Is Development Dead??
Is anyone thinking of getting out of development for at least the next 36 months? There is no way deals make any sense, and those who say they do, are lying to themselves. Those that have deals in construction are seeing higher interest rates than they underwrote and while rents may be better than they pro forma'd, there is no way their cap rate is going to be higher than what anyone can put debt on the property at. They're neg leverage.
For those looking to find deals, construction cost keep going and no one knows what cap rates to underwrite…..
Is this industry dead for the coming years to come??
This is such a classic new guy question lol.
There is a massive housing shortage as well as industrial in many many markets across North America. Inflation and a temporary dislocation in capital markets isn't going to kill development in those asset classes long-term with the huge pent up demand for new supply.
Is development hard to make work in the near term between cost escalations and interest rates? Absolutely. Will multifamily/industrial development be at a standstill for a year or two? Yup. Is it going to extend far past that? Likely not. Rents are exploding due to the lack of supply, there's always going to be people willing to bet on that, and there's always going to be all cash or low leverage buyers who will pick up brand new core assets.
Now office and retail development is a different story. Office for sure is going to be at a standstill for the foreseeable future. Retail development will likely be limited to grocery anchored plazas and centres for new residential nodes in expanded urban boundaries.
If the point of this post is to ask "hey should I avoid getting into development because of the current market conditions" the answer is absolutely not. If it is what interests you pursue it, you're going to see a number of cycles in your career and seeing how a good developer survives the down periods is invaluable.
Right, right.. because markets only go up for developers. No one talks about anything else. It's taboo.
I literally said that office and retail are going to be horrendous for the foreseeable future? lol
It's not that markets only go up, it's that a smart developer plans their work to work around downturns. If you see opportunities and tie up multiple projects and get them capitalized in the good times it can keep you going for 18-24 months on fee revenue to keep the lights on while you wait out the market. My firm is pretty much accepting the fact that nothing is going to get tied up in the next 6-12 months, but we're still looking at deals, putting in offers, etc. to stay in the market so that once things do start to make sense we can capitalize on it. Plus there still are opportunities out there, real estate is great because it's the most illiquid, opaque and fractured market out there, there are still opportunities to squeeze value. We've shifted priorities, less urban ring 5-over-1s and more garden style 3-story walkups, and that's what you need to do when markets shift, but I can tell you in 3-4 years we'll be right back to urban core markets as rents continue to go up and debt comes down.
Rates went up so quickly that even a lot of deals that recently started construction locked in cheap debt. Two deals I've been heavily involved in that broke ground in late 2022 have construction-to-perm debt in the 4%-4.75% range. So those should be fine- even if cap rates are high for a while, you don't need to sell. But no chance of getting debt like that now.
How'd you get the construction to perm debt? We wish.
Institutions have access to this debt. Many life company's offer construction to perm to keep their average life of their loan book higher at rates that work for them, today.
I work in healthcare development for what it's worth but all of our loans are construction to mini perm.
I work for a very large and well capitalized developer and this will be a very active year for us. We are starting construction on 15+ projects this year. Sometimes we use debt, sometimes all cash. Two of the projects that I'm working on we are doing all cash, one is $50M the next is $85M.
Subtle flex. I'm jealous
In multi development and we are wayyyyyy busier than our REPE team right now.
What LTC are you getting from the bank?
57-60 LTC. 25-35 percent repayment guarantee. 300-350 over.
Look at forward rates, if you lock in now at 5-6% and hold for 10-yrs on your refi, rates are expected to drop and by extension, cap rates too.
Hahahaha. "Tell me you don't know anything about development without telling me you don't know anything about development."
My guess is all you know about development is what you learned to underwrite in Excel in that weekend boot camp class you took, right? There are plenty of ways to make deals pencil, from the obvious to the more involved, so no, development isn't dead. And anyone who cuts and runs on a career in which individual projects take 3+ years because they foresee a couple months of slowdown is a freaking moron in the first place.
You are the stupid money that makes everyone else look good. Please, please don't leave!
May I ask - what are you building now days?
Multifamily rentals, affordable and market rate (well... all "market rate" in NYC includes some affordability, but that's splitting hairs).
Since that is all we build, good times or bad, I can't tell you whether we'd be building industrial or office or what have you. My guess is that we would, because we're not idiots and thus would find ways to make deals pencil... you know, just like all reputable operators do in their respective asset classes.
Lol now is the best time to be in development, if you're capitalized to survive that is.
You'll be the first to deliver to market on the other side of this shitshow, into a supply situation that continues to erode/constrain further since no one can pencil new deals. The tailwinds will be epic coming out of the recession into the new cycle and you'll be the first to get paid for it.
