Currently, we are still building, however me and my team's mood changes by the day. On one hand, all the metrics - demand for apartments (at least in our region), lack of supply, lack of affordable single family options due to prices/mortgage rates, are all good, but this 10 year treasury jumping to 5% has us rethinking. We're still able to build to 8+% return on costs, but going from a refinance rate of sub 4% to 6+% has us a little concerned.
One scenario I see, is maybe the Fed readjusting their 2% inflation target, or at least how inflation is defined. Maybe rates creep down 100 basis points if at all, inflation comes to the 4-5% range. Labor market continues to remain strong, although unemployment creeps up maybe 4-mid 4% range. I would think the tailwinds of the boomers retiring and younger folks filling those positions would be hard to fight - even with the rate increases. Hopefully wages increase to help offset the many years where wages did not keep up with inflation.
On the one hand, I don't see rents declining in our markets (tier 3 markets if you could even call it that). I would think the 10 year treasury would go back down and mortgage rates don't remain this high for long term, however I'm certainly not willing to stake my net worth on that.
How the hell were multifamily developers building back in the day at higher return on costs and selling at high cap rates?
I know there's plenty of smart people in this forum - what's everyone thinking right now given the environment and what's their strategy? Go ahead and light up my analysis.
Where are you building at 8%+ YOC? Garden I’m assuming.
We are building Class A high rises in the most sought after markets in locations with 93+ walk scores.
Kidding - rural south east markets with populations of less than 50,000. And yes, garden.
What does garden mean?
Low-rise, three story or less. Typically no elevators.
While this is not the topic of discussion I really really struggle to believe your 8% untrended YOC in rural markets.. I am very close with a group of bankers (we go on golf trips.. etc). Over the last 12 months they rarely if ever see anything over a 7.25%…
Give us an example with high level metrics?
Sure, that's fair. I came from an institutional type development company that built Class A and it was rare to underwrite anything under a 6, and believe me, we were usually pretty aggressive on rents to get that 6%. I had a meeting with a guy who was building smaller stuff, 36, 48, 56, 80 unit complexes and when he explained to me that he was building these projects with 9% return on costs (at least for the smaller ones which required little to no infrastructure), I didn't believe him. After he showed me his T12's, I decided to join him.
Anyways, we self GC everything. Without that, we wouldn't be able to get the returns on our projects we want. That's honestly the single biggest thing we do to add value. We bid out a recent project we had completed and the lowest bid came in at 20% higher. 10% they put in their pocket, and the other 10% is because they don't care about the sub's prices - it's not their money. At least a GC isn't going to care as much about costs as you will.
Another thing we do is we build the same building everywhere we go. That way we are able to vet bids better, estimate costs, and project timelines to a better accuracy - at least substantially higher than if we were to build a new type of building everywhere we go. Notice how Dollar Generals and McDonald's virtually look the same everywhere you go? We are trying to solve a housing problem here, not trying to build the fanciest building ever. Besides, in our submarkets, the typical product is 20-30 years old, it's not that hard to look better than the competition.
Everything we do is to the bottom line - our units are smaller, one bedrooms are less than 500 square feet, 2's are around 700. So while we may charge about $900 for a one bedroom, on a rent per square foot basis, it is knocking around $2.
We don't pay outrageous prices for land, typically less than $200-$700 a unit. We built a 56 unit on land we bought for $40,000. Our most expensive piece cost us close $2,000 a unit.
We buy a lot of our stuff directly from China so that there's no middleman involved. Flooring, cabinets, mirrors, etc. My partner speaks Mandarin and has relationships with suppliers there.
At my old firm, it was common to pay $800k and $2m+ on architectural fees, and $150k+ on engineering depending on whether it was a garden style apartment or a hi-rise. For us, it's usually about $5,000 to get the same plans tweaked and stamped. On the engineering side, it's usually about $30-$40k.
We don't build amenities. Why build stuff that's going to increase operational costs? At probably 85+% of apartment complexes, the gym is a piece of crap anyways. There's two treadmills, a row machine if you're lucky, a bouncy ball, a pull down cable, and a dumbell rack that goes up to 40 pounds. Anyone who actually cares about a gym is getting a membership somewhere else.
We also don't add dishwashers or laundry hook ups in the units. We are putting a shared laundry area within the context of the housing building, usually in a storage closet. This cuts down on costs, plus putting it within the framework of the building means we won't have to build a free standing building for laundry.
Let me know if this helps.
There are other, existing topics already discussing the above - so not going to regurgitate those thoughts.
With that said, we've been in a fixed income bull market since the mid-80s, which means capitalization rates (and cost of capital in general) has been decreasing for 40+ years. How did Developers do deals in higher rate environments? Well, they grew NOI in higher nominal inflationary environments. Real estate is a natural inflation hedge as replacement costs increase and thus rents trend higher. So lots of (nominal) wealth was made in those 70s - 80s higher inflationary environments because the nominal capital value increased dramatically versus recently most of the capital value has been through decreasing cost of capital / compressed capitalization rates.
To be fair, I think those threads that you are referring to were pertaining more to acquisitions than development.
I've been watching a lot of youtube videos about gardening. Pretty chill hobby.
Seriously though, making sure existing deals don't shit the bed and trying to get creative with fundraising on pursuits. Feels like we're going to get new starts underway late this year/early next but we're going to be raked over the coals in order to do so. The bosses need fees though.
Switched to AM. Development has been dead for the last year roughly. It’s going to be dead for the next several years since yields are already way too low and peak NOI is behind us. I think the only way we get back to a point where it makes sense to build again is if/when rates fall and construction costs come in all of which will take time and pain.
