Multifamily Construction

Apartment developers are getting creative in order to keep the construction pipeline flowing amid construction and capital challenges.

Four of the developers leading those efforts described their approach to continue building new housing in a session at the 2023 NMHC Apartment Strategies Conference in Las Vegas Tuesday. Each of the panelists has seen delays in their construction projects as the macroeconomic environment has shifted.

Jair Lynch Real Estate Partners had planned to have three market-rate projects start construction in 2023, but those projects are now delayed, said Ruth Hoang, the Washington, D.C.–based company’s senior vice president, development. “We’re still hoping one of them moves forward, but that’s 1,500 units and hopefully 600 move forward this year.”

Hoang said the developer is pivoting to ramp up its attainable housing strategy, investing $1.6 billion in acquisitions in that portfolio such as The Barcroft, a 1,300-unit affordable community in Arlington, Virginia. The strategy of pivoting to mixed-income or affordable housing development was echoed by the other panelists.

“We are going to focus on workforce housing,” said Kimberly Grimm, chief development officer for Menomonee Falls, Wisconsin–based Continental Properties. Grimm said that focus allows the company to go into more secondary or tertiary markets where the municipalities are “a little more reasonable” when it comes to scope, permitting and reducing fees. 

“We are trying to build a pipeline to have a significant number of groundbreakings in 2024,” she said.

Teaming up with municipalities and other partners is one creative way to move projects forward. On The Barcroft project, Jair Lynch partnered with Arlington County and the Amazon Housing Equity Fund to secure $310 million in low-interest financing to win a competitive acquisition process and preserve the community’s affordable housing.

Is pricing relief here?

The potential upside of the shifting economic environment and declining starts is an easing of labor supply constraints, and the panelists predicted the trend will have an impact on construction costs as the year goes on.

“The most common question I get is when is construction pricing going to come under control to save my deal?” said Dan Hull, president of construction for Cleveland-based NRP Group. Looking back at the period from late 2020 to mid-2022, the industry saw permits skyrocket 50% while completions only slightly ticked up as demand outstripped the industry’s ability to build and complete projects. The COVID-19 supply chain shortages amplified the problem.

“As I look at the next 9 to 12 months, I look at our ability to complete to start ticking up and permits to come back down to parity, and when that happens I see our buying power increase with subs,” Hull said.

NRP has also had success in recent years by expanding direct purchasing to improve buying power. The developer executed a large lumber purchase for 13 properties, for example, as a way to squeeze out some additional savings.

Value by design

Value engineering is an inevitable step in making projects pencil out as capital costs rise, and the panelists said they’re looking for creative ways to reduce costs without negatively affecting the resident experience.  

Rather than having those value-engineering conversations at the end of a project, where decisions will impact finishes that residents can see and touch, the process should start earlier during building design, said Chip Bay, chief construction officer for Boca Raton, Florida–based Mill Creek Residential. At the design stage, developers can look at making their floor plans more efficient and more easily repeatable for subcontractors.

That strategy is especially important for affordable housing. Whereas in market-rate housing the pressure is to go bigger and better, Hull said NRP Group is working with municipalities and housing authorities to reestablish a more reasonable scope of work that’s closer to projects the firm was completing four years ago.

On the labor front, the panelists predicted that capacity will start to trickle in this year from the single-family for-sale market as starts decrease. But the developers are also working hard to develop their own pipelines for talent. 

Bay said Mill Creek is hitting colleges with construction programs and beefing up its internship program. 

“We’re trying to get out there early, get ahead of it with the younger construction folks that want to get in our industry and that’s worked out very well for us,” he said.

Most signs point to 2023 being a much slower year than 2022 for apartment starts. In addition to persistent commentary from development and lending executives saying that financing isn’t there for new construction, multifamily permits fell 16.4% in November, according to the U.S. Department of Housing and Urban Development and the U.S. Census Bureau. Although they’re still at a robust annualized 561,000 pace, it is the lowest reading since September 2021.

