November 28, 2023
Affordable housing costs per unit increased 24 percent over the last year in San Jose, a new study found.

It’s no surprise that building housing in San Jose isn’t cheap, but this year is shattering records for construction costs in the nation’s 12th-largest city.

A new report commissioned by San Jose officials finds the residential development landscape for both market rate and affordable projects “bleak” as builders face “numerous challenges” due to enormous economic pressures, including historically high interest rates, soaring construction material and labor costs and other inflation-related issues.

Buried in the study is an astounding figure: The cost of building a single unit of affordable housing in San Jose over the past year exploded by 24 percent, from $757,900 to $938,700 — a three-fold jump compared to relatively routine annual increases over the last decade and a half. Compared to other Bay Area counties such as San Francisco and Alameda, San Jose’s prices are 26 percent higher per unit, a figure attributed to a shortage in the labor market and differences in wage structures, the report found.

For the second year in a row, the report looked at the cost feasibility of five different types of properties across San Jose — and none of them penciled out.

When considering the construction costs of 5-to-22-story market-rate housing projects anywhere in the city, the report concluded that potential developers stand to lose hundreds of thousands of dollars in every instance. Meanwhile, rent costs have plateaued or even declined across the region, leaving new projects in the red. The city’s study found that even if rents increased by five percent or construction costs decreased by five percent, it still wouldn’t make a major difference.

The worsening climate for construction comes as housing affordability and homelessness remain top of mind for Bay Area residents. In a poll conducted by this news organization this month, 75 percent of the region’s registered voters think homelessness is going in the wrong direction.

Nanci Klein, the city’s head of economic development, said this year’s report can be narrowed down to a simple phrase.

“Worse than last year,” said Klein, who joked the study could have just been those four words. “Unless something crazy changes, we’re not going to get much development, housing or commercial.”

According to CoStar, an international real estate analytics company, not a single market-rate apartment project broke ground during the first half of this year in Silicon Valley. Rising construction costs have also hit transportation projects — notably San Jose’s BART extension, which has seen its estimated price tag nearly double over the last three years to $12.2 billion, and its target date delayed another three years to a 2036 opening.

Those involved in both affordable and market-rate housing projects said interest rates — which are at a 20-year high — remain the key stumbling block in a long line of dominos that have constrained development.

“Interest rates have really shut down the capital markets,” said Shawn Milligan, a San Jose-based developer. “You can’t borrow at 9 or 10 percent and underwrite a project. It’s impossible. It was possible when interest rates were three percent. It’s kind of turned everything upside down.”

This has created a vicious cycle, said Louis Mirante, vice president of public policy at the Bay Area Council.

“The fewer projects, the less labor there is,” he said. “The less labor there is, the fewer projects there are. That death spiral is going on.”

But there are other, less obvious issues stymying developers, the report found. Monthly operating costs for developers have spiked because of rising insurance rates that have sparked a crisis across the state, especially for those living in wooded areas who face wildfire dangers. Some homeowners have even had their coverage plans canceled. Developers also said layered on top of the insurance rates are difficulties getting projects linked to utilities, with some waiting months for Pacific Gas & Electric to get them hooked up with electricity.

A residential higrise under construction is seen in downtown San Jose, Calif., on Monday, Oct. 23, 2023. (Dai Sugano/Bay Area News Group) 

Ray Bramson, chief operating officer of Destination: Home, a group that advocates for affordable housing, said developers are more recently forced to look beyond the usual funding streams.

“The county’s ($950 million) Measure A (housing bond) is drying up,” he said. “It’s why having a local subsidy is so important. We need to have that local money.”

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Can the problem be fixed? Developers and others involved in construction said interest rates will have to go down — and city officials said they are exploring a variety of different levers it can pull to help ease the situation. But the options are extremely limited.

Even if San Jose wiped away all of its fees associated with starting a project, the results would be minimal, this year’s report found. And that could also cause issues with transportation and park infrastructure, which rely on this funding stream. Klein said they’re exploring other options, such as reviewing construction-defect laws.

But what would make the biggest difference, she said, would be a tweak to the California Environmental Quality Act, which critics have long blamed for holding up housing projects.

“If we could get rid of CEQA or substantially change CEQA, that would save a whole lot of money and a whole lot of legal fees,” said Klein.