The saddest part is the Fed screwed everyone so badly that the only way to make deals pencil is for rates to come down. Theres some sad logic here.
Or for land or construction costs to come in. Acting like the Fed has "screwed" everyone is such a bad take. You can argue just as easily that the Fed was handing out easy money for years by allowing rates to be kept so low.
This isn't a particularly bad credit environment. We've had periods where SOFR or it's predecessor equivalents have been as high or higher than it is now, and still things got built. The rapidity of rate increases has maybe caused a dislocation in terms of bid/ask on land and construction basis, but other than that, the last 10 years is the anomalous period, not 2022-23, which far more closely resembles historical norms.
What you mean to say is that the only way for deals to pencil at 2021 land prices is for rates to come down, which is not at all the same thing. We'll have a dead period while sellers adjust, and then some people will get back to building, the ones who were prudent enough to make provisions for a rainy day and can wait this out without churning new deals, or the ones whose business models never saw an interruption in the first place
I say this on every thread that brings it up and ill say it again. Yes, rates hurt, land still too high, but all this shit PALES in comparison to construction costs.
Until construction costs come down we're all gonna be twiddling our thumbs. Whenever all the greedy subs have their come to jesus we can get back to work on new pipeline.
Can I PM? Interested to connect with someone who has done both development and asset management.
Fire away.
Huge part of the reason construction costs are out of control = massive margin expansion i.e., price increases at many of the building materials suppliers. I hope these companies get fucking rocked next year and have no choice but to severely cut prices.
High rates are a painful necessity.
We just put a project out for pricing and are seeing the first instances of softened pricing. Saw a ~5% decrease in pricing over initial concept versus our other recent projects with price escalation throughout the GMP process. GC said that subs are less and less confident in their new business pipelines with so many projects being put on ice and are coming back with tighter numbers.
Can you share what market / when was the last time you had them price? Thanks.
Honestly, looking to switch out of development for right now. Too many things not going right mostly because of construction costs. At this point any other changes in budget for projects in construction even minor just feel really compounded than what it would be in other times. I'm hoping to come back hopefully in a year when the market is settled and costs to build aren't off the charts.
Honestly outside of a few long term deals I have been working on for a while, I am shifting all of my capital resources into covered development opportunities. I think this is a HUGE market opportunitiy to get into development deals at a drastically reduced basis compared to the past 5 - 7 years. I think those who are launching construction in the next 6 months with 24 - 36 month projects will be entering the market in a very interesting time, hopefully a much better debt market with very limited competition that will further help push down cap rates. Underwriting to a stabilized caprate at delivery of 8 - 9 with market conditions pushing that down to 4.5 - 5.5 transaction cap will create very big wins.
What markets are you getting to stabilized 8-9’s? What is untrended look like for those. We are only seeing stabilized 7-7.5’s in FL
Pretty much any market. I can buy development projects at a buildable basis that is 30 - 40% lower than they were 18 - 24 months ago. When I am modeling out projects I am looking at the massive development crunch that is likely to happen in some asset classes and factoring that in. Look at past developmet busts to get an idea about how long it takes for the cycle to turn around. The 1980s bust is in my opinion is what we are going to see opposed to the market post GFC.
Regarding construction/labor costs, I'd be surprised if they didn't come down pretty fast.
For our manufacturing businesses, labor has come down quite a bit in the last 12 - 15 months. Feels like 2019.
100%... and construction unemployment is one of the best early indicators of a recession.
Not sure about everyone else but I work for a mid size regional developer and we’re starting up pre-dev on all of our pipeline deals and to get them shovel ready. We are taking a risk with spending money on deals with yoc around mid to high 5’s but we are betting that construction costs are going to be down all time in the within the next 6 Mo-1 year. When that happens we will hit go and get a desirable basis and refi at a later time (hud fixed rate). It’s definitely something I can get behind because it’s keeping our jobs. Also, we are trying to tie up as much land as possible with numerous extension periods that aren’t typically market.
Curious: why do you believe construction costs will come down?
I concentrate on several different asset classes and can develop and acquire, depending on the relative favorability of either. With that said, we've had two really interesting multifamily sites hit our desk in the last 24 hours and I've been spending time working through the numbers. Holy crap do these suck. Like a 5% ROC if I stretch on rents. This is with $2.40-2.50/SF rents and a $15K/unit land basis. How the hell are any of you guys making this work?
What market?
Midwest.
Can you elaborate? I would think at $15k/unit land basis and $2.50 sf rents you should be able to get 5% roc
Rents weren't quite $2.50/SF. If they were you are right, it would be over a 5%. It was also an inefficient building (sub-70 units), so the opex ratio was pretty poor. I also needed to build two levels of structured parking which increased the costs. Biggest issue in our market is taxes - $5,500/unit is a good baseline assumption. $2.40/SF rents, $300K/door basis, 40% opex ratio - you aren't getting to a 5% ROC.
Any VP level folk out there looking to chase distressed multi in LA + other markets? I’m sure the capital I’ve mingled with would entertain a few other markets if the story is solid and similar, but I had a portfolio of smaller distressed dev deals come across my desk where the lender wants to short sale potentially, but developer claims to have big money that would drag their feet out instead of being wiped out. Broker who brought it is tight with the debt and the developer so I want to go directly to the debt and make an offer. Some apartments and some condos buildings in the 2-20/30 unit range, where condos are something I’ve been very intrigued by lately (publicly on here too lol). DM me if anyone’s on the development side of things, looking for someone to master the execution and help on the capital raising perspective. Co GPs welcomed potentially too
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