“We think 2023 is going to slow down,” said Brian Oates, executive managing director of development at Atlanta-based apartment developer RangeWater Real Estate. 

But some developers might see a benefit. Fewer starts could stall some of the astronomical pandemic-era price increases they were experiencing by limiting competition for materials, labor and, eventually, land. Inflation, which has been an issue, is starting to level off.

In fact, construction input prices tumbled 2.7% in December from the previous month, the largest monthly drop since April 2020, according to an Associated Builders and Contractors (ABC) analysis. Despite that monthly drop, overall construction prices remain 7.9% higher than a year ago, according to the report.

But costs should be moderating soon, many experts say. Here are three reasons why building new units may be more affordable in 2023

1. Materials costs should stabilize

Construction costs have risen sharply over the last couple of years. On his company’s third-quarter earnings call, Houston-based Camden Property Trust CEO Ric Campo said his REIT was seeing them increase 1% per month — 12% per year. 

“We think that number is going to slow or go negative when we start seeing starts fall because most merchant builders are telling me today that their starts are going to be down substantially in 2023 and 2024, given [the] cost of capital and the lack of bank financing,” Campo said on the call.

Right now, there still are a lot of apartments — 932,000 — under construction. In fact, it's been nearly 50 years — December 1973 — since more units were being built. But some of that activity will soon burn off, potentially freeing up contractors. RealPage predicts that 575,591 new apartment units — the highest on record — will hit the market over the course of 2023.

With that many properties being developed, developers aren’t seeing a lot of across-the-board cost declines. “Prices haven’t gone down dramatically,” said Adam David Lynd, president and CEO of Shavano Park, Texas–based The Lynd Group. “That hasn’t happened yet.

But the situation has improved in some areas, especially for commodities affected by supply chain issues over the past couple of years. In mid-December, lumber dropped to $370.40 per thousand board feet — its lowest level since June 2020. 

“It has come way down from the supply-chain-driven peaks of last year and into this year,” said Ryan Davis, CEO of Witten Advisors, a Dallas-based firm that provides apartment companies with advisory services.

In addition to falling prices for some commodities, materials are generally more readily available. “You’re not seeing the supply chain issues that we experienced in 2020. [But] I wouldn’t say It’s smooth sailing by any stretch of the imagination,” said Lissette Calderon, CEO of Miami-based Neology Life Development Group.

Developers and builders of apartments aren’t out of the woods yet, according to Anirban Basu, ABC chief economist. “Though there is evidence of improving supply chain functioning and moderation in input prices, contractors should not be tempted into complacency,” he said.

Some items, like electrical transformers, can be especially challenging to acquire. “Our electrical equipment — transformers and switch gears — have 12-month lead times in several of our markets,” Oates said.

2. A single-family slowdown will ease some labor concerns

Although there are historically high levels of apartments under construction, there has been a pronounced slowdown on the single-family side, with the pace of construction down 32% since mortgage rates began to rise last February, according to the National Association of Home Builders.

That’s making materials like lumber and labor more available for apartment construction. “Seeing the single-family projections coming to a much slower pace is a big indicator with regard to the availability of the groups we can partner with on our projects,” said J.B. Curry, president of Indianapolis-based TWG Development.

Developers of wood-framed, garden-style projects are seeing a direct benefit, according to Davis. “There's a considerable overlap with the single-family side in terms of just the knowledge to construct those properties,” Davis said.

But on the more complex projects, like high rises, prices haven’t dropped across the board. Contractors are currently maintaining their longest backlog since 2019, according to ABC’s construction backlog indicator, Basu said.

Oates agreed. “Until that backlog gets eaten up, I don't think we're going to see much movement from a labor perspective or from a material cost perspective,” he said.

3. Land costs should eventually fall

If the economy falls into a recession as many predict, land prices probably won’t fall immediately unless a particular seller is under financial stress or is highly leveraged. “Land guys are always the last ones to capitulate,” Davis said. “Right now, they’re holding steady.”

