The real estate development game has changed drastically, and getting construction financing is an uphill battle. Developers better buckle up because the lending landscape is rougher than ever before.
The Interest Rate Onslaught
Interest rates have skyrocketed, making financing exponentially more expensive. In 2021, a $5 million construction loan at 3.5% interest would have cost around $300,000 annually. Fast-forward to today with rates hovering around 8.5%, and that same loan now costs a whopping $483,000 per year – a 60% increase! This rate hike has made countless projects financially unfeasible. A recent survey found that 61% of major apartment projects were no longer viable as of June 2023, up from just 18% in March 2022 before rates started climbing.
With the Fed having not backed down on “High-for-longer” rates to keep inflation in check, this hasn’t changed much since last summer. It’s also causing continued stress among lenders that fear the loans they have been having kicking the can down the road are not going to get relief before the refi comes due.
Lenders Getting Stingier
But high interest rates are just the start of the developers’ woes. Lenders have drastically tightened their lending standards, making it much harder to even get a loan approved in the first place. According to the Federal Reserve’s Senior Loan Officer Opinion Survey, a startling 72% of banks reported tighter lending standards for construction loans as of late 2023 – a complete 180 from just two years prior, when money was flowing freely.
This isn’t just for construction loans either, regional and local lenders, we’re hearing, are requiring borrows put up large (think +20%) deposits into new accounts to even get considered for a loan.
The Construction Cost Apocalypse
As if the financing hurdles weren’t enough, construction costs have gone through the roof thanks to supply chain disruptions and inflation. Material costs are 30-45% higher than pre-pandemic levels, with some increases being the largest in over 75 years. Even with moderating inflation, these exorbitant costs show no signs of coming back down to earth anytime soon.
Some developers have had to go begging to local governments for additional funding just to keep affordable housing projects afloat. Wake County, NC had to cough up $2.3 million in early 2023 to cover ballooning costs on a 156-unit complex.
The Path Forward
With interest rates, lending standards, and construction costs all in the stratosphere, developers have a tough road ahead. Those with deep pockets and a strong stomach for risk can still find opportunities, but the game has changed tremendously. Developers now need to take a hard look at feasibilities and be prepared to value-engineer like never before.
The weak hands will fall out of the game, but the strong, savvy developers will adapt and survive this harsh new world of real estate development and construction financing. Buckle up, because it’s going to be a bumpy ride.
Written by Claude AI. Edited by Andrew Dixon.
