Hard Costs vs. Soft Costs – What’s the Difference?

Real estate development is not for the faint of heart. Taking a project out of the dirt or redeveloping an existing site has many variables, and concurrently, many costs. These costs encompass both hard fees and soft costs that collectively make up a project budget. 

This article details the contrast between hard and soft costs and the related line items of each.

What are hard costs?

Anything consumed in the tangible development of a property is typically considered a hard cost. This encompasses the physical materials needed to build a project (e.g., steel, concrete, interior furnishings, etcetera.) and the contractors’ labor required to develop the project. 

Material costs: Material hard costs can comprise of steel, wood, cement, drywall, electrical, carpet, plumbing appliances, life safety systems, green & HVAC systems, landscaping, and more. To determine the supplies needed for a project, a developer requires an advanced design team, including architects and engineers. 

In addition, there are third-party construction estimators who can help allot quantities and costs to each of these material line items. However, most developers will adopt a market average (e.g., a specific dollar amount per square foot) as an estimate during their early cursory underwriting exercises. 

Labor costs: Labor costs are among the highest and most variable hard costs that belong to a project. The big differentiator is whether a developer employs union or non-union labor. The former can be significantly more expensive, but developers are required or sometimes incentivized to engage union labor for a defined percentage of construction in some markets. 

Labor required during the project usually includes disciplines and skillsets from: construction (e.g., carpenters, plumbers, electricians), site work professionals (e.g., excavators, environmental remediators, and others concerned in site grading); and landscapers.

In a stifled labor market, developers pay a premium for labor costs. In an unrestrained market, labor may be more affordable. It varies on the availability of craftsmen and women, so in turn, labor costs can fluctuate year over year and differ from market to market. 

Contingency: Nearly every construction forecast figures in a contingency line item. A contingency is an amount of money, a reserve set aside to cover unexpected costs or site conditions. Developers will customarily build in a 5-10% variance into their hard cost pro forma. 

Other Site Work Expenses to Consider

There are other site-related hard costs to account for in the budget, including:

Land acquisition. Most developers will consume significant time examining opportunities before actually pushing forward with a purchase and sale agreement. 

For example, a developer may approve an NOI (notice of intent) with the seller. Next, they’ll place some funds into escrow to prove their good faith intent to move forward with the deal. 

Then the developer will then spend additional time reviewing the site conditions and starting preliminary design work (soft costs) before finalizing the purchase and sale agreement. Between P&S and closing, other requirements may be met, such as securing permits needed to proceed with the development. 

Thus, the developer is picking up multiple soft costs even before receiving the parcel. Finally, upon closing, the developer will transfer the funds required to purchase the property, otherwise understood as land acquisition. 

Environmental remediation: Depending on the property’s location and prior use and history, the site may need some ecological remediation. Almost all urban projects necessitate some level of remediation. “Greenfield” sites, the least contaminated, are likely in outer suburban and rural areas. Consequently, remediation costs can fluctuate depending on the scope and characteristics of the contamination. 

Utility and road extensions: Some construction projects require new utility connections and/or roadway extensions. Both forms of site work are considered hard costs and will be reflected in the budget accordingly.

Advanced earthworks like bridges require site work like abutments, grinders, and decking. Roads, asphalt or concrete, i.e., a new 2-lane undivided road – about $2 million to $3 million per mile in rural areas and about $3 million to $5 million in urban areas. Constructing a new 4-lane highway? $4 million to $6 million per mile in rural and suburban areas, $8 million to $10 million per mile in urban areas. 

What are soft costs?

Soft costs are all of the expenses beyond the hard project costs. They are the foreseen intangibles that are critically important to a project. 

Labor costs during development

Labor costs during development are linked to various professional services. The most significant professional services line items are commonly by way of architecture and design. As a result, project management-labor fees usually trail in cost. 

Architecture:  Several architects could be required to plan a successful project. These could involve master planning architects, concept design-level architects, individual building architects, and landscape architects. 

Engineering: In commercial real estate development, multiple engineers are usually involved in designing and executing a project. Engineers can originate from various disciplines: traffic, environmental, civil, and more.

Project Management: Real estate development projects usually have a dedicated project sponsor. The core role of that sponsor is likely to identify, acquire and aggregate capital for the development undertaking. Sometimes the sponsor will initiate the development process themselves; other times, they’ll outsource these responsibilities to a third-party project management company. The project manager will customarily collect a percentage or set a monthly fee to provide the day-to-day supervision of the development project on behalf of investors. In addition, the project manager will ordinarily work as the quarterback to the other consultants, authorities, and contractors involved with the project.

Accounting / Legal fees:  Bookkeeping and legal fees are two integral soft costs part of the forecast. Accounting is frequently managed in-house by the sponsor or developer; otherwise, it’s outsourced similarly to project management responsibilities. Even large real estate developers with their in-house legal teams will regularly seek assistance from outside counsel, depending on the project’s demands. Legal fees accrue from facilitating permitting and entitlements, managing city and state regulatory processes, and the like. 

Carrying Costs

Every pro forma should reflect carrying costs. Carrying costs are the non-controllable fees that a real estate developer must pay each month, regardless of the project’s status. These fees typically include taxes, utility bills, and insurance. 

 Financing Costs

There are numerous types of multifamily loans for developers to examine, reaching from traditional financing to CMBS/life co debt products. Furthermore, some multifamily loans can be structured with an interest-only period to relieve the developer until the property is fully leased-up and stabilized. In any event, the type of financing used for a project can significantly reshape the pro forma. 

Permits and Other Regulatory Fees

Real estate developers will need to pull a full scope of permits for their projects. For example, there may be fees blended in with rezoning a site for a new use. If a variance is needed, there’s typically a cost associated with that, as well. In addition, state permits may come into play, such as building permits granted by various authorities, environmental regulatory agencies, or highway departments. Determining which permits and regulatory fees will apply or if a project is exempt is typically one of the duties of the local outside counsel and/or project manager. Often there are penal and insurance-related consequences if the correct permits are not obtained.

Post-Development Costs

The soft costs continue as they relate to a project, even as it nears or reaches completion. 

These costs include:

Advertising: Most developers will retain a marketing agency or brokerage shop to assist with advertising their property. This helps with lease-up efforts and expedites stabilization.

Property Management: Let’s say a developer chooses to hold (instead of sell) the property, before receipt of Certificate of Occupancy (COO); a property manager will be necessary. A property manager – an individual or a team of people – will oversee all day-to-day onsite activities. This includes lease-up and renewals, subsequent rent collection, minor repairs and maintenance, and down the road, investment in capital improvements as needed, and more. In addition, property managers will often hire third-party contractors for ancillary tasks, such as valet trash and landscaping.  

Security: Must be baked into every property management budget. This could be investing in and then monitoring security cameras to a fully-staffed team of people who work a desk in the lobby at a downtown office building.

Conclusion 

Whether you’re a developer or a passive investor, it is crucial to understand what goes into a project’s pro forma. This necessitates a fundamental knowledge of the soft costs and hard costs associated with the development project. 

These costs can be challenging to determine, especially for first-time developers. Still, it always makes sense to have high confidence in the budget before moving forward.