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The rents needed to justify apartment construction costs

May 14, 2014

This month’s column focuses on the costs of developing market-rate rental apartments, and the rents and household incomes needed to justify their development. The summary data is from a more detailed analysis that I recently prepared for a client.

The analysis shows the difference in the costs of developing three different types of apartment projects in San Diego County. The three types are a three-story garden walk-up, a five-story with two decks of above-surface concrete parking (known as podium parking) and a 22-story high-rise.

Each assumes current land costs, construction costs, the price of money and each assumes a 200-unit project with apartment units averaging 850 square feet.

The monthly rents required are based on a ratio of 2.5 times household income — yes, most owners would prefer 3.0 times — and assumes that the residents pay all utilities, as is now the case on most new projects.

The cost of development of apartments (and, of course, condominiums as well) relates to two principal factors: the cost of parking spaces and the materials used for the building. In two of the examples, the residences are wood-framed with only the high-rise built of concrete.

The cost of concrete parking depends on whether it is above or below ground and, of equal importance, how big the garage is. Space for the ramp is the same for a small garage as a large one — you still need to get in and out. Therefore, the larger the garage floor, the lower the per space cost.

  • The first example is a three-story walk-up garden complex with no elevator and typical carport parking on the surface at a ratio of two spaces per unit. It assumes that the project is in a suburban area. That apartment project would cost $192,000 per unit to develop. To make the unit “pencil out,” it would be necessary to achieve stabilized rents of $1,434 per month and necessitate a household income of $43,000 per annum.
  • The second example is five stories of wood-frame residences with two decks of parking above ground. That project has a per-unit cost of $295,000 and requires rents of $2,220 and therefore an annual household income of $67,000.
  • The last example, which is a typical downtown high-rise structure, costs $375,000 per unit to develop. As a result, rents need to average almost $2,850 per month and require a household income of $86,000.

The key here is the stunning difference between the rent and household incomes needed to justify developing various types of apartments.

The lesson that apartment owners can take from this analysis is that owning apartment units today is very sensible because when new units are brought online, they are inevitably going to have to achieve rents far higher than in the project you own, and that can only augur well for the future value of your units.

This article originally appeared on The San Diego Daily Transcript.

This article was originally published by Xpera Group which is now part of The Vertex Companies, LLC.

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