When embarking on a commercial construction project, you’ll find that your costs are divided into two distinct categories: hard costs and soft costs.
Hard costs in commercial real estate are directly related to the physical construction of the building. They’re tangible expenses Soft costs are more intangible and are not directly related to construction.
“Hard costs refer to direct construction costs or the physical materials and labor needed for construction,” said Tomas Sulichin, President of Miami real estate brokerage RelatedISG’s Commercial Division. “Soft costs, on the other hand, include any expenses that are not directly linked to the actual construction of a project but are necessary for the project’s completion, such as legal fees, closing costs, architects, approvals, etc.” Hard costs and soft costs also differ in that hard costs usually have an end to them, whereas soft costs do not.
“Once a construction project has completed, soft costs can be ongoing as they are related to the upkeep of a rental property and include maintenance, insurance and security,” said Michael Gevurts, CEO of Bluebird Companies. Consider the costs of building an apartment complex. Hard costs include construction of the building itself, while property maintenance, leasing-up, hiring a property management company, and so on are hard costs.
Some expenses that fit under the category of hard costs include:
Examples of soft costs include:
It’s important to understand the difference between hard and soft costs because they affect your overall budget and rate of return differently. Hard and soft costs “occur at different times and have varying levels of impact on potential profitability,” Gevurtz said. “Hard costs start and end with construction and are costs that any similar project would have to incur at similar levels, so a potential buyer will be more willing to pay you a premium. However, soft costs can begin at the moment you start pursuing an investment … and some will continue until you are able to exit the investment.”
If construction gets delayed or takes longer than anticipated, Gevurtz added, then those hard costs “can quickly erode your potential profit,” especially because you’re paying longer-term soft costs. Knowing the difference between hard and soft costs helps you to better budget your project. “Once you budget soft and hard costs, you can get a proper pro forma and idea of how successful the project could potentially be,” Sulichin added.
When making cost estimates on a commercial project, it’s always best to consult a financial advisor with expertise in your specific type of project to get a better idea of what your costs will be. Generally, hard costs account for about 70% to 80% of total construction costs, while soft costs account for 15% to 30% of total construction costs, Gervutz explained. “However, it is important to note that inflation is hiking construction costs, and prices can vary from state to state, meaning estimates for both categories may fluctuate.”
Leadership in Energy and Environmental Design (LEED) is a type of certification for sustainable buildings. LEED certification falls under the category of soft costs because it’s not directly related to physical construction. However, LEED requirements may add to the overall total of your hard costs, as certification sometimes requires the use of more expensive materials in construction. According to the US Green Building Council, the amount added to your total costs depends on your construction project. However, Carden Company estimates that obtaining LEED certification usually adds 1-5% to the total hard costs of a commercial project.
One reason to get LEED certification is that LEED-certified buildings save a great amount of energy, leading to tax credits and lower utility costs. So even though LEED certification costs more upfront, it does lead to more long-term savings.
When embarking on a new commercial project, it’s crucial to have an understanding of your hard and soft costs. Although hard costs make up the majority of construction costs, it’s important as part of your due diligence to budget correctly for soft costs as well, especially in your long-term budget, as soft costs are ongoing.
