Apartment construction in Silicon Valley grinds to a halt amid cost crunch

Apartment construction in Silicon Valley grinds to a halt amid cost crunch

If the Bay Area hopes to solve its housing crunch, it will need to build a lot more apartment buildings. But after adding thousands of units in recent years, construction is grinding to a halt.

In fact, no apartment projects broke ground in Silicon Valley during the first half of 2023, according to data from CoStar, an international real estate analytics company. Compare that to the last six months of 2022, when developers started construction on 5,298 multifamily units in the region.

There’s also a slowdown in the East Bay, where construction began on just 672 apartments, condos or townhomes, down from 1,170 during the last half of 2022. In San Francisco and on the Peninsula, work started on only 229 multifamily units, falling just slightly from the back end of last year but well below the 1,846 units during the first six months of 2022.

The reasons for the downturn are plenty: Higher interest rates are making financing development more expensive, project lenders and investors are pulling back in the face of smaller expected returns, and material and labor costs that spiked during the pandemic haven’t come back to Earth. Additionally, demand for market-rate apartments in many areas is sputtering as people have fled big cities and continue working from home.

On top of all that, longstanding hurdles persist, including local regulations and bureaucracy, neighborhood opposition and lack of subsidies for desperately needed affordable housing.

“It’s almost a perfect storm,” said Kenneth Rosen, chair of UC Berkeley’s Fisher Center for Real Estate and Urban Economics, who expects the decline to last into 2025. “The worry is if we don’t build the supply and the demand rebounds, we could see a big rent jump.”

The slowdown also threatens to thwart the Bay Area’s effort to meet its ambitious new state-mandated goal of building more than 441,000 market-rate and affordable homes over the next eight years, representing a roughly 15% increase in the region’s housing stock.

In past decades, most cities and counties haven’t come close to meeting their individual targets for low- and middle-income homes. Housing advocates contend that chronic failure to build enough affordably priced apartments is having a detrimental impact on the region.

“That means more people are displaced — they have to move farther away from their jobs or family to find an affordable place to live. Other people are forced out of their homes completely,” said Aaron Tiedemann, policy manager with the East Bay Housing Organizations advocacy group. “We keep seeing rising rents and higher costs in general. That falls disproportionately on the poor and the already disadvantaged, like Black and brown people in the Bay Area.”

Doug McDonald, president of SummerHill Apartment Communities, which develops properties across the South Bay, said the economic challenges have forced the company to pause construction on two projects in Santa Clara and Milpitas, together totaling around 600 units.

McDonald said the construction downturn could be hitting the South Bay the hardest because of how few tech workers are returning to the office. That’s a big part of why average area rents — while still among the most expensive nationwide at $3,250 a month, according to Zillow — have been rebounding more slowly than in most other parts of the country after cratering during the pandemic exodus from larger cities. (South Bay rents were down 6% from July 2022, compared to a 4% increase nationwide.) In turn, banks and investors are choosing to park their money in places with more rapidly recovering job centers.

A capital squeeze is also a problem for the rest of the Bay Area, which is seeing rents stagnate as the region’s population has dropped by around 3% since 2020. The recent failures of Silicon Valley Bank and First Republic Bank, once among the region’s top lenders to small and mid-size developers, is another factor making it harder to find construction loans. Plus, a steady stream of headlines depicting worsening homelessness and out-of-control crime are also giving investors pause.

“The Bay Area and San Francisco are dealing with a really tough PR moment,” McDonald said.

Even if developers can secure financing, they’re stuck paying stubbornly high interest rates. Since the Federal Reserve has raised the cost of borrowing to tamp down inflation, rates for construction and development loans have almost doubled from pre-pandemic levels and now sit at around 7% to 9%, McDonald said. That’s adding as much as $75,000 to the cost of building each unit, he said.

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Another obstacle: Steep material and labor costs, which swelled due to supply chain issues and worker shortages during the pandemic, continue to add 20% to 30% to construction expenses. For example, the price of ​lumber, which has been especially volatile in recent years, averaged around $530 per thousand board-feet this month, compared to $371 in August 2019.

“Stick and bricks and people are really not getting any cheaper,” McDonald said.

Meanwhile, affordable housing developers are facing yet another set of challenges. Most low-income projects rely on various public subsidies that have become increasingly oversubscribed in recent years.

To fill that funding gap, advocates and officials are working toward bringing an unprecedented Bay Area affordable housing bond worth up to $20 billion before local voters in 2024. Another $10 billion statewide housing bond measure could be on the ballot next year.

Tiedemann described the two bonds as a “game changer.” But he also wants to see local governments loosen zoning restrictions for multifamily projects and roll back parking-space mandates and other requirements that increase costs and prevent affordable housing from getting built.

“We’re getting better on removing constraints in the law,” he said, “but there’s always more we can do there.”