The consequences of COVID, inflation, rising interest rates, supply chain issues and geopolitical events have all combined to create a perfect storm for residential developers and sponsors. They face a challenging operating environment in the housing market, in both single-family and multi-family developments. Explosive demand has boosted home prices, dramatically increased rents and led to critical housing shortages in some markets. Yet developers have been stymied by rising costs, material and labor shortages, and project delays.
In March, the U.S. Census Bureau reported that housing starts had recovered, rising 6.8 percent in February to 1.769 million, the highest since June of 2006 and above-market forecasts of 1.69 million. At the same time, the National Association of Homebuilders said its measure of single-family homebuilders’ confidence had fallen to a six-month low.
According to the National Multi Housing Council Quarterly Survey of Apartment Construction and Development released in March, 89 percent of developers had experienced construction delays, which for 85 percent involved both starts and permitting. In the survey, 98 percent of respondents said they were affected by materials shortages and 100 percent reported materials price increases, with a 45 percent rise in lumber alone. Ninety-two percent said that deals had been repriced higher during the previous quarter, also upping costs.
These trends show little sign of abating as we go forward into 2022. According to data from the National Association of Realtors, home prices hit a new record in March while rising mortgage rates slowed the pace of home sales, which decreased 2.7 percent from February and 4.5 percent from March last year. High home prices and lack of inventory have driven some homebuyers into the rental market, where prices have soared above pre-pandemic levels. In April, the national average rent increased by another $15, according to Yardi Matrix’s survey of 140 markets.
In this climate, with demand still strong and supply still constrained, there are a variety of strategic factors to keep in mind that will help keep your project moving, from both operating and financing standpoints. Here are five important considerations:
1. Look for land that is already entitled
The purchase or use of entitled land will allow you to save valuable time—and money—in the development process and allow for quicker commencement of development.
2. Build in more lead time
In our experience, projects that would usually take 18 months are now requiring 24 to 30 months for completion. You should expect and provide for more lead time in your development and construction timetables. Consider ordering critical path items earlier than normal to reduce construction delays.
3. Liquidity is crucial
It is not just the cost of lumber that has risen exponentially. Appliances have increased some 7 percent, for example. In the NMHC survey, 55 percent of respondents reported higher-than-expected labor costs. Overall, with inflation and ongoing supply chain shortages, you should expect that your costs will increase somewhere in the 14 percent to 20 percent range. Given this picture, liquidity is crucial. Generally, lenders prefer to lend to sponsors that have experience with real estate cycles and those with deep pockets, increasing the project’s chances of success.
4. Choose your partners carefully
Present circumstances may dictate the need to bring on additional project partners. You should assess and select your partners carefully to ensure they have the same long-term goals, and will contribute materially to your project, in terms of financial wherewithal, portfolio experience or local market expertise.
5. Lock in your interest rate
The Federal Reserve increased interest rates a quarter-point in March, with an additional half-point increase in May and projected further increases to tame inflation. Yet interest rates remain historically low. In this rising rate environment, you should consider locking in your interest rate for as long as you can. Even at today’s higher rates, fixing your debt service cost will enable you to increase margins as rents rise or projects lease up more rapidly.
The effect of COVID on housing supply and demand reinforced by the impact of geopolitical events has led to an unusual market. Developers and sponsors who plan for these contingencies can still leverage what is projected to be robust demand for housing into the future.
Douglas Rutley is senior vice president & head of Real Estate for commercial bank BHI, the U.S. division of Bank Hapoalim. Bank Hapoalim provides its clients access to a broad array of products and services available through its bank and non-bank affiliates. Not all products and services are provided by all affiliates or are available at all locations. All credit products are subject to credit approval. Nothing contained herein should be construed as a commitment to lend by BHI or any of its affiliates. The matters discussed herein express the personal views of Mr. Rutley and are not necessarily those of BHI or its affiliates.