Development Market Conditions
Has the projected Fed rate increases impacted your underwriting? Have you seen increased interest rates with lenders? Has your firm slowed down on the pipeline for new development projects? How are you compensating for the increased financial costs? By increasing projected NOI growth? What does the market look like for development over the next several years?
in a major west coast market that was hit hard by covid, rent levels still haven’t fully recovered. We are getting aggressive on rent growth assumptions to make deals pencil, the underlying fundamentals are there and we’ve been able to show why it should happen, but ultimately need believers on the LP side. Construction costs are what they are, including insane amounts of contingency and escalation, which crushes the untrended YOC. If you’ve got a good basis and long term capital, deals can be done.
Rates haven't gone up much on our end... yet. We've been underwriting projected increases (Bank of Canada, I'm in the great white north) forever and forecasts through 2026 have only incrementally gone up from our lenders over the past year.
Rising construction costs are FAR more of an issue than rates. You can only reasonably push projected rent growth so far. Because of this, in pretty well every major market across Canada cost inflation has far outpaced rent and is making apartment development unfeasible. The vast majority of developers are pivoting towards condo on shorter-term projects. Really the only companies doing apartment deals right now are those with pension fund partners who are happy to build to a 4.5-5 cap at 12% IRR and those with long-term redevelopment projects that have a ton of future towers to go up.
rates are still super low and interest carry has a marginal relative impact on development returns. Cost basis on deals is getting higher due to construction cost inflation in the 7-10% annualized range. Untrended yield on costs are probably 30-50 bps lower than they were 12 months ago, but cap rates have also moved lower in many sunbelt markets so the profit spread between projected exit caps and yield are maintained. General consensus is to build as fast as possible as cost inflation relief seems unlikely in the foreseeable future.
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