Though there have been a few exceptions, the situation is no different now, according to Davis. “For the most part, they’re going to stick to their prices,” he said. “But it's going to be more favorable [for developers] in terms of there no longer being these big escalations in prices.”

In a fluid market, it’s hard to peg a price for land, according to Campo. “There is definitely some sort of movement on land sellers in terms of what the price should be in the future,” he said. 

But land sellers will probably get more desperate if developers who committed to buy their properties back out of deals. 

“Most of my merchant builder friends, if they're not hard on a contract and have significant investments, they've dropped their contracts, and they know those land sellers are all getting dropped across the country,” Campo said. “And it will be interesting to see what happens in the first quarter.”

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Dive Brief:

• The New York City metropolitan area finished as the top market for commercial and multifamily starts in 2022 at $37.1 billion, an increase of 37% from 2021, according to a recent Dodge Construction Network report.
• The Dallas metropolitan area placed second, reaching $16.7 billion in 2022, a 51% jump from 2021, while the Washington, D.C. metro area ranked third during 2022 with $11.4 billion in starts, a 38% gain over 2021, according to Dodge.
• “2022 will go down as a banner year for construction starts,” said Richard Branch, chief economist for Dodge Construction Network. “Even when adjusted for inflation, commercial and multifamily starts were impressive as construction activity began to move back toward downturn urban cores.”

Dive Insight:

The top 10 metropolitan areas accounted for 40% of all commercial and multifamily starts in the U.S., up from 37% in 2021, according to the report. Commercial and multifamily starts consist of office, stores, hotels, warehouses, commercial garages and multifamily housing. 

Increased demand for data centers and retail projects largely fueled growth on the commercial side. Meanwhile, strong demand for apartments and condos boosted start activity in the multifamily sector, according to Dodge.

Below are the top 10 metropolitan areas in 2022 for commercial and multifamily construction starts, according to Dodge:

Looking forward, though, Branch does not expect that rate of growth to continue over the next 12 months.

“This pace of activity, however, is unlikely to be sustained in 2023 as the economy is slated to slow and approach stall speed,” said Branch. “Commercial and multifamily construction starts are likely to take this on the chin and post declines for the year.”

Indeed, a recession in the housing market is already underway. National Association of Home Builder’s chief economist Rob Dietz said this week at the International Builders’ Show in Las Vegas he expects the sector’s malaise to spread to the rest of the economy. 

“We’ve never had a period where home prices have declined and there has not been a recession,” he said. “I think the rest of the economy will feel it in 2023 via slowing economic output and rising job losses.”

As apartment starts slow in 2023, developers need to be much more careful.

For Atlanta-based apartment developer RangeWater Real Estate, that means being more cautious about how it moves through its pre-development pipeline. 

“There's so much uncertainty in the market,” Brian Oates, executive managing director of development at RangeWater Real Estate, told Multifamily Dive. “Where previously we'd get a project under contract and move as quickly as we could, we're being a little bit more strategic in looking at the milestones so that our pre-development spend is tracked a little bit better.”

RangeWater will still be active, planning to start 1,327 units this year. But that will be a dropoff from the  2,774 and 2,482 apartments started in 2022 and 2021, respectively. It also manages more than 93,000 multifamily units across 11 states.

RangeWater will continue to look at new markets, but Oates said the company will focus on growing in the areas where it already has offices. “We’re really focusing on Texas, Colorado and Arizona, where we currently have a presence, but want to have a deeper penetration,” he said

Here, Oates talks with Multifamily Dive about the labor, materials and the financing outlook for 2023.

This interview has been edited for brevity and clarity.

MULTIFAMILY DIVE: Do you expect construction to slow in 2023?

