Construction Costs And Delays Feeding Each Other, Throwing Projects Into Doubt, Builders Say

Developers and construction managers are facing a slew of challenges hampering their business — right when the city needs it the most.

“It's a very difficult situation, and one that requires a lot of creative thinking now, which may take longer,” Capalino Managing Director Susan Hinkson-Carling said at Bisnow's New York Construction and Development event Wednesday. “You spend a lot more time trying to figure out where you're going to get your money from, what it's going to look like in your capital stack — especially if you're relying on government money, it even becomes harder.”

Chief among the challenges, panelists said at the event, held at the New York City Bar Association, is the lending environment. But soaring material prices, acute labor shortages, bureaucratic delays — as well as new regulations that  cap buildings emissions in New York starting next year — are all complexities slowing projects and driving up costs.

“The economics become much more difficult, and obviously rents have also risen quite a bit,” said Josh Siegel, the president of development at Pembroke Cos., which is developing a senior housing project in the Bronx alongside Asland Capital Partners. "But not enough to really support much higher rates."

Lauren Cahill, the senior vice president at Grubb Properties agreed that rents have risen — but not as fast as interest rate hikes. The Federal Reserve’s benchmark rate is now 4.5% to 4.75%, up from basically zero this time last year.

“I’m looking at one of my deals, I had to add $21M, just because interest rate nearly doubled from last year. It’s hard to make those numbers work,” she told the audience. “It’s the construction lending, and it’s getting pushback on having a buffer … initially it was six months, and then we are hearing they are more conservative and pushing for nine to 12 months.”

The result has completely disrupted the capital markets environment, stalled deals and put a general malaise of uncertainty over the market. Nonbank lenders have ramped up offerings to fill the void, offering bridge financing as projects have blown past their budgets and timing.

All the same, projects are being slowed down and put on hold, Michael Giaramita, the CEO of Group PMX, a construction project management firm said.

“They go up to a certain point and they stop, and then it comes back out again. Those take months, and that's a problem for when you're staffing things,” he said. “I'm also seeing projects that are now being reduced in size. You’re starting a billion-dollar project, then the next month it's a $500M project.”

Typical hurdles in a project — like check-ins with the investment committee — are becoming more drawn out, said RXR Realty’s head of construction, Greg Clancy. But it is asset-specific, he noted, pointing to the company’s residential developments in New Rochelle continuing at full steam.

“It's driven by the demand in their market, the absorption rates have actually gone up since the beginning of the pandemic,” Clancy said. “Capital is not afraid to invest in those types of projects.”

But the run-up in costs, combined with delays in projects, have started to wipe out subcontractors, he said, which will only push up costs.

“As PPP expires, as pricing demands go up, and as developers are paying more slowly … subs are feeling that pressure,” Clancy said, adding he has heard in the last six months of the instances increasing. “As more subs go out of business, it reduces the supply of qualified contractors, which further exacerbates pricing pressure.”

These problems are coming where there is major demand for new construction across the asset classes. The housing crisis is now widely accepted as a threat to the viability of the city, and aging office buildings need to be upgraded to stay viable. Plus, the entire real estate community will be impacted by Local Law 97, which, when it comes into effect next year, will fine property owners who don't reduce their emissions by a certain amount.

That is playing out in the construction world, as builders consider what kinds of approaches to take in the creation of buildings.

In some ways, building sustainably can be an advantage in securing funding, BRP Cos. Managing Director Mary Serafy said — particularly as lenders are under pressure to make good on ESG pledges.

“We have two projects right now that we have lender pre-development loans. These will be 100% electric buildings," she said. "We have financial development crunch … So having this type of incentive, and working in to align with the requirements of the New York City Building Code is really working to our advantage.”

Still, the city needs some 500,000 homes by 2030, according to the Real Estate Board of New York. But according to the lobby group, developers filed applications for 440 projects during the first half of 2022— a figure which dropped down to just 186 projects during the second half of the year.

That marks a nearly 60% decrease in the housing pipeline over the course of 2022. Both Mayor Eric Adams and Gov. Kathy Hochul have laid out policies aimed at jump-starting housing development, including setting ambitious targets, creating incentives and adapting zoning. In particular, the expiration of 421-a, or Affordable New York, is said to be a major deterrent for affordable housing development.

Hochul has proposed extending the 421-a deadline back until 2030, meaning developers hoping to make use of the affordable housing tax break would have an extra four years to finish their projects. Panelists said proposals are welcome, but won’t make much of a difference until changes become laws.

“As much as the city might take transformative action on rezonings and emerging neighborhoods, and really try to incentivize mixed-income housing — [you need] the certainty at the state level for the extension or renewal or re-creation of these programs,” Two Trees Management principal Bonnie Campbell said on stage. “People aren't closing on their construction loans when they're putting their first pile in. So then you really have this mismatch, and it makes it impossible to execute.”