Just gotta survive the storm. This business is not for the faint of heart, which is why those GP returns are so juicy. We earn every penny with the bs we deal w everyday.
When you say deliver to market- how many units do you have in mind? What's the scale?
Will be a few thousand units out of this fund between hotel keys (majority) and multi
You fail to realize that we are going to have double digit inflation for the next 10 to 15 years. Reindustrialization is happening. Get on board.
Definitely recognize the environment but are you really getting institutional money to underwrite double digit rent growth?
Are you actually this dense? Or do you just pretned? I said inflation, not rent growth. While inflation drives rent growth they aren't the same. As for the question, yes. You just need to know how to pitch it. If you came to me and said "oh hey bro we are totally gonna get 12% rent growth because hey look at my totally tublar chart over here says so", I would kick you out of my 30th floor office window. But if you said something like "The rapidly chaning global demographics, geopolitifcal landscape, and supply chains are creating underlying frameworks that will drive significant repositioning of populations, industrial bases, and capital through a decade plus long shift of productive capacity out of China and Russia with resulting production landing in America and Mexico that will drive down supply chain costs by X% over that time period." Well I would tell you to sit the fuck down and explain it to me in more detail.
Look at the bigger global picture. The world in changing, globalization is collapsing, reindustrialization is happening, and people are going to make billions of dollars. Well not you, but other people.
Yes, let's all listen to the guy trying to raise capital from a forum mainly frequented by interns. Solid.
Ah yes, let's listen to a guy who is a 1st year that doesn't seem to understand that this site is frequented by MDs, SMDs, Principals, and heads of family offices. You provide snark, while I recieved dozens of direct messages in that post. Four of which resulted in conversations that resulted in the deployment of capital in one direction or another. But yes, let's just continue to assume that this site is 100% interns. Fucking hell I know people who I met on this site over a decade ago who are now senior VPs, pushing MDs when they were just analysts. Do you know how time works?
Industrial will come back very soon IMO because rent growth (NNN NOI) will overcome higher cap rates.
Multifamily feels pretty screwed for a few years. The big growth markets the past few years have a supply glut coming and they will not be experiencing industrial like NOI growth. It is likely NOI margins deteriorate too with expenses (except property taxes…) outpacing rent growth. On higher cap rates, that you're lying to yourself if you're not underwriting, multifamily is much more reliant on some steep cost declines to pencil. It is a real shame because America has an affordable housing crisis. Most compelling market from NOI growth perspective to me is NYC, but even there you are reliant on a tax abatement for deals to work. Second place id give to Miami.
Not to hijack this thread but it sounds like those who have commented have much more experience than I do, so wanted to ask a few questions:
Assuming you're at a well capitalized shop that is still active, how has your work process / evaluation changed relative to the slow down in capital markets? How are you dealing with the higher cost of capital? Is it simply more equity, or are we also considering alternative debt sources such as private capital markets that can provide fixed rate financing? Are we mostly pencils down?
I very recently joined the capital markets team of a large developer and am curious what to expect over the next couple years. I come from a debt background and have a bit of experience (6-7 years), but haven't been through this type of market in that time obviously
We are mostly pencils down, with the exception of multifamily in a couple select markets that will have outsized rent growth for the foreseeable future while also offering favorable financing through the CMHC Select program in Canada (similar to HUD loans in the US from my understanding - offers very favorable and high leverage financing terms relative to a points system for affordability, accessibility and environmental criteria).
Totally agreed. LIHTC type deals will always be alive. Affordable housing will always be in need. Plus LIHTC developers collect 15-20% development fees. Not sure how the developers that built and building luxury products are going to do - let's see what happens.
We're still active, just shifting our priorities. I mentioned in another comment that we're moving from our typical urban core 5 over 1 type MF product and trying more garden style projects since we can still get good rents there and costs are lower (no elevator, more efficient floorplans, etc.). The biggest shifts from an underwriting perspective is our yield has a higher floor, previously in my market we could get away with a high 5 on industrial, now we're talking minimum 6.25%, and debt is reducing LTCs overall, so 50-55% instead of 60s. You can still make it work if you can get LPs along for the ride and get the right sites.
Take a look at a construction/development boom and bust cycles since 1950s. Average US construction bust cycles is 2 years with bull-run 5 years. Usually raw land prices fluctuate the most in real estate during downside. Large developers who can afford to buy land during downside collect significant profits thereafter. Where do you think we're currently in the cycle depends on your view.
Just FYI - last US high-inflation period of 1972-81. In 1973 an investment in US Bond after inflation would yield a negative return of -5.48%. Real estate took a downturn for 3 years as well. Hope this time around it's different..
