Tariffs Fuel Already High Construction Costs

Tariffs are fueling already high construction costs. Raw materials tariffs, which include lumber and steel, are adding to construction costs, which are up 2.5% to 3% annually. We sat down with Andy Starrels, a member of Holland & Knight’s West Coast Land Use and Environment Group, to talk about the impact the tariffs have had on both residential and commercial construction costs, including the long-term impacts, the assets classes most impacted and advice for developers facing increasing costs.

GlobeSt.com: How have the current tariffs impacted Los Angeles construction activity thus far?

Andy Starrels: There’s no question that construction costs have been escalating for many months, and the impact of tariffs has certainly exacerbated the inflationary trend because so many aspects of construction rely on imported materials, significantly steel, lumber, electrical components and even stone. There is consistent data indicating that construction prices continue to escalate as much as 2.5% to 3% per quarter, but there’s no quantitative way of attributing what part of that price increase results from tariffs, and what from other significant impacts on price. Anecdotally, I do hear many developers attributing an even greater pricing impact to tariffs. That said, it still may be too early to identify any specific tariff-driven effect. Construction activity continues pretty fervently in Los Angeles, and I don’t know of any major projects that have been stopped or cut back solely because of construction costs. Once a project has gone through the long process of securing development approvals and has building permits to construct, it would be extremely unlikely to see construction halt solely because of cost increases – whatever the source. This is because the developer’s only way of monetizing its long investment is to bring the project to completion. At the same time, increased costs, over a sustained period of time, will of course have a negative impact on the feasibility of projects – the determination of whether costs and expected return on investment make a project “pencil.” As tariffs on imported construction materials drive up prices, it will be harder to make projects work, and that will lead to either increased prices to consumers and end users, or fewer projects.

GlobeSt.com: The tariffs are still new. What are the long-term impacts of these tariffs?

Starrels: If construction costs increase for a sustained period of time—whether as a result of tariffs or any other external force affecting price—we will see rents and prices escalate. Unfortunately, this will be felt most severely on product types that cater to consumers, and the most precarious of these types is housing. Construction pricing is currently at extremely inflated prices in housing markets with the greatest need for housing—the Los Angeles and San Francisco Bay areas—and tariff-related impacts on construction pricing will only make new housing more expensive. There are few safety valves in housing construction for builders to use in reaction to tariffs—major construction components such as steel, lumber and electrical components are essential to housing construction and all of these have been impacted by tariffs. Unfortunately, if construction costs continue to rise, it will make housing costs more and more expensive and make more difficult the construction of affordable housing. In terms of pure numbers, California as a whole has a shortfall of nearly 3.5 million housing units, and the need is felt most gravely in metropolitan areas like Los Angeles with extreme shortages of affordable housing, especially in areas like the Westside where land values are so high. GlobeSt.com: How are developers responding to these tariffs, and do you have advice for developers that are seeing increased costs as a result? Starrels: In terms of responses by developers, there’s no one single reaction. Some projects have slowed, and some developers have changed designs or materials to save costs. Most of my developer clients, however, see the tariff impacts like any other outside force affecting pricing and are not likely to deviate from their market-driven decisions. There is some anecdotal evidence that the upper ends of the housing market have continued unabated despite the cost increases, but I’m not sure that that market confidence translates to all other sectors.

My advice to developers would emphasize the need for careful management of the bidding and construction processes, to identify price increases as quickly and accurately as possible. On large projects, a pre-construction “buy-out” of a development budget can provide a helpful check on estimated construction costs very early in the process, and this information can then be incorporated into feasibility modeling and the construction loan budgeting process. Careful oversight of construction trades by experienced builders will also minimize the impact of price increases to the greatest extent possible, and mechanisms can be deployed to take advantage of ebbs and flows in materials markets where possible. GlobeSt.com: Are certain assets classes more impacted than others? Starrels: Cost increases, especially to construction components as widely essential as lumber, steel and other materials and components, affect all asset classes. The greatest impact will be in the housing sector because the need for all categories of housing is so severe, and because housing construction activity has been sustaining the overall development industry in recent years. The most severely impacted projects will be those that use high quantities of tariff-affected components, high rise construction, for example.

There is some prior history that may be informative to this question. In the past, construction costs were significantly impacted by outside forces – when petroleum prices spiked, for example, developers saw increased costs in construction components that use those materials (which impacted all sectors of development and virtually all types of materials). Similarly, some imported materials became unavailable, and therefore more expensive, when large capital projects in China caused a reduction in exported stone products about 15 years ago, or when quality control issues impacted the import markets for certain materials such as drywall. In both those cases, price fluctuations in important elements of the development process impacted overall project costs. The effect of tariffs on imported materials is potentially even more widespread. And if history is any guide, we simply haven’t seen domestic markets for construction components able to pick up the slack in terms of supply of these materials when imported goods are unavailable or more expensive.

GlobeSt.com: How could these tariffs potentially impact consumers or renters?

Starrels: Undeniably, increased construction costs will mean that housing prices, for both renters and owners, will rise Similarly, prices of goods and services for consumers who frequent businesses that must pay higher rents will see those prices impacted as well. In terms of housing, we will likely see continued reliance on expensive high-rise housing product in order for developers to justify higher construction costs, which will further exacerbate the shortage of affordable housing. New high density housing tends to be high-rise, expensive product that utilizes large amounts of steel, and this pattern is exacerbated in transit rich areas where city policies incentivize developers to build affordable housing with density bonuses and increased building permissions. There’s no escaping the reality that if construction prices continue to increase, the impact will be felt by consumers.