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Is Inefficient Construction Worsening the Affordable Housing Crisis?
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Is Inefficient Construction Worsening the Affordable Housing Crisis?

How rethinking the construction supply chain can reduce building material costs and increase access to housing.

The nation is struggling with one of its worst housing affordability crises in memory as the demand for reasonably-priced homes far outstrips supply. Nearly half of U.S. renter households are cost-burdened, spending more than 30 percent of their income on rent. Potential home buyers also feel squeezed. Compared to a year ago, fewer households can afford the limited number of homes on the market. Homes at entry-level price points are so scarce that many middle class earners are getting priced out of homeownership in most major cities. An analysis by the residential real estate site Trulia found that in the San Francisco and San Jose metropolitan areas – two of the nation’s least affordable housing markets – restaurant workers could not afford any of the homes listed, while teachers and first responders could only afford 10 percent of them.

For would-be buyers and renters alike, income and wage growth simply aren’t keeping pace with soaring housing costs, a dilemma that’s pushing the construction industry to search for innovative cost-cutting measures.

Labor and Material Costs Led to the Affordability Crisis

The high costs of construction have an undeniable impact on housing affordability. Whatever the costs are to complete a project, they are ultimately passed on to renters and home buyers.

A plethora of factors contribute to the unabated growth in construction costs—everything from high land costs, short supply of housing due to jurisdictional hurdles and regulation, growing urban density, and more. Two factors, though, can be counted on to drive costs for every housing construction project: the high cost of labor and materials.

The roots of the chronic construction labor shortage began with the 2007 recession. When the housing bubble burst and home prices tanked, a large number of construction workers lost their jobs. Many of them ended up in other industries and never returned, leaving 248,000 construction positions open as of March. The dearth of skilled laborers means builders are both paying more for their labor and also struggling to staff their projects and keep up with demand for new housing. Both factors add to the bottom line for property developers, who ultimately pass on the cost to homeowners and renters.

Perhaps an even more significant issue facing housing affordability is the cost of building materials, which can represent anywhere from 30 to more than 50 percent of total costs for a housing construction project. A closely-watched government index shows that construction material costs jumped 6.4 percent in April from a year earlier, the steepest year-over-year increase since 2011.The recent spike and ongoing volatility in material prices is tied to recent trade policy disputes involving lumber, steel, and aluminum. As these trade disputes play out, builders can get jittery. “If a builder is prepared to build but doesn’t know what the price of steel is going to be, that’s problematic,” said Anirban Basu, chief economist at the Associated Builders and Contractors. “That’s the kind of uncertainty that can cause a builder to delay construction, and that would further constrain the supply of housing and drive prices up in the near term.”

Further exacerbating the cost burden of building materials is the inefficiency baked into the traditional model of purchasing building materials. Imagine, for instance, if an automotive company were to buy the steel and rubber separately for every car they manufactured. This is how the construction industry commonly operates today. Materials are often bought directly by subcontractors from retail stores such as Home Depot. Purchasing in this way means several price markups are introduced along the way in the long chain from manufacturers to distributors to retailers to subcontractors and GCs. The fragmented nature of this approach also means that purchases are made with little planning—job-by-job, day-by-day—pushing the purchasing decisions down to the last minute and smallest volume and sacrificing any kind of negotiating power that might help to control costs.

Leaving Behind a Legacy of Inefficiency, Insufficient Technology

A macro-level factor reinforcing the status quo of the construction industry is its low level of technology adoption. Construction remains one of the least digitized industries throughout the world, with its heavy reliance on manual labor. Accordingly, the industry has yet to adopt the technology and automation that’s transformed the global manufacturing and supply chain operations of the automobile and electronics industries.

As a result, while nearly every other major industry has progressed, U.S. builder productivity has stagnated at the levels of 80 years ago. Reversing that trend will be tough, but even the slightest uptick in efficiency could result in hundreds of millions in savings for the global construction industry.

With all the forces working against housing affordability, it’s become even more critical to wring out inefficiencies in the way building materials are purchased, distributed, and tracked in order to contain costs and make the best use of limited resources.