Don't get out of the industry because of a downside - if you current role does not have a runway, there are plenty of other roles you can learn and succeed in development. You learn a LOT more during downside(s).
Too many wildly optimistic people in this thread... I think many of the ultra bulls in here are going to have a rude awakening in the next 12mo.
Good operators do well in all markets, because they are good at their job. The folks who rely on cheap credit, or who can only swim with a tide that is coming in, have your attitude, because they never really added anything of value in the first place.
I've said it many times, but downturns are where really good sponsors separate themselves from the pack. Being in this business from the end of the GFC to last year was like going into a casino and being told there was a 75% chance the roulette wheel would settle on red. Are you guaranteed to win? No. But the odds were so stacked in your favor that it made sense to keep betting.
The titans of CRE that are active today have that status because they encountered markets like this one and not only survived, but thrived. So yes, you are correct that there are some bullish folks who will get wiped out, that is always the case. But the guys who know what the fuck they're up to? They're going to do well and come out the other side in a position of strength. And the bearish folks... well, they'll spend two years doing nothing at all and will be that much further behind.
TL;DR - if you are good at what you do, a down market is a time of opportunity, not challenge. If you are a run of the mill, "lets put in new countertops and ovens and jack the rent by 25%!" types of operators, you'll do poorly. That is a reflection on a person/firm, not the market, and only a bad sponsor blames an adverse market for poor performance.
Not so much industrial, but I think even if you're at a shop that slow on ground up dev or acquiring value add deals there could still be interesting opportunities. Maybe since there's a slowdown your shop sees interesting opportunities in debt and you start considering those investments. Maybe you have stabilized assets that buyers are interested in for tax reasons (if you have an abatement for example) and you look to sell/put that into safer assets to generate stable cashflow. There are still things going on, depends on what type of shop you're at but if you're at a smaller private developer with significant assets/liquidity maybe there's opportunity to invest in other areas of the capital stack.
If you're bored as a more junior guy, I guarantee the senior guys are even more bored and probably have less menial tasks to do. They want activity as well, maybe worst case you can discuss this with other analysts/associates/VPs and get to know them more, have conversations around what's happening in the market and what they're seeing in terms of potential debt opportunities, updates on projects, etc.
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Not sure if mentioned in the thread yet, but wouldn't the price of land just adjust until the deal makes sense for someone?? Isn't this how free markets work? If deals don't pencil at $10mm land cost then the land is not worth $10mm…
In theory, yes. However, markets don't adjust over night. There needs to be a period of price discovery. The issue I see is that we are in a period of pice discovery and I do not know how long the period is going to last. In order for the price of dirt to adjust, we need to know what market cap rates should be. In most markets I am in, transactions are frozen because you can't put debt on a deal without being negative leverage. Most property owners underwrote in a low interest rate/cap rate environment. Therefore, they aren't going to take a hair cut but exiting at a 6% cap when they underwrote a 5% exit. This period of price discover is what prompted my original post.
Agreed that it will take time for prices to adjust, but I also I think this is a time for opportunity. CRE defaults are increasing and projects in construction right now are hurting, so this creates a lot of opportunity for well capitalized buyers. I work at a much smaller scale (Sub-$10mm) and I'm seeing a lot of construction projects that are half gutted being put on market or properties that have been entitled but the owner doesn't want to construct it or even stabilized properties that are being sold at very reasonable prices because the owner needs to recoup capital to carry other projects. I would only think that this will also happen at the larger scales as well. So if you work for a developer that is well capitalized, then this honestly is a very fun time to be in real estate development. If you're at a developer that is about to go belly up...then yeah...not so fun
I've mentioned this in other threads but land cost is not the biggest problem. Most deals land would have to pay us to build on it right now lol. The hard costs are the biggest problem and those are largely still not budging in the right direction. Until that happens development will largely be in a stalemate for new deals IMO.
Yup. I have deals with free land and big public subsidies and I'm still nowhere even close to getting something to pencil.
Yeah I didn't think about this. I live in a city where land is incredibly scarce, so the land price is actually what hinders development (apart from zoning regulation)
Not dead but super slow. Maybe slow enough to make people wonder whether it's dead.
I work at an a LP, and it's really hard to find any multi development deals that pencil right now. For a deal to make sense today, at least one of these things have to move to our benefit: 1.) land price, 2.) construction costs, 3.) rent growth, 4.) spot cap rates, and 5.) debt market. So far, they're all moving in the wrong direction.
PM me, I have some deals that meet some of your criteria.
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Commercial Real Estate Developer
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