New Projects on the Horizon Betray Sluggish Construction Growth
Announcements of large-scale development projects in some of the nation’s cardinal markets are fueling a shared illusion: space is already running tight. Most large metros can boast at least one submarket where supply constraints are choking renewed growth, entreating developers to be munificent. In a very few cases, prices have climbed far enough that developers are responding in kind.
Large parts of Manhattan fall into this rarefied company, with residential, office and mixed-use projects rebounding on architects’ drafting tables and on site. Except in the apartment sector, the observation of renewed development does not hold up in the national metrics. Reflecting the recovery’s disappointing labor market and absorption trends, as well as prevailing prices that remain well below construction costs, developers, construction lenders and the latter’s regulators are appropriately diffident.
New York remains a world unto itself, both in terms of its outsize role in the financial collapse and the aplomb with which it has navigated the recovery. Apart from the rapid and ongoing expansion of the hotel room inventory, the city is dotted with legacy projects that are approaching various stages of completion. Among them, the 1 World Trade Center tower, the Barclays Center arena at Atlantic Yards, and a spate of condominium and rental apartment buildings have sustained an otherwise moribund construction sector.
As those projects take shape, New York’s skyline is making room in the near-term for new residential development. Among the most visible projects, few can compete with Extell’s One57. Against that project’s 90 stories, Toll Brothers’ the Touraine is Lilliputian in scale. Both address a relative shortfall in the supply of luxury housing options that evince New York’s distinguished position. Further along, Brookfield’s Manhattan West and Related’s Hudson Yards add to the World Trade Center’s office inventory. Manhattan West alone would add 5.4 million square feet to Brookfield’s market-leading portfolio of New York assets.
A significant expansion of Manhattan’s office supply could easily drive market-wide vacancy rates higher. While the city has generally outperformed its peers in job growth, hiring has been erratic in recent months. Nor do the statistics show frenzied hiring in office-using occupations. Financial activities employment, in particular, has flatlined under weaker trading profits and the looming implementation of Dodd-Frank provisions. Financial activities employment in New York was practically unchanged in December as compared to a year earlier. The industry has lost almost 9 percent of its payroll count over the past four years.
Demonstrating a healthy level of bravado, well-positioned developers can expect to outperform the broader market statistics. Historical patterns indicate that the city’s aging core office inventory, coupled with internal migration of tenancy within the metro area, will see new trophy assets outperform colocated properties. In short, new buildings will hasten the life cycle for functionally obsolete assets. The latter will capture the brunt of higher vacancy rates and lower rents.
The Architectural Billings Index, a leading indicator of hard construction spending, has pointed to expansion in each of the past two months, albeit at negligible levels. The index’s commercial and industrial component indicates a relatively stronger outlook for commercial property investment. That supports a consensus outlook for commercial spending growth of 5.6 percent in 2012, with the largest gain in the hotel sector. By 2013, spending growth is forecast to rise by 11.4 percent, reflecting a combination of higher office and retail construction and pressure on construction costs.
The outlook for construction is not yet reflected in the observables. So far, the data show that nonresidential construction and contractor employment is only 2.1 percent off its nadir. Residential construction is up 2.3 percent, with losses in single-family housing offset by gains in the apartment sector. Some developers might be ready to proceed. Apart from a worrisome outpouring of cheap multifamily development financing, construction loans in other sectors are difficult to secure. Among banks’ recent commercial construction loans, our documents show that US Bank is providing $92.4 million for Chicago’s three-hotel development at 501 North Clark Street. Overall, financing is tight. With default rates on banks’ construction loans running 15 percent, four times the level for in-place assets, and loss severities more than doubling those on stabilized properties, sobriety is still the apposite tone at credit committee.
Sam Chandan, PhD, is president and chief economist of Chandan Economics and an adjunct professor at the Wharton School.