“It’s clear that construction has been left behind,” said Trevor Schick, who runs the materials and supply chain operations at Katerra, a Bay Area start-up that uses technology to streamline the building process and bring down construction costs. “Apartment buildings, for instance, are largely still built using balloon frame construction, which was a method of building stick-by- stick first established back in 1833.”

That helps explain why builders can’t move quickly enough to ease the affordability crisis. One recent analysis found that the nation needs an average of 328,000 new units annually. The industry has not built that many units in nearly 20 years, with the average closer to 244,000 since 2011.

Reducing Material and Construction Costs Through Smarter Sourcing and Supply Chain Management

As the pressure to respond to the affordability crisis keeps mounting, innovation is beginning to spark in some of the worst-hit communities. In Denver, the city recently teamed up with employers and charitable foundations to offer some vacant luxury apartments at below-market rents to teachers, nurses and other workers. In San Francisco, a company is trying out “dorm living for professionals”, communal living spaces for workers in search of reasonable rents. Last year, California’s Orange County rolled out the state’s first multifamily housing made from shipping containers, a project to house veterans. And new technologies are emerging, including bricklaying robots and self-driving bulldozers.

But sometimes, the best solutions may be those that borrow from existing models. Just like Silicon Valley electronics manufacturers rely on in-house experts to produce their products, Schick and his team at Katerra cut costs by designing buildings in-house with their own architects and engineers and owning the process all the way through handing the keys to an owner. “End to end control is the first step. We absolutely need to be able to control everything — design, sourcing and manufacturing of materials, and final construction and installation — if we really want to drive time and cost out of the industry,” Schick said.

Led by folks like Schick, who spent time at HP and Apple, Katerra is working to distinguish itself with its tightly-integrated supply chain prowess, which squeezes out savings at every step of the construction process. To rein in building material costs, Katerra has procurement experts who scour the globe for deals on quality components and materials — everything from faucets to flooring to lumber. The goal is to build more affordable multifamily housing in part by buying materials in bulk directly from suppliers to avoid costly mark-ups imposed by middlemen. “We see anywhere from 10 to 30 percent savings when we buy direct,” Schick said.

In order to purchase the right quantities at the right time for the best prices, Katerra takes stock of the materials it will need all for future projects and aggregates its orders. By forecasting out across their entire pipeline, Katerra wields more negotiating power than the typical contractor or subcontractor that is buying lumber or plumbing project-by-project.

The company also builds as much of its housing projects as possible—particularly walls, floors, and roof sections—in its component factories. To save on expenses involved in transporting components to the job site, Katerra flat packs the parts — in the same way IKEA furniture is packaged — so that each truck leaves the company’s factories with as big a load as possible.

While the off-site model has been embraced in Finland, Japan and Sweden, it hasn’t attracted sustained attention in the United States despite its cost-saving track record. According to a study from Berkeley’s Terner Center for Housing Innovation, the off-site method can save up to 20 percent in construction costs for a three- to four-story wood frame multifamily apartment building, which leads to more affordable housing options for buyers and renters. The automated, assembly-line nature of the factory work allows for better quality control and requires fewer specialized skills, a plus in this labor-starved construction market. “A less skilled and less expensive labor pool can complete work off-site that would require costly subcontractor labor on-site,” the UC Berkeley report said. Containing the work in a factory setting also can reduce waste by up to 90 percent in part by protecting materials from weather-related damage, enabling the use of excess material from one project to go toward another, and discouraging theft — all of which provides added cost savings.

At Katerra, factory construction has dramatically reduced the time it takes to build a multi- family property, cutting it in half in some instances, Schick said. The speed factor gets the units to market faster, results in fewer disruptions in the community, and saves money for the builder — and by extension, renters and buyers as well. “The mantra we often use at Katerra is: Better, Faster, Cheaper,” Schick said. “The inefficient ways that construction is managed today has left it unable to meet the demands of communities. That simply isn’t acceptable for an industry so important to the social fabric of our country.”