I'm seeing in a lot of deals recently (development deals) that it's not so much the land basis which makes the deal challenging, but the cost to build. I'm curious if anyone has any insight as to how much construction costs are likely to fall in a downturn. Is there any historical data on hard costs? Any resource to see where deals were pencilling say, in 2010-2013? I have to imagine it's supply/ demand driven. More project starts and a static amount of steel will drive prices for steel higher, for example. Contractors overwhelmed with projects will require a much higher profit margin to take on a new build to make it worth their while. All of this in the opposite direction in a downturn.
Together with this... Development is sort of like a freight train. If a downturn hits it's not like you can immediately stop the momentum of the train. Capital has been committed and projects are underway. Any ideas on how you'd assess the lag time as to when a bad market will start to impact hard costs on new projects?
I’ve worked with hotels. The execs at my firm said in 2008 they built hotels for $150/sf (and old documents support this, roughly). Today we’re building a hotel for $310/sf. A lot changes from project to project, but that’s an extreme difference.
That’s a huge difference. I’m more worried about construction costs falling than land prices as the markets I’m active in are very supply constrained.
Any idea what this does to rents when you have a downturn? Any historical data out there for long term rent performance in a given asset class?
There’s a lot of data on this. A lot of the brokerages publish data, same with Trepp. DBRS Viewpoint has a lot of data on CMBS and you can see how specific properties performed in your exact market. All this stuff is free. I would suggest taking to experienced brokers too, they should know how rents fared.
Truth is, it depends on the specific market and product type. Luxury apartments in Miami? Absolutely blew up and many lost their shirts. Affordable housing in Santa Monica? Tighter times but most did okay.
My take is that during the next downturn there's going to be a lot of vacancy and a bit of a bubble burst for a lot of recent build product in Multifamily specifically. Construction costs running up means all the developers are underwriting to tip-top rents in order to make their deals pencil and new supply is piling up pretty quick in a lot of markets, partially due to cheap financing. At some point a wave of developers will get caught with their pants down when rents stagnate or decrease a bit during their construction timeline and they have to deliver into a non-aspirational market.
Still bullish on industrial and workforce housing throughout the cycle though.
So in my case I'm building storage in high barrier to entry markets - NYC and select tri-state markets. We pass on a lot of deals. Everything we source is direct off market with the owners. We've put a lot of focus on our in house capability to source deals and almost never deal with brokers on the site acquisition side. We're underwriting all of our deals with no rent growth, just assuming flat rates based on today's numbers. I suppose it's anyone's guess, but take an asset class you like... Workforce housing, last mile industrial, etc. Something with strong demand drivers and supply constraints... How likely is a sharp decline in rents? Take something you feel less bullish about... Class A multifam for example... How much negative rent growth would you expect in a downturn?
I think a lot of these rent growth assumptions are total BS. So much supply coming online across numerous asset classes. Also not sure if real wages are still growing/ expected to grow... Maybe depends on asset class, but how much more can users be squeezed after a 10 year run? Feels like we need a reset.
I think building materials prices would drop substantially, as would unskilled labor, but the current skilled trade shortage is more a result of demographic trends whereas skilled labor is aging out and not enough younger people are making up the difference.
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