New York City Construction: Making Deals in a Cautious Market

Construction lending in New York City remains robust, with many high-end deals and luxury developments abounding and no shortage of commercial real estate projects. The New York City Building Congress anticipates $52.5 billion in construction spending in 2018, followed by $50.1 billion in 2019, representing the city’s biggest building boom of the 21st century. From Manhattan to Brooklyn, several ambitious, expensive development and infrastructure projects are underway that will transform the city in decades to come. Megaprojects include luxury condo towers, office buildings, and multi-use city spaces. A series of recent rezoning efforts in New York City includes an approval last year by the City council to rezone a section of East Midtown Manhattan, with the intention of encouraging the development of more office space and the development of a major business center.

Despite this ambitious construction growth, a sense of caution has permeated the New York City lending space, perhaps auguring a “new normal” for other large markets around the country. Construction prices are way up in most major cities, with New York leading the way as the most expensive  place to build in the world. Headwinds include high cost of material goods, including lumber and steel, labor shortages, and the impact of global tariffs on economic stability. Because New York City is so inherently expensive to build in, and because sellers are finally capitulating on price negotiation, there is more movement on development of projects other than luxury condos. Land prices in New York City, which have some of the highest index values in the world, have nevertheless been tempering slightly over the last few years, as aggressive real estate sales have abated. And, while foreign investors are still snatching up New York City commercial real estate, they aren’t as aggressive, and the slowing sales (particularly of office space) have catapulted other cities past New York as a foreign investment destination.

As a developer or CRE investor, if you’re breaking ground now, it will still be 2-3 years until you’re leasing or selling the space, so the investment takes some faith, planning, and risk management. A precipitous drop in land sales in Manhattan in 2016 (a $3 billion fall in transactions!) slowly rebounded as stakeholders all adjusted to new realities and a shifting landscape. Construction lenders indicate that there is still a massive amount of capital on all sides waiting to be deployed. However, cheaper land, a saturation in luxury markets, and steadily rising interest rates have elongated closing time for deals and patience for the right transaction. The cost of lending is going up, but opportunities and capital continue to be available, so developers are more willing to take out riskier loans. The rises in cost and interest rates have been gradual and expected, and not a huge shock to the market. These costs are being built into investment plans. This is the new reality.

Managing construction risk in this type of market involves time, careful assessment and experienced guidance from consultants. More risk simply means more due diligence. Investors and developers should consider if their project is feasible, if it will be completed on time, on budget, if the pricing is accurate, if they are rushing into the front end to beat rising interest rates, if their contractors and subcontractors are taking on too many projects. All of these can compound potential default or project failure, but can be mitigated or avoided by construction risk management services. Contractor evaluations, budget reviews, document and cost reviews, construction progress monitoring and construction completion commitment are all components of ensuring projects are completed on time and on budget. Finally, a long lending cycle and dwindling new construction opportunities might provide incentive for developers to pursue auxiliary projects such as adaptive reuse or industrial and warehousing. It is more important than ever to employ environmental due diligence and physical building assessments at these properties to decrease financial risk and future liability.