BRIAN OATES: We think 2023 is going to slow down. One of the biggest factors is interest rates and capital markets. The debt markets have gotten a lot more expensive. That is making things challenging. And then because of interest rates, the cap rates are expanding, which means values are going down. 

This year we'll start fewer projects than we have the last several years. But our key is to execute and really make sure to get those started. We feel like anything we can get done and which has a unique story is going to outperform because there is going to be limited supply when these projects are delivered in 16 to 24 months.

What do you see happening with labor and materials?

Even though we see starts slowing down, contractors are still busy. Until their backlog gets eaten up, I don't think we're going to see much movement from a labor perspective or from a material cost perspective. 

What we are predicting, based on our conversations with our contractors and our in-house general contractor, is that pricing will hopefully moderate. Last year, across our markets, pricing went up about 18%. We think they're going to be up 3% to 5% across most of our markets this year. We're just looking for stability.

Are supply chain issues easing?

We don't have pricing advantages yet. We're still in the process of seeing the delays shorten for the availability of materials. Our electrical equipment — transformers and switch gears — have 12-month lead times in several of our markets. So we're still trying to play around with those supply chain challenges.

How difficult is it to get construction financing?

There are larger banks that potentially have exposure in other asset classes that are saying, “We're just not lending for new construction right now.” That's a portion of it. 

We also work quite a bit with some regional banks, and their lending requirements have tightened up. Then on top of that, historically, a lot of these banks were working with merchant developers. And the idea is that as loans are coming off their books, they are replenishing us with new loans. But since there are limited sales, developers aren’t paying off those loans. 

So some of the lenders we deal with are saying, “We enjoy working with you guys, but we need to replace one of these construction loans. Since we’re holding on to deals a little longer, there’s not as much capital to put back into new construction.”

Do you see some merchant developers being forced to sell their projects before they want to?

In my mind, the first domino to fall will be some of those groups who may have the values reset by 20% but still want to take the chips off the table and make a little bit of money. Then I think, later in the year or next year, the developers who used some aggressive financing, have mezzanine debt or have added additional people in the capital stack will be forced to sell. But we have not put additional preferred equity on our deals.

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Dive Brief:

• The housing industry downturn is poised to push the U.S. economy into a mild recession this year, according to the National Association of Home Builders’ chief economist.
• Elevated inflation and mortgage rates coupled with the high building material and construction costs that have plagued the industry since the start of the COVID-19 pandemic continue to take a toll on residential contractors, Rob Dietz said at a press briefing at the International Builders’ Show Tuesday in Las Vegas.
• 2022 was the first time in 11 years that single-family starts declined, falling an estimated 12% to 999,000 units, the NAHB reported. “Our thesis is that recession is underway,” Dietz said.

Dive Insight:

Dietz noted that the home building industry is a bellwether for the health of the entire U.S. economy.

“We’ve never had a period where home prices have declined and there has not been a recession,” he said. “I think the rest of the economy will feel it in 2023 via slowing economic output and rising job losses.”

NAHB is projecting negative GDP growth for the first two quarters of 2023. Two sequential quarters of economic contraction is one traditional indicator of a recession.

Although home prices are declining in many U.S. markets, it has not been enough to boost housing demand. Affordability conditions continue to deteriorate, as mortgage rates have more than doubled since the beginning of 2022, Dietz said.

The difference between a 3% and 6% mortgage rate can add more than $700 per month to the cost of a typical home loan. As a result, NAHB is forecasting that home prices could fall as much as 15% in 2023 following a nearly 40% gain since the pandemic began.

Interest rate outlook

NAHB is also forecasting that the Federal Reserve will raise short-term rates by another 25 basis points in February and a final quarter-point increase in March, according to a press release.

The NAHB believes the cumulative effect of the central bank’s rate hikes will be a peak rate of just above 7%. But looking forward, the group expects mortgage rates to fall below 6% by 2024. 

“Falling rates will set the stage for a housing rebound later in 2023, and a better affordability environment will lead to a recovery of housing demand,” said Dietz.

