Construction file photo by Frank Lopez

As we enter 2023 with talks of a looming economic recession, inflation across the board and rising interest rates, next year is building up to be apprehensive for investors financing construction projects.

On Nov. 2, the Federal Reserve increased interest rates by 75 basis points, bringing the target range between 3.75%-4%. This along with talks of a recession is leading banks and investors to be a little bit tighter with their wallets when it comes to construction and property investment.

This slowdown is coming after hot activity in the construction industry, with data analytics company Dodge Construction Network reporting that year-to-date, total construction activity was 16% higher in the first 10 months of 2022 when compared to the same period of 2021.

The combination of high construction costs and increasing interest rates is leading to trepidation in lending to break ground.

At Fresno commercial real estate agency Stumpf & Company Real Estate, owner Ron Stumpf said that this past year, all clients have been writing checks to buy, instead of waiting for financing from lenders.

Stumpf said there were a few clients that did seller-carryback financing with the balance being all cash.

Most sellers, especially those higher in age, would prefer to get all cash to close quicker, foregoing waiting for a lender to possibly approve a loan, Stumpf said.

Even with this trend, Stumpf said that it is still a seller’s market when it comes to commercial property. 

The biggest factor when it comes to construction, however, will be the federal interest rates.

“The rising interest rates are going to stop some people from being able to qualify [for loans,” Stumpf said. “Chances are that appraisers will get more conservative on their appraisals.”

There is more trepidation from lenders for new construction projects as opposed to a renovation project.

Investors are also more likely to increase their cap rates to make a return on their investments with the higher interest rates.

Stumpf said that he is reading that distributors including Amazon are going to pull back on constructing new warehouses as more people are returning to shop in person instead of buying online.

As Covid protocols wane and more companies deciding to have their workers come back to the office, an increase in demand for office construction can be expected.

With