Category: Development

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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Volatility in Construction Materials Pricing Is Putting Strain on Multifamily Developers

Multifamily developers don’t know what to expect when it comes to budgeting for materials prices.

Apartment developers continue to be stressed by the unpredictable cost of construction materials.

Overall, materials prices keep rising faster than inflation. But what’s worse is that prices for individual construction materials are unpredictable from month to month. The price of lumber and diesel fuel has fallen sharply, for now. But new policies from the U.S. government continue to jolt the markets, from possible sanctions on oil producing countries like Venezuela to government tariffs on imported steel.

Developers and contractors are struggling to adapt. “It’s likely that contractors will try to protect themselves from unexpected price jumps by putting contingencies into their bids or asking owners to share price risks,” says Ken Simonson, chief economist for the Associated General Contractors of America.

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High Level of New Construction Will Continue to Strain Apartment Demand in 2019

Developers plan to deliver 337,000 new apartment units this year, up from 320,000 in 2018, according to RealPage.

Developers will keep adding pressure on the apartment sector in 2019, with plans to open hundreds of thousands of new luxury units in 2019.

New renters filled most of the new apartments delivered to the market in 2018, but not all of them. The percentage of apartments that will be occupied in 2019 is likely to keep falling.

“Occupancy should backtrack slightly, but still prove healthy as the current occupancy performance is so strong,” says Greg Willett, chief economist for RealPage, a provider of property management data and services. Like most industry insiders, he predicts that multifamily occupancy in 2019 will hover around 95 percent, with almost no available apartments in class-B and class-C categories.

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Do Developers Ignore Mid-Tier Renters?

Why the potential over-development of luxury rental units adds to the shortage of affordable housing and what can be done about it.

Lately, every city skyline is laden with cranes and every boulevard crowded with billboards advertising new luxury apartments for rent. These complexes have flooded markets across every metropolitan area―large or small―around the country. Renting, it seems, is no longer the cheap alternative to home ownership it once was.

With demand as high as it is, multifamily construction continues to boom and that trend is expected to extend into 2019, when construction of this type will reach its peak.

Developers have been so focused on catering to a wealthy market with high-end finishes and over-the-top amenities that most have continued to overbuild in this category. This will soon lead to a flattening or a market correction. They’ve also ignored the needs of average citizens and contributed to a nationwide shortage of affordable housing that has reached a crisis level.

For the time being, demand for luxury housing remains high. Millennials and baby boomers are among the two fastest-growing groups of renters, and an increasing number of empty nesters, high-net-worth households and double-income-no-kids households are choosing to rent. Both generations are seeking mobility, convenience and community. And since most of these renters are discretionary, meaning that they don’t need to rent for monetary reasons, their tastes skew towards luxury, amenity-rich accommodations. Package storage, pools, high-end fitness centers, room service, concierge services and even full-service pet spas have become the norm rather than the exception.

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