Construction Costs and Operations Costs: What’s Really the Problem?

I am hearing different stories from clients in my discussions.  There is no doubt that occupancies in Senior Living are down.  There is no doubt that projects are requiring more equity, and equity demands a higher return.  There is no doubt that staffing is more difficult to find and more expensive.  There is also no doubt that construction prices have risen dramatically in the past six to eight months due to supply issues caused by a myriad of factors. 

A client said to Bob Ritter, our Director of Business Development, the other day that he couldn’t look at new construction projects because construction costs were too high.  I wonder if that is accurate.  My experience in owning Senior Living projects is that capital costs are a minor part of the total operating budget.  Operating costs are the vast majority.  So if construction costs go up 10%, as an example, it has a relatively small impact on Proforma profitability.  But construction cost is the largest factor in sources and uses and the most visible.  So I think it naturally gets the first and largest attention.  There is no doubt that occupancy levels need to increase, and with the pent-up demand that is accumulating, they will.  Rental rates also need to increase, which will of necessity happen since the entire industry is dealing with operating cost increases.  Though it makes sense that the accumulation of factors listed above makes new projects more difficult, I am not sure that construction costs are really a significant issue.

Conversely, in discussion with another client, he stated, “If my Proforma can’t handle a 5% increase in construction costs, my Proforma is too tight.”  So he is moving forward with his project. 

Peter Douglas, P.E.
The Douglas Company

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