Category: Development

Apartment Developers Scout Adaptive Reuse Possibilities

That math will become easier for developers if more distressed properties become available at a steep discount.

It’s too soon for most developers to sign a contract to buy a failed hotel—but apartment developers are watching and waiting for prices to drop to buy other property types damaged by the economic crisis to redevelop into multifamily buildings.

Even before the crisis, apartment developers were eager to buy well-located properties like old office towers and empty malls that they could transform into apartments. The chaos of the pandemic caused most of these developers to pause and wait for new opportunities, such as distressed hotels available at a discount.

“There is just little interest on the part of developers to jump into anything like that at the moment,” says Jim Costello, senior vice president for data firm Real Capital Analytics, based in New York City. “Assets are not being sold at substantial discounts … yet.”

Hotels may be the fastest conversions to apartment

However, at least a few redevelopers have leapt to buy hotel properties—6 percent of hotel assets bought in the second quarter of 2020 were acquired with the intent to redevelop or convert the properties to a new asset class, according to Real Capital. This rate of purchase for redevelopment was twice the average rate seen in a second quarter between 2014 and 2019.

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    Homebuilder sentiment posts biggest monthly surge ever, a sign housing is rebounding from coronavirus

    Builder sentiment jumped a striking 21 points in June to 58, the largest monthly increase ever in the National Association of Home Builders/Wells Fargo Housing Market Index.

    A faster-than-expected turnaround in homebuyer demand, following a sharp drop-off at the start of the coronavirus pandemic, has the nation’s homebuilders bullish on their business again.

    Builder sentiment jumped a striking 21 points in June to 58, the largest monthly increase ever in the National Association of Home Builders/Wells Fargo Housing Market Index. Any reading above 50 indicates a positive market. In April, it plunged a record 42 points to 30.

    “As the nation reopens, housing is well-positioned to lead the economy forward,” said NAHB Chairman Dean Mon, a homebuilder and developer from Shrewsbury, New Jersey. “Inventory is tight, mortgage applications are increasing, interest rates are low and confidence is rising.”

    Meanwhile, mortgage applications to purchase a newly built home jumped 10.9% annually in May, according to the Mortgage Bankers Association.

    Of the homebuilder index’s three components, current sales conditions jumped 21 points to 63. Sales expectations in the next six months rose 22 points to 68. Buyer traffic more than doubled from May to June, from 22 to 43. This last component was surprising, given how many builders reported more online inquiries and virtual tours during the pandemic.

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      COVID-19 Creates New Barriers for Developers

      The outlook for construction and development has been thrown into deep uncertainty by the COVID-19 pandemic.

      The economic disruption due to the extensive social distancing measures being taken nationwide in response to COVID-19 has been severe. That’s including bringing a halt to some construction projects already in progress as well as delaying ones that further down the pipeline that had not yet broken ground.

      New York City has been Ground Zero for the pandemic in the United States. And while construction initially continued after the first wave of shutdowns, now most work has been halted, putting the city’s $66 billion construction industry in limbo. Many other states and municipalities, however, have allowed construction to continue as essential businesses even amid stay-at-home orders.

      Still, given the massive slowdown in economic activity along including the jaw dropping addition of 16 million Americans to unemployment roles has thrown many projects into question. Developers are reassessing both current and future projects amid the uncertainty that will greet them when they come online.

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        Only 3 major metros saw new construction increases in 2019

        However, remodel activity is increasing in most large cities

        While February’s Housing Market Index revealed a small dip in homebuilder confidence, the overall takeaway is that sentiment levels are still high.

        In fact, according to the National Association of Home Builders and Wells Fargo, the last three monthly readings mark the highest sentiment levels since December 2017.

        The latest Housing Health Report from BuildFax reflects that. The housing data and analytics company released its latest report on Tuesday and stated that year-over-year increases in single-family housing authorizations exceeded 6% from December 2019 to January 2020. The trailing three-month outlook grew 6.8%, according to the report.

        “Housing activity has started on strong footing this year, which should be welcome news for the broader economy. The housing market, which accounts for a substantial portion of U.S. GDP, has the potential to drive increased growth, providing a balance to any concerns of a sluggish market heading into 2020,” BuildFax Managing Director Jonathan Kanarek said. “While we’re still experiencing some growing pains regarding the recent housing shortage, as more inventory becomes available, we might see the housing market growing at an even faster pace.”

        That said, there are certainly areas of the U.S. that are still sluggish in terms of new housing construction. According to the report, only three major metros saw increases.

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          Multifamily Faces a Packed Development Pipeline

          The sector is expected to add 330,000 new units in 2020, up from 304,000 a year ago.

