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Development Projects in LA and External Effects

Construction projects have seen a sharp increase in cost of construction materials. The problem is that buyers are still very active in markets, but there isn’t enough supply to sustain construction projects.

Builders are needing to reassess their business models to account for the rise in prices so they can profit without charging clients too high of prices so they won’t lose business. It is critical for developers and homebuilders to understand the cost and worth of materials so they do not overpay. Also, they must have good contracts with their contractor to avoid unexpected increases in costs of  lumber, copper, drywall and other materials.

Builders are now mitigating risks by adding construction contingencies for price increases to their contracts. Recently, clients that have locked in prices in their contract have saved significantly as a result of the cost of materials doubling. As a result, builders have to absorb the cost, creating risk of them working at a loss. However, buyers that agree with these types of contracts face risk of operating expenses rising significantly and having the project become unaffordable. Developers in current projects are stuck and others wanting to develop or even homebuyers that want to make home improvements are disincentives as their projects’ costs are absurd.

Lumber prices have shot up to record prices this year. The increase in prices is a result of the pandemic. This problem was caused by a surge in demand of homeowners and inability to keep up with the market from sawmills. Many sawmills were shut down at the beginning of the pandemic for health reasons and because owners assumed there would be a lack of demand. They did not expect homeowners to make home renovations and repairs including adding decks, fences and even building treehouses. Similarly to the toilet paper scenario where Americans bought bulks of toilet paper due to fear of it running out, they are doing the same with lumber. Contractors started hoarding lumber, so they could keep building. Scarcity resulted in the supply chain to the point where people would pay any price to obtain lumber. As a result, lumber prices shot up 20-25%.

Construction projects are trying to use alternative materials to avoid the lumber prices and shortages. For commercial projects, lack of lumber means you would have to build with concrete. However, building with concrete would increase operating expenses significantly. Another alternative would be steel, but across commercial construction, steel price increases in recent weeks have caused contractors to rework the material costs on their jobs as well.

Lack of affordable materials did not stop homeowners and developers from renovating and building. A total of 40,888 permits were issued between April and June, compared to 26,324 in 2020. Construction projects did not shut down last spring despite lockdowns, but developers often had trouble navigating the different restrictions in place and many projects were put on hold, in part because of economic uncertainty and lender tightening. The city also put in place more stringent worksite safety rules, which could have discouraged builders.

Home centers like Home Depot’s wood need have slowed down significantly especially for items like decking and fencing. Now, people are stuck at home less and have the ability to go out and travel more. We project material prices will keep fluctuating as the demand does.

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