grove despite strong demand, a move that affects 470 apartments.

Doran said the cost of the additional phases of his Triple Crown project in Shakopee and the Reserve at Arbor Lakes in Maple Grove, have risen $8 million from initial phases primarily because of lumber prices. That adds an additional $15,000 to $18,000 to the cost of building a single apartment. To cover the additional expense, he said, he'd have to increase the monthly rent roughly $95 on an average apartment.

"I've got $100 million worth of projects I was ready to start that I'm not going to start," he said.

Curt Gunsbury, owner of apartment developer Solhem Cos., said the spike in lumber alone has driven up the cost of a typical large building nearly 4%. That's on top of double-digit price increases and delays in deliveries of critical building components including appliances, lighting and plumbing fixtures and roofing materials.

He's developing a $50 million apartment project that's already $2 million over budget. "That's enormous," he said. "If we had known before we might not have started that project."

When a developer is planning a project the budget typically includes a construction contingency, a reserve fund that's set aside to cover unexpected costs. But with the cost of so many components rising at the same time, Gunsbury said it's inevitable that some developers will raise rents or not pursue certain projects.

He said he passed on several development sites in St. Louis Park and Edina in part because lower financial returns are making it more difficult to attract investors.

"Projects are just falling out of bed," he said. "It has a long-term impact on what doesn't get built and that drives housing inflation."

Though the pandemic quelled demand for rentals in some parts of the metro, especially downtown Minneapolis and St. Paul, there's been an uptick in recent months, according to new data from Marquette Advisors. That was especially true in the suburbs where there's already a shortage of housing that's affordable to working-class renters.

Cecile Bedor, executive vice president of real estate for CommonBond Communities, said volatile construction costs are particularly burdensome for nonprofits, key players in developing apartments for renters with lower incomes.

During the early months of the pandemic, as lumber prices began soaring, CommonBond was in the final stages of securing bids for a 60-unit suburban rental building for people who earn less than 60% of the area median income.

Normally, developers lock in lumber pricing for 90 to 120 days, she said, but in the weeks leading up to the closing on its project, the lock was reduced to seven days, then down to just two days.

"That gives you an idea of how volatile this market is," Bedor said.

The lumber bid alone came in $175,000 more than initially budgeted, so the project had to be "value engineered." That meant using narrower dimensional lumber when possible and sheets of gypsum rather than plywood when possible.

"We never have enough affordable housing ... this just exacerbates a really challenging environment for low-wage workers," Bedor said.

Leslie Roering, senior real estate developer for Aeon, said when the nonprofit sought final construction bids last November for a four-story, 70-unit income-restricted apartment building in Edina, the lumber bid had jumped $200,000 more than budgeted six months earlier. Then, as closing approached in January, the bid soared another $330,000.

The organization was able to cover that increase with its construction contingency, but "not all projects have been that lucky," she said.

Mark Vitner, managing director and senior economist with Wells Fargo, said the Twin Cities apartment business is recovering from the pandemic fairly solidly. For landlords, rents are rebounding from the hits they took a year ago. Investor demand has also been very strong. However, if costs remain high, building owners will need more rent to make the numbers work.

"If we do see a significant delay in apartment starts, and apartment leasing remains strong, we could see more pressure on rents later this year and in early 2022," he said.

He's hopeful lumber prices will continue their retreat from their recent highs as mills ramp up production around the country.

Already, though, high material prices and delays in deliveries are stifling construction employment for nonresidential projects, including factories, hotels and office buildings. During May, for the third time in the past four months, construction employment across the country declined. Meanwhile, residential construction has notched modest gains. But the outcome is uncertain.

"There are concerns with additional costs," said a representative for the Minnesota Building Trades. "We have heard conversations that the increased price of lumber is having effects on single-family home construction and that it is having impacts on multifamily [wood-framed] construction."

Sunny Bowman, president and owner of Dakota County Lumber said that with contract prices falling there's a false expectation that retail prices are also down.

"Nobody is breathing easy yet," said Bowman. "There are still a lot of things out of our control."

Last year her company stopped selling lumber to apartment developers to focus on smaller homebuilders and remodelers who are placing much smaller orders.

During the pandemic, she said, more people were doing home improvement projects because they weren't spending their money on vacations and other discretionary items. Already, she's seeing a decline in that demand as those consumers also postpone their projects.

"We're starting to see people say 'That's just too expensive for me and I'm going to have to think about something else,'" she said. "While you hate to see people being priced out, that definitely lessens some of the demand."