Construction and market downturn? Whats the relationship?

Question

I am looking to turn my SFR in San Diego into a Triplex. This has been some planning in the stages for the past several months and I am looking to possibly break ground in late September/October depending on permit approval. And from my readings, during economic downturns/recessions, we know that the rate of new projects or new constructions decreases. Majority of us know that a recession is coming, so my question is, how are construction costs affected? (IE labor, building materials, construction loans, etc). I know construction overall decreases, but do costs drop due to lack of work (cheaper labor)? or do they increase?

If it makes sense to hold on my construction, then I may wait an additional 6 months to a year to start.

Scott Choppin · Answer

@Jay Johal

@Greg Dickerson and I had this conversation a couple of days ago, but in a slightly different way. In that conversation, I expressed my assessment is that we are due for a recession - albeit our expectation is this next one will not be predominantly a real estate centric downturn. We expect rents will remain relatively stable in non-podium, non-Millenial rental housing, i.e. B and C product, workforce housing etc. We ground our assessment related to general rent stability on stats from the '08-'10 period in the last recession, where CoStar rental rate tracking showed almost no change in average rental rates across the SoCal market. Of course, all need to be aware of their micromarket situation, and assumes good management, etc. We believe with the vast supply constraint in middle market rental housing, no oversupply in that sector, and stable middle income families as renters, rents will be stable generally.

We are presently raising long term hold equity on new deals, with the logic that rents in these specific product types will remain stable, and that a longer term hold period - 7-10 years, would allow sufficient time to ride out the recession. Values in MF will/may fall, but if you can plan on lower leverage on a purchase, or lower leverage at permanent loan funding once a new construction project is stabilized, that would provide some relative amount of insulation against valuation decrease in a downturn scenario.

Greg Dickerson · Answer

I qualify these statements based on local markets. Real estate and construction are hyper local. Not every are of the country is experiencing the same conditions so some of this may apply to some markets and not others.

Construction costs are all about supply and demand like most things in the economy. Costs are at an all time high right now with no signs of stopping anytime soon.

The other factor to consider is there is a labor shortage due to demand and with the amount of construction in progress its taking a lot longer to get things done so you need to account for that as well.

On the flip side interest rates are at an all time lows so its kind of wash.

Its tricky to try and time a market but it while take a huge shift in the economy for construction costs to adjust in any meaningful way any time soon in most areas of the country.

Scott Choppin · Answer

@William Coet

Great question.

This means we are raising equity that will stay in the deal for 7-10 years - i.e. "Long Term Hold".

This is in contrast to a "merchant build" project, where we would build, rent, then sell immediately.

Let me know if that helps.

~Scott

William Coet · Answer

@Scott Choppin  From your previous post, what does this mean: " raising long term hold equity on new deals" ?

Thank you

Jay Johal · Answer

Thanks guys, I may pursue construction then in a few months irregardless of the economy. Historically, rents maintain and I don't see the San Diego rental market taking a big hit. It did not do so during the last recession.

George W. · Answer

What if in six months to a year the economy is solid and new construction increases demand for construction goes up and is more expensive? Will you still wait then or kick yourself for not doing it now? When the economy does turn down again eventually, it might not even be real estate related. Sure you might find someone cheaper but the cheapest contractor isn't always the smartest option.

Dan H. · Answer

My view is no one knows that a recession is coming and those most confidant that a recession is coming are hoarding cash waiting for the recession.  Some of these people have been sitting on the sideline for a few years missing part of an outstanding RE appreciation cycle.

Now to your question...   during the GR prices fell in my market.  However, financing options dried up so it was not easy to take advantage of the opportunity.  In addition, there was a lot of fear so even people with financing were waiting on the sidelines for fear of jumping in too early.  There were as many excuses then for not jumping in then as there are now.  Those who sit on the sideline miss playing in the game.

Good luck

Construction and market downturn? Whats the relationship?

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