{"id":15546,"date":"2023-04-18T03:42:57","date_gmt":"2023-04-18T10:42:57","guid":{"rendered":"https:\/\/essential.construction\/news\/banking-turmoil-stirs-up-new-headwinds-for-construction\/"},"modified":"2023-04-18T03:42:57","modified_gmt":"2023-04-18T10:42:57","slug":"banking-turmoil-stirs-up-new-headwinds-for-construction","status":"publish","type":"post","link":"https:\/\/essential.construction\/news\/banking-turmoil-stirs-up-new-headwinds-for-construction\/","title":{"rendered":"Banking turmoil stirs up new headwinds for construction"},"content":{"rendered":"

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Signs point to decreased construction activity in coming months as financing costs for many developers have become prohibitively high, sources told Construction Dive.<\/span><\/span><\/span><\/span><\/span><\/span><\/p>\n

For example, increased interest rates are making construction projects more risky and less profitable, said Nicolas McNamara, director of project management at CBRE, a Dallas-based commercial real estate services firm.<\/span><\/span><\/span><\/span><\/span><\/span><\/p>\n

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Nicolas McNamara<\/p>\n

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\u201cIncreased financing costs remain a concern around construction.\u201d said McNamara. \u201cDevelopers are challenged with projects that simply are not penciling due to increased rates.\u201d<\/span><\/span><\/span><\/span><\/span><\/span><\/p>\n

Recent <\/span><\/span><\/span><\/span><\/span><\/span>uncertainty in the banking industry<\/span><\/span><\/span><\/span><\/span><\/span><\/span><\/span><\/a> is compounding that issue for construction firms, he said.<\/span><\/span><\/span><\/span><\/span><\/span><\/p>\n

The impacts of those headwinds are already visible. Construction <\/span><\/span><\/span><\/span><\/span><\/span>backlog decreased to 8.7 months<\/span><\/span><\/span><\/span><\/span><\/span><\/span><\/span><\/a> in March, its lowest level since August 2022, according to Associated Builders and Contractors.<\/span><\/span><\/span><\/span><\/span><\/span><\/p>\n

Meanwhile, the Dodge Momentum Index, a benchmark that measures nonresidential building planning, <\/span><\/span><\/span><\/span><\/span><\/span>tumbled 8.6% in March<\/span><\/span><\/span><\/span><\/span><\/span><\/span><\/span><\/a>, a fall that Sarah Martin, Dodge\u2019s associate director of forecasting, tied to banking insecurity.<\/span><\/span><\/span><\/span><\/span><\/span><\/p>\n

\u201cLending standards for small banks in particular have substantially tightened as banking insecurity intensifies,\u201d said Martin. \u201cAs a result, owners and developers are more likely to pull back in the short term.\u201d<\/span><\/span><\/span><\/span><\/span><\/span><\/p>\n

This uncertainty will cause big banks to either be cautious in lending or to mitigate risk with higher rates, said Todd Burns, president of project and development services at Chicago-based JLL, a real estate services company. These large banks, such as JP Morgan, Citi and Morgan Stanley, tend to set the market price for the cost of capital.<\/span><\/span><\/span><\/span><\/span><\/span><\/p>\n

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Todd Burns<\/p>\n

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\u201cThe increased interest rates and the cost of capital will continue to influence financing negatively,\u201d said Burns. \u201cIf the cost of capital is high, then financing will obviously be high as well.\u201d<\/span><\/span><\/span><\/span><\/span><\/span><\/p>\n

That trend is fueling increased concerns about access to capital in general, and the development of a vicious cycle where lenders charge more to limit their risk, and developers won\u2019t or can\u2019t pay higher interest rates to achieve their targeted returns. The result could trigger a long-talked about recession, said McNamara.<\/span><\/span><\/span><\/span><\/span><\/span><\/p>\n

\u201cBanks do face asset issues, such as unhedged exposure to government securities and exposure to falling real estate values,\u201d said McNamara. \u201cThe current situation could lead to tighter credit conditions and the possibility of a moderate recession in the second half of 2023.\u201d<\/span><\/span><\/span><\/span><\/span><\/span><\/p>\n

Focus on yield<\/span><\/span><\/span><\/span><\/span><\/h3>\n

Another factor influencing financing availability is the focus on yield, said McNamara. Developers are now required to achieve higher unlevered yield on cost \u2014 a property\u2019s return after purchasing costs and renovation expenses \u2014 to move forward with projects due to this changing financing landscape.<\/span><\/span><\/span><\/span><\/span><\/span><\/p>\n

This creates challenges for new projects to meet their financial goals and may lead to fewer projects being approved, he added. McNamara said to expect \u201cseeing projects getting canceled entirely or significantly phased or cut back to be able to be financed.\u201d<\/span><\/span><\/span><\/span><\/span><\/span><\/p>\n

At the same time, owners and developers are showing a willingness to wait out these interest rate fluctuations, which further slows down building starts, said Burns. When projects do pencil out in the current environment, it\u2019s only after considerable diligence.<\/span><\/span><\/span><\/span><\/span><\/span><\/p>\n

That delay ultimately leads to more costs, said McNamara.<\/span><\/span><\/span><\/span><\/span><\/span><\/p>\n

\u201cIf they are penciling, it\u2019s after a significant round of time and preparation has happened,\u201d said McNamara. \u201cThen additional escalation is required for rising construction costs.\u201d<\/span><\/span><\/span><\/span><\/span><\/span><\/p>\n

For instance, Shopoff Realty Investments <\/span><\/span><\/span><\/span><\/span><\/span>paused construction<\/span><\/span><\/span><\/span><\/span><\/span><\/span><\/span><\/a> on its approximately $550 million Las Vegas Dream Resort due to construction financing issues, according to Bill Shopoff, its president and CEO, in an email to Construction Dive.<\/span><\/span><\/span><\/span><\/span><\/span><\/p>\n

High interest rates and unfavorable capital markets also pushed Vornado to <\/span><\/span><\/span><\/span><\/span><\/span>delay its Penn Station project<\/span><\/span><\/span><\/span><\/span><\/span><\/span><\/span><\/a> for another two to three years, according to Michael Franco, its president and CFO, during the company\u2019s most recent earnings call in February.<\/span><\/span><\/span><\/span><\/span><\/span><\/p>\n

\u201cCapital markets are now making it almost impossible to build new,\u201d Franco said.<\/span><\/span><\/span><\/span><\/span><\/span><\/p>\n