          Apartment developers have not been shy about bringing new product to market in recent years. And early indications are that 2020 will be another boffo year. The question is after several big years of hefty additions whether the market can digest the units that are in the works.

          “The volume of apartments on the way in 2020 certainly could test the market’s ability to absorb a big block of additional units in a short time frame,” says Greg Willett, chief economist at real estate technology and analytics firm RealPage, Inc.

          This late in the real estate cycle—after more than a decade of economic growth—many investors are making conservative choices, wary of a potential downtown. But apartment developers plan to make 2020 one the busiest years in the last decade for new construction. They continue to focus on the largest metro areas—especially “gateway” cities—where strong local economies can help fill new apartments. The amount of construction is being facilitated by the fact that lenders remain willing to provide construction financing even with so many projects on the books.

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            Multifamily Developers Find Less Space for Parking. What it Might Mean for Pricing.

            The lost income will cut into the eventual sale price.

            Apartment developers on new projects are often building less parking at their projects than the old standard of two spaces per apartment.

            Developers can often save millions of dollars if they build fewer parking spaces. But they also risk losing potential residents if they fail to build enough parking spaces to satisfy their residents. The stakes are high. Any lost income from losing tenants could into the eventual sale price. Meanwhile, a development with too much parking will have a lower yield than it could have, because the developers built empty parking spaces that don’t earn any money.

            “We see the parking demand only further decreasing in the future,” says Michael Smith, design director for Humphreys & Partners Architects. “With things like Uber’s air taxis on the near horizon, the demand for cars will be even further reduced.”

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              Lenders Enter 2020 Willing to Fund New Apartment Construction

              Lower interest rates are helping offset rising labor and materials costs and helping sustain apartment construction levels.

              As fears of a possible recession and overbuilding in the multifamily sector diminish, lenders are showing they still have an appetite for financing construction projects. The availability of mezzanine loans and lower interest rates are helping fuel this activity and helping to offset rising construction costs.

              Even if the economy shrinks sometime in 2020 or 2021, multifamily pros believe demand for apartments is still strong enough to prevent major damage to apartment properties in most markets—even with the thousands of new apartments recently opened by developers across the country. “There is clear evidence that multifamily is the asset class best equipped to weather a downturn,” says David G. Shillington, president of Marcus & Millichap Capital Corp., based in Atlanta, pointing to overall fundamentals in the sector that remain healthy.

              “Occupancy rates continue to stay steady in the face of new supply,” adds Bill Leffler, senior vice president of equity and structured finance for CBRE, based in based Atlanta. “The strong economic conditions, job creation and population increases (in the southeast) still fill up the new product hitting the market.”

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                Construction Materials Costs Are Expected to Rise

                In spite of the fallout from trade wars, construction materials prices remained stable in 2019. That’s likely to change.

                The prices of many construction materials may rise again in 2020.

                “I think the lull in materials cost increases is close to ending,” says Ken Simonson, chief economist for the Associated General Contractors of America (AGC).

                Despite trade tensions between the U.S. and nearly all of its major trading partners, the cost of many materials used to build apartments has remained relatively stable in 2019 (though subcontractors have been raising their bids in anticipation of materials prices rising). Even the cost of labor has been relatively stable, despite an extreme shortage of construction workers.

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                  Lenders Won’t Cover Rising Construction Costs on Multifamily Projects

                  To make up for rising materials costs, apartment developers are being forced to put more equity into their projects.

                  Low interest rates are not enough to make up for the rising cost of construction on new apartment building projects.

                  “The drop in interest rates will not make a bad project look good,” says Matthew Swerdlow, director of capital services for Ariel Property Advisors, a real estate and advisory services firm based in New York City. “If it didn’t work with higher interest rates, it might not work with low.”

                  Apartment developers across the U.S. are struggling to pay for the rising cost of construction. Banks and debt funds are still eager to make construction loans at low interest rates, but these loans are not typically large enough to cover the higher cost of development. Many developers are now being forced to accept lower profits to make their deals work.

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                    Tackling Affordability Challenges

                    Here are five strategies for cities to bring more affordable apartments to market.

                    For many cities, the housing storyline remains unchanged: Demand for multifamily housing is far outpacing our industry’s ability to create supply.

                    The number of renter households grew from 35.7 million in 2000 to 43.8 million in 2016. During that period, the number of affordable apartments for low- and middle-income renters fell short of meeting demand by 1.2 million units. It will get worse if we can’t work with cities to do something about it. Research from Hoyt Advisory Services found the U.S. needs an average of 328,000 new apartment units annually to meet rising multifamily demand.

                    While affordability challenges are complex, local, regional, and state policymakers have alternatives to what we know are ineffective policies. Here are five things our industry needs to encourage cities to do to bring more affordable multifamily inventory to market.

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