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April 27, 2017

A walk down a busy street in many major markets might have you seeing as many cranes as skyscrapers. But what’s here today, might be gone tomorrow.

Development has been on a roll.  JLL’s Construction Report says that developers spent $296 billion on commercial construction across all asset classes in 2016, a nearly four percent increase over the prior year. But there is cautious optimism for 2017 as market forces are making construction lending a bit tougher for certain projects.

“Regulators and many banks are concerned that we could head toward over-supply, especially in the multifamily business,” said Tom Fish, JLL Executive Managing Director and Co-Head of the firm’s finance practice. “They caution there is overexposure, and it seems borrowers in some markets have gone to the well one too many times.”

According to the Federal Deposit Insurance Corporation’s (FDIC) semi-annual report, nearly 80 percent of insured institutions grew their loan portfolios during the third quarter of 2016, nearing the peak of the 83 percent that grew their loan portfolios in 2005.

Adds JLL Managing Director John Manning, “It’s really a market-by-market issue when it comes down to the specifics of multifamily construction lending. But one thing holds across the board: construction lending is getting more difficult.”

We spoke with three experts from around the country who explain what they are seeing.

Lenders tighten purse strings

Chicago, and many markets in the Midwest, have seen a boom in commercial construction lending for multifamily development – and development across the board. But with the swell of luxury offerings has come a more cautious approach from lenders, says Maggie Coleman, JLL Managing Director, Chicago.

“Banks are still willing to finance developments in the right submarket with experienced sponsors who have a proven track record. However, we are seeing more conservative leverage levels more in the 70 percent range compared to loan-to-cost ratios in 50s and 60s earlier in the cycle,” said Coleman.

Part of that is a reaction to a slowing of net rent growth, which was under 4 percent in the last quarter of 2016 for the first time since 2014, according to JLL’s U.S. Investment Outlook.

Still, and importantly, the numbers show a constant flow of new product hitting the market and a solid national absorption rate of 1.6 percent through 2016.

Demand stays strong

“The margins on multifamily are already thin – here in the Pacific Northwest and in many other gateway markets – and rising land, interest rates, labor and financing costs are eating into that a bit,” said Manning. “But here’s the thing: there is still huge renter demand out there, and with that demand there will always be a way to finance a multifamily building.”

One way developers accomplish this is by securing alternative capital sources such as debt funds and private capital, which look to make their returns in the mezzanine space and provide higher leverage. “This is great for our clients, because we know what lenders are looking for and can connect developers to capital sources they might not even know about,” added Manning.

Primary markets are on notice

Of note, it’s the primary markets that will likely feel the most impact the soonest, according to Fish. That’s where the most construction has happened and where the most capital has been invested.

But, says Fish, the tightening lending policy is not all doom and gloom.

“At the end of the day, it is going to serve as a barrier to development,” Fish noted. “That’s not necessarily a bad thing, as it can prevent overdevelopment and keep prices from falling too much. It’s the market and regulators working how they should.”

Tom Fish
Executive Managing Director, JLL Capital Markets

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