Cost escalation in new construction: A 2024 update

2024: More turbulence ahead for development in Canada?

Commercial real estate (CRE) construction cost escalation is everyone’s favourite – or perhaps, least favourite topic. After all, the last few years have been undoubtedly difficult on the cost escalation front, as pandemic-related headwinds, supply chain challenges, and economic strain placed additional pressure on CRE; more specifically, on the construction sector.

As we head into 2024, development demand is ripe (particularly in the case of residential development), but investors, builders, and developers are understandably wary in this high-interest rate environment. And while escalation projections are, in essence, a well-educated guess – especially in the current, more volatile landscape – it remains important to highlight the anticipated impact of cost escalation over the short term, midterm, and longer term.

Short-term: The next 12 months

Across Canada, we are seeing rapid reductions (potentially up to 5%) in both high and low-rise residential construction costs, with much larger reductions anticipated in Toronto, followed by Montreal and Vancouver. However, in the Atlantic (Halifax, in particular) and the Prairies (Calgary, in particular), cost reductions are not expected. If anything, we see the potential for a continued upward trajectory in these regions.

This cost correction can largely be attributed to interest rate hikes, which have impacted the condominium and low-rise markets in the most expensive cities, by the largest degree. In the current environment, sales have plummeted, and construction starts are slowing (if not coming to a near halt). The ongoing housing crisis is expected to worsen as a result, with regions like the Greater Toronto Area (GTA) expected to be hit the hardest.

According to Build Force Canada, employment in the residential sector is forecasted to decline by more than 11,000 workers – or approximately 5% of the 2021 workforce – as demand for new home construction recedes. The non-residential sector helps to offset this; however, the skills need to be transferable, and location plays a key role. Quebec and British Columbia will also see large drops in workforce, with a significant decline in Quebec non-residential expected as well.

How do construction costs come down?

• Labour costs are not expected to decrease; union agreements in addition to the increased cost of living mean there is little wiggle room.

• Material costs have stabilized (albeit higher than pre-pandemic) with some reductions, but nothing significant on an overall project scale.

• We will likely see a reduction of overhead and profit as companies adopt lean operational models. To insulate profit margins, some construction trades will reduce their labour force and focus on recreating productivity for the inevitable resurgence in residential construction.

Housing development is expected to slow outside of Calgary and Halifax in 2024. However, the infrastructure/institutional market (including transit and social investments) will remain robust for the foreseeable future in Ontario, Atlantic, and Alberta regions – and to a lesser degree in British Columbia.

The popular phrase ‘Survive until 2025’ segways nicely into our projections for the following decade.

Mid-term: 2025-2026

Interest rates are expected to begin their decline in 2024, at which point condominium sales will likely recover. By this time, we should also see increased momentum in purpose-built rental development, with credit to government-led incentives and an increase in infrastructure spending.

As sales increase, the construction market could become flooded with development projects, especially in regions like Toronto. There are potentially 90,000 condominiums on deck, ready to go out for sale over the next few years in the GTA, along with 30,000 rentals that should be approved and ready to go (with even more moving through the system). In simpler terms, we may see the construction industry shift from 2nd gear to 8th gear in the span of 6 to 9 months.

Success in this mid-term period will hinge on timing the market and beating the rush, taking a deal, and hitting the ground running. This kind of environment is all about relationships, rather than competitive tendering. The lowest bid is not always the best choice; rather, it’s about selecting the right person who can get the project finished. This sentiment applies to trades as well – pick the right owner, because getting paid should be the priority in a high-interest environment.

When considering private sector construction costs, it’s also important to recognize that time is an exceedingly important factor in the overall cost of any project. Slow construction timelines (and delays) translate to higher trade, interest, and overhead costs, as well as the loss of opportunity. Within a construction site, ‘too many white hats’ is often a bad sign for coordination and efficiency. In simpler terms, the most efficient construction sites are typically those that have leaders and decision-makers in more limited quantities. The presence of too many “cooks in the kitchen”, so to speak, can become more of a productivity bottleneck than an asset. After all, in the world of development, the speed at which decisions are made is a key determinator of profit potential, and if you have the right people, they know how to get things done.

Ultimately, the mid-term is expected to endure some serious turbulence. Labour demand is likely going to exceed available supply in 2026; most acutely in Ontario, British Columbia, and Nova Scotia.

The long-term outlook

In the worst-case scenario, the wheels may come off the hypothetical development freight train, and we could see double-digit escalation over the long-term. Even in the best-case scenario, housing needs, infrastructure challenges, and the lack of skilled labour in the market are on a collision course to create a massive construction cost headache – or hangover.

The housing shortage is no secret; if anything, it’s well documented, as are the limitations of our municipal system as it relates to planning and approvals. Toronto – perhaps to no one’s surprise – is the most notable ‘problem child’, while Calgary sets a more positive precedent for development momentum. However, the biggest challenge when addressing this crisis won’t be policy; rather, it’s the shortage of labour. More specifically, it’s the shortage of skilled and highly trained labour. Even in the face of current demand, we are coming up short on talent – let alone when the construction sector inevitably ramps up. Now, more than ever, we are seeing productivity plummeting, construction schedules running long, and overall quality on a downward trajectory while union halls run empty.

In the long term, we are likely to find ourselves losing the demand versus supply fight, and costs may continue to escalate while the housing crisis intensifies. The fix? It’s a complicated issue, but the development of a national housing plan that is focused on tangible outcomes and the continued removal of red tape and bureaucracy would be a step in the right direction.

Long story short – if we don’t make major changes to the market now, it’s going to become expensive to build anything, anywhere. Innovation is required; modulization, building information modelling (BIM), and artificial intelligence (AI) need to be applied across the industry. Moreover, we need to find a way to better attract and retain skilled labour. Trade workers build homes that house families and foster communities – this is critical and honourable work that should not be minimized, but celebrated and propped up, now more than ever.

Want to be notified of our new and relevant CRE content, articles and events?