North Texas’ Commercial Real Estate is in Hyper-Growth Mode

Thanks to the influx of people moving to the area and pent-up demand from last year’s pause in multifamily construction, Dallas’s commercial real estate is in a hyper-growth mode with many construction projects underway. Despite this generally positive state of affairs, it’s evident that our industry as a whole is experiencing macroeconomic influences on construction costs.

John Griggs, Presidium

While I personally thought there may have been a temporary pause or even a reduction in construction costs due to COVID-19, and the resulting delay in construction starts in Q2 of 2020, this has not happened.

Volatile Costs Rattle Developers

The main headline throughout 2021 has been the parabolic rise and subsequent fall in the price of lumber, with prices escalating to a high of more than 300 percent of what they were in April 2020.

Then in mid-July, we saw lumber prices crash so much so that it started to give hope to developers and builders. Although lumber certainly is consuming the headlines, it is not the only area of concern. Collectively, the cost of building supplies has increased by close to 13 percent over the past year, according to Bisnow.

The U.S. Bureau of Labor Statistics’ producer price index has reported staggering increases in other essential building materials, such as steel mill products escalating by 87 percent and aluminum by 33 percent. And, while we’re on the topic, there have also been supply chain issues, labor shortages, and production bottlenecks that have only added fuel to the fire.

Fluctuating prices in the building industry have been so frequent — often changing dramatically by the day — that accurately estimating building materials costs and pricing out projects has become a significant hurdle for multifamily developers. Not to mention, the extended lead times we’re experiencing have resulted in us having to shift our focus from fast and efficient completions to more careful planning and coordination. This is why I believe that pre-construction is the essential phase in any significant project now more than ever.

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We must be both proactive and reactive, being flexible and adjusting to the latest industry insights. Without a solid plan (and backup plan) in place, things will slip through the cracks that could have been mitigated otherwise. Now more than ever, developers need to stay in close contact with construction trades to track the fluctuations of various materials and labor inputs.

The fluctuation of building material prices could catch one off guard if they’re unaccustomed to the market’s volatility, specifically as it relates to multifamily development.

For industry veterans, the challenges of rising construction costs are both frequent and inevitable, though perhaps not quite to the severity we’ve been experiencing throughout this year. We’ve experienced temporary demand spikes in the past, like when China was buying an abundance of steel or following Hurricane Katrina when high volumes of lumber were needed to rebuild an entire region. Now, we are in a prolonged and complicated hypermarket because it wasn’t due to a temporary macroeconomic event, but rather one that has been unprecedented in over a century.

While I’m unsure when the extreme highs and lows will settle, some of these issues are likely to be transitory, and I do expect prices to stabilize sooner than we think. But they are likely to stabilize at or near today’s elevated levels.

Rising Rents and Values Save the Day (for now)

Fortunately for developers, the rising costs have now been offset by rising rents and rising sale values for completed projects. This escalation didn’t happen in concert – there was a period lasting several months where costs rose before rents and values also inflated. But, just as things were getting more untenable on the cost side, rents began to take off in the last six months.

By July 2021, Dallas-Fort Worth’s average apartment rents were up 9.3 percent year-over-year, with many submarkets notching double-digit rent increases. Vacancies also shrunk dramatically, and move-in concessions tapered as well. With this furious increase in the top line income for apartments, projected NOI for new developments justified construction again, even with higher costs.

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After rents began their climb, sales prices for completed projects also rose nicely over this year, with price increases also well into the double-digits. Suburban Class A buildings new routinely cross the $200,000 per unit mark with more infill projects selling for well into the $200,000s per door and beyond – sometimes far beyond.

This pricing spike mirrors single-family pricing, which is also up 16 percent year-over-year in Dallas, which directly contributes to demand for apartments. The net result of escalating rents, coupled with cheap financing for newly built assets, was a frenzy of bidding for quality Class A multifamily product. And this rise proved to be the ultimate validation that it can still be worth it to build multifamily projects, despite the increased costs.

Risks Remain for Developers

While the escalation in rents and terminal values for projects have for now balanced out rising costs, this is not an “all clear” moment where it makes sense to build anything anywhere regardless of costs.

In some ways, this remains a fraught time for developers, as we take on the bulk of predevelopment expenses in getting a property to a groundbreaking before debt and equity are sourced. It’s relatively common for a developer to spend $1 million in predevelopment costs and deposits before a shovel hits the ground on a suburban project – and those costs are sunk if a project never gets off the ground.

With rents and exit values again justifying the construction of new multifamily in North Texas, it once again makes sense to build quality projects in robust submarkets. However, should costs continue to run further, there is always a risk that the balance once again tips the wrong way. Now more than ever, developers need to keep their fingers on the pulse of ever-changing data.

John Griggs is the co-CEO and co-founder of Presidium.

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