Higher Interest Rates Expected To Curb CRE Development In 2024

After years of seeing city skylines dotted with cranes, the landscape is poised to change as elevated interest rates, high inflation and strong wage growth curb developers’ enthusiasm for starting new projects, according to a recent report from commercial real estate (CRE) firm Marcus & Millichap.

Projects that already have broken ground or locked in financing are moving forward, but new construction starts are being stalled. Banks are pulling back on construction loans compared to previous years as they tighten underwriting to reduce their risk of exposure.

If developers can get loans, they’re at rates well above pre-pandemic levels. Compounding the issue is that materials cost 33.5% more than they did before the health crisis and construction sector wage growth was 5.8% in 2022, outpacing the private sector average.

“While the effect on new supply will be minimal in the near term, higher costs for financing, building materials and labor are expected to slow future development,” according to the Marcus & Millichap report.

Still, some CRE sectors are faring better than others. For example, supply chain disruptions and changes in consumer spending habits are driving demand for industrial space, which has resulted in an increase in new products.

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Although additions to the supply will reach a two-decade high this year, Marcus & Millichap predicts a development slowdown. Construction starts declined by about 40% in the fourth quarter compared to the previous three months. And Amazon.com Inc., which accounted for about 16% of all warehouse construction starts over the past three years, recently announced it plans to stop building new facilities.

Even with rising interest rates, recent bank failures and more expensive materials and labor, the apartment sector continues to see record inventory growth. About 400,000 new apartment units are expected to be completed in 2023 — the first time in 30 years the multifamily sector has reached that mark.

And in February, multifamily project starts reached the second-highest monthly measure in three decades, indicating that momentum for new construction hasn’t slowed in the sector. Marcus & Millichap attributes the flurry of activity to an ongoing national housing shortage with steep barriers to homeownership, which is boosting developer confidence and will continue to drive the development of new communities in the near- to mid-term.

While industrial and multifamily have continued to flourish, office and retail are stagnant. The total amount of square footage for both office and retail is projected to increase year over year in 2023, but new proposals are declining, so construction starts are expected to do the same.

The prevalence of online and omnichannel shopping and work-from-home trends have lessened the demand for brick-and-mortar retail and new office space.

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