To say that 2020 has been difficult is an understatement. According to Chinese Zodiac, 2020 is the Year of the Rat. It’s very fitting, but not because of the animal’s negative perception or associated health risks. It’s fitting because the Year of the Rat symbolizes new beginnings, changing directions and moving on to a new chapter in life.
We’re now halfway through 2020 and the change to our day-to-day lives has become painfully evident. In navigating this new environmental, it’s always helpful to look toward your peers. Should you follow suit, or take the contrarian approach? Last month we decided to poll our clients (residential developers) to get a sense of what they’re thinking. Below are some of our findings:
It comes as no surprise that most developers are still cautiously looking for sites. Developers make their living by… developing; and, it’s tough to develop without a development site. It’s also not surprising to see a relatively small contingency on opposite extreme ends of the spectrum with 10% aggressively pursuing sites vs. a combined 10% of developers not likely to pursue or not at all pursuing sites. There are arguments for both sides of this coin. On the one hand, why take on a new development, already an inherently risky activity, when we’re in the beginning stages of a recession with so much uncertainty as to how this all shakes out. On the other hand, why stop when your competition is sleeping, market fundamentals are still strong, and rates are this low.
An overwhelming majority, 89% of developers still have readily available debt. Will lenders be more selective? Probably. Will borrowers get the same terms they were getting pre-COVID? Probably not. Still, it’s incredibly encouraging to see capital continuing to flow. It’s a key distinction that makes this recession far different from the last.
Before the pandemic hit, you’d be hard pressed to find anyone expecting a decrease in construction costs. It felt as if the “click-clack-click” sound of an ascending roller coaster would never stop. A severe shortage of labor was a large component of the seemingly never-ending rise in construction costs. While it’s tough to view all-time high unemployment as a good thing, perhaps it provides some much-needed relief to the construction industry’s labor problems. Yet, 17% of respondents are skeptical that costs will decrease over the next 12 months. While COVID might have solved some of the labor issues, it brought on a whole new set of problems to the construction industry’s supply chain. But overall, this is an area of optimism among developers.
We’ve all heard the famous line, “Insanity is doing the same thing over and over and expecting different results.” Even the most beneficial projects come with their share of detractors and NIMBYs. As technology progresses and access to information increases, the opposition’s ability to mobilize improves and their voices amplify. As a result, developers have increasingly become the scapegoat for all avenues of public distrust, and bear the weight of undue criticism for every dreadful, ugly, and crooked development that came before them. Meanwhile, local municipalities rely on a mix of sales and property taxes. It’s tough to generate sales tax under widespread quarantine; and with both commercial and oil and gas property values taking a hit, the Gallagher Amendment is expected to trigger an 18% drop in the residential assessment rate next year (from 7.15% to 5.88%). 94% of our survey respondents aren’t expecting the development process to get any easier. So, consensus says that instead of increasing tax revenue by fast-tracking thoughtful development projects, our politicians are relying on Colorado residents to voluntarily increase residential property taxes by repealing Gallagher this November… try to look the other way when Tommy Faragher’s “Look Out for Number One” is blaring through everyone’s speakers.
With all the talk of COVID causing people to flee dense urban areas for greener pastures, 84% of the developers we surveyed are planning to build infill – nearly double the amount planning on suburban. Maybe this is a case of “planning to” vs. “wanting to.” The cost savings of building 3-story walk-up seem to outweigh the rent discounts seen in the suburbs. However, suburban sites are difficult to find. Most suburban sites aren’t large enough to scale, require a rezone, or are too far on the fringes of established areas. Or maybe it’s the fact that social distancing goes against human nature, especially for our younger population with a higher propensity to rent. This pandemic won’t last forever, and, for better or worse, the past can be easy to forget. Only time will tell how this pandemic will impact consumers tastes and preferences. There is one thing we can be certain of: this pandemic won’t result in a flood of new condos – despite an acute shortage of condos, and average sales prices outpacing wages, only 5% of developers are willing to take on the litigation risk.
-Travis Hodge, Sr. Investment Advisor
Published in the August 2020 CREJ Multifamily Properties Quarterly.
for full issue: https://www.signatureflip.com/crej/mp/2020-08-05eEdition.pub/