While construction debt is much more limited now, construction costs have come down so much that deals are penciling out again.

And after three years of virtually no new construction, developers see a not-too-distant future where rents and values will soar due to undersupply.

“In two years there may be a housing shortage like I’ve not seen in my 35-year career,” says Brad Miller, president of Encore Multifamily, a division of Dallas-based Encore Enterprises. “If you can deliver units toward early 2012, that’s the absolute most optimum time to maximize rents.”

The multifamily division of Encore Enterprises is just a few years old, but the firm now has 1,760 units in its pipeline, all of which are expected to start by year’s end. In a sign of the times, all of those units will be financed through the FHA’s Sec. 221(d)(4) program.

Yet, to a large degree, the largest companies are leading the charge, wielding a balance sheet that can bypass the need for traditional debt. AvalonBay Communities had nine developments under way in mid-June and hopes to break ground on another eight this year. And the company grows more bullish as the year progresses. Earlier this year, AvalonBay announced $400 million in total development costs planned to start in 2010, but at the end of the second quarter, the company upped that projection to $600 million.

“We don’t think we’ll see construction costs any lower in the near future,” says Rick Morris, senior vice president of construction for Alexandria, Va.-based AvalonBay. “And we’ll be delivering when the economy is strong and there’s no other new product coming into the marketplace.”

Labor Pains

In fact, construction costs are down so much that a developer building the same property today that they built in 2007 would find comparable if not higher yields. “Construction pricing is down 15 percent to 20 percent across the board, but your rents are the same” says Brent Little, vice president of higher education at Indianapolis-based Buckingham Cos. “You’ve got a different leverage point now, because you’re only getting 70 percent debt. But the decrease in construction costs more than covers that change in the leverage.”

And labor costs are so low, they’re practically giving it away. General contractors (GCs) and sub-contractors are feeling the pinch, and many are quoting prices at breakeven, just to keep the lights on. Even large developers with in-house construction groups are outsourcing to take advantage of today’s low rates. “We’re doing everything with third parties right now. We like the guaranteed price features we can get from those guys,” says Mark Wallis, a senior executive vice president with Highlands Ranch, Colo.-based REIT UDR. “We strategically felt like that was the best way to go; the capacity is out there, the prices are right, and it all flows a little bit of risk.”

UDR was wrapping up three new communities in early June and just broke ground on the second phase of Vitruvian Park in Addison, Texas, near Dallas.

Multifamily contractor LandSouth Construction recently bid a job in North Carolina, along with 10 other GCs. “It was the cheapest pricing I’ve seen in over 10 years. People are hungry,” says James Pyle, president and CEO of Jacksonville Beach, Fla.-based LandSouth. “Subcontractors are now at their break-even point. Even the strong subs have gotten down to their core people, and now they’ve just got to do some work.”

Some developers have lowered construction costs on the fly during the downturn by renegotiating or re-bidding labor contracts. But it’s a very fine line: how much of a reduction is too much to ask?

“We could’ve broken a lot of people’s backs, but we didn’t take advantage of our subcontractors,” says John Leonard, a vice president at Cleveland-based NRP Contractors, the construction arm of The NRP Group. “I wanted to assure that, if we had a quick recovery and were left in a labor shortage, that we had the labor base necessary.”