ELEVATED INTEREST RATES ARE EXPECTED TO CURB CRE DEVELOPMENT IN 2024
Construction starts hindered. A tight labor market, strong wage growth, and elevated costs for food, services and housing have all contributed to keeping overall inflation elevated. The Fed has responded to this by hiking interest rates. As of late March, the overnight lending rate was at 4.75 percent, the highest level since December 2007. Also, despite a retreat in shipping costs and the average prices of steel and gasoline in recent quarters, construction materials costs remain elevated on a historical basis. Both higher interest rates and steeper building costs are having an impact on the commercial real estate construction sector.
Costs for building remain elevated. While projects that have already broken ground or locked in financing are still moving forward, many external factors are limiting new development starts. Banks have been executing fewer construction loans relative to previous years, as lenders tighten underwriting in response to increased risk exposure. If developers are able to secure loans, they come at rates well-above measures recorded prior to the health crisis. Furthermore, material costs for developers are still 33.5 percent above pre-pandemic levels, and wage growth in the construction sector registered 5.8 percent in 2022, outpacing the private sector average. While the effect on new supply will be minimal in the near-term, higher costs for financing, building materials and labor are expected to slow future development.
Industrial sector affected. Supply chain disruptions and a change in consumer spending habits elevated the need for industrial space, driving a significant rise in new product. Supply additions will reach a two-decade high in 2023; however, a slowdown in development is expected. Construction starts already declined by roughly 40 percent in the fourth quarter of 2022 relative to the previous three-month span. Also, Amazon, which accounted for roughly 16 percent of all warehouse starts over the past three years, recently announced plans to halt new construction. Fewer groundbreakings this year will translate to fewer deliveries down the line.
* Through January; ** Index: January 2019=100 Sources: Marcus & Millichap Research Services; U.S. Census Bureau; U.S. Bureau of Labor Statistics; Coresight Research