Cost of Capital Has CRE Projects Mostly Stalled

Article originally posted on Globe St. on March 2, 2023

Demand Drivers Should Return by Early 2024.

The rising cost of capital has stalled most commercial real estate development in 2023. Unless projects were already underway or financing had been secured, there will be few projects started, according to John Chang, senior vice president of research services, Marcus & Millichap.

In the firm’s 2023 Construction Trends Report video, Chang said that otherwise, “builders are being pushed to the sideline.”

The cost of capital is rising due to the Federal Reserve’s decisions to raise rates considerably, “making it difficult to get a construction loan, and if you do, it’s rather expensive,” Chang said.

Loans are running 350 to 400 basis points over the Secured Overnight Financing Rate (SOFR) of 4.5%.

Alternative debt financing is running between 8.75% and 10.5%.

Forecasting Growth for Key Asset Classes

Forecasting for what’s coming online in 2023, Chang said apartments are forecasted to complete 400,000 new units in 2023, growing the overall inventory by about 2.1%. Some 43% of that will be in just 10 metros.

Industrial will see 400 million square feet in 2023 for an inventory gain of 2.3%. Half of that construction will be in eight metros.

Marcus & Millichap expects 42 million square feet of retail to be completed, a “meager” half-percent of growth, Chang said, and two-thirds of that will be single tenant. Office will see 86 million square feet or growth of 1 percent and two-thirds of that will be situated in the suburbs.

Self storage should see 2.5% inventory growth – or 47 million square feet, which is well below the 73 million square feet completed in 2019. Self storage is a rare asset class where completions possibly will also grow in 2024.

Chang said demand drivers should begin to strengthen by early 2024 for most property types.

He added that there has been relative relief in materials costs for lumber (currently 38% above pre-pandemic rates) and cement (28% above).

Supply chain issues are now mostly under control, Chang said.