Other issues addressed by Dietz include:

Supply-side factors. While building material price increases have slowed, many contractors continue to experience supply chain disruptions for electrical transformers, concrete, appliances, doors, windows and other products.

One bright spot is that the price of framing lumber has fallen below $400 per thousand board feet — back to pre-pandemic levels, Dietz said. However, builders will need additional lumber as the housing market rebounds later in 2023.

“We need the administration to reach a new softwood lumber agreement with Canada so that lumber supply will be sufficient for future gains in construction,” Dietz said.

Labor. The number of open construction positions was 388,000 in November, and resolving the labor problem will be a key issue for the industry in the coming decade, he said. 

“We will need 740,000 construction workers annually to account for industry expansion and industry retirements,” said Dietz. “Recruiting, training and retaining skilled workers will be job No. 1.”

Multifamily. Apartment construction boomed in 2022 to 545,000 starts, an estimated 15% rise from the previous year. Because of slowing rent growth, rising unemployment, tighter financing and a decades-high level of inventory in the pipelines, NAHB is projecting that multifamily starts will fall 28% this year to a 391,000 total and will stabilize in 2024 at about 374,000 starts. 

There are currently more than 940,000 apartments under construction, the highest total since 1973.

Looking ahead, Dietz said he is hopeful that the second half of 2023 could lead to a turning point for housing and the economy.

“With interest rates projected to normalize in the second half of 2023 as the Federal Reserve taps the brakes in its fight against inflation, the pace of single-family construction will bottom out in the first half of 2023 and begin to improve in the latter part of the year,” he said. “This forward momentum will lead to a calendar year gain for single-family starts in 2024.”

Dive Brief:

• As more companies adopt remote or hybrid work, the need for office space is declining. In the third quarter of 2022, office vacancies hit 17.1% — a nearly 30-year-high, according to CBRE. That reality has forced more office property owners to consider repurposing their spaces.
• In 2022, more than 12 million square feet of office space was converted to other uses after more than 8 million was completed in 2021. In 2023, that number is expected to jump to almost 20 million, according to CBRE.
• Apartments have constituted one-third of office conversion activity since 2016, making them the most common reuse option, according to CBRE. In that time, approximately 16.4 million square feet of office space has been converted into 89 apartment properties with more than 14,000 units across 26 major markets. 

Dive Insight:

Despite interest in apartment conversions, there are challenges, according to Jonathan Bennett, president of New York City–based AmTrust RE, who said the company was deciding whether to convert an office building overlooking the Hudson River in Westchester County, New York, into apartments.

“Offices are designed very differently than residential buildings,” Bennett said. “They’re designed with larger floor plates that try to cram more workers in during the day. And only the executives get windows, even though that’s changing a little bit today.”

But in residential buildings, every apartment needs to have windows. “So it doesn’t work on these massive floor plates,” Bennett said. “You end up with the interior of the four plates being dead weight and not usable.”

Even though some floorplates are just not compatible with conversions, CBRE notes that there can be creative solutions, “like creating common space, private lockers and storage facilities, gyms and offices, or gutting the area to add light and connectivity.”

If owners can convert offices to apartments, it can help them generate cash flow and benefit market fundamentals, according to Trepp. It notes that developers can also design central courtyards in larger structures, creating more access to the exterior.

As Bennett weighed the decision to convert an office building to residential, environmental benefits were also a factor.

“I’m hearing that if you can retrofit the existing buildings, there’s less of an environmental impact, and maybe it costs you less money as well,” Bennett said. “So maybe it’s a win-win. But I’m also concerned with what the living environment will be when we’re done.”

Apartments aren’t the only option for office conversions. In recent months, life sciences conversions (which is a sector where it is difficult to work remotely) have been popular among office owners, according to CBRE. Of the 26.8 million square feet of office space conversions in the fourth quarter of 2022, 11.4 million square feet will become life sciences space.

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