Although we have been seeing signs over the past couple of years of a slowdown in construction starts for multifamily projects in hot coastal markets, over the past six months this trend has noticeably escalated to the point where a growing number of developers just can’t make a project work financially. The combination of high land prices and construction costs have been the main factors for killing deals in major cities such as Los Angeles, San Francisco and New York City. Ten years ago, construction costs to build in Los Angeles were less than $200 dollars per square foot, while today we are seeing upwards of $350 per square foot. While rents have grown substantially over that time, we are at a tipping point as to what the rental market can bear.
As a recent example, I have done a dozen or so construction loans over the years with a very experienced and successful multifamily developer. This developer had to make the decision to walk away from a fully designed and entitled, 200-unit Los Angeles area project. Now, they are trying the sell the parcel, but new prospective buyer/developers can’t make it work for their purposes either. It is an unfortunate situation that is a problem for a growing number of developers.
Ultimately, land prices will need to come down in the coastal markets in order for projects to pencil favorably for developers again. It is also important to note that while construction costs are higher throughout the nation regardless of a given market compared to several years ago, areas like LA, San Francisco and NYC come in even higher due to higher costs of labor, taxes and fees.
With that said, opportunistic developers are seeking alternative markets that have favorable job growth and demographics, and lower land and labor costs such as Denver, San Antonio, the greater Phoenix area, Salt Lake City, and North Carolina, among others.
In Denver, Parkview Financial is providing a construction loan for a 126-unit apartment project. The developer bought the land for about $2 million whereas compared to the Los Angeles market, that same parcel of land would have been $7 million to $10 million. In San Antonio, we are funding a 144-unit project that is coming in at $80 per square foot, an impossibility in other core markets. And, even though rental rates are less in Denver and San Antonio than LA, the lower cost of land and construction provide developers with a more promising profit margin upon completion.
Ultimately, the demand for housing continues to far outweigh the supply for major coastal areas, but land sellers will have to lower their expectations on asking prices in order for a transaction to occur. In the meantime, developers looking to survive will seek out locations where they are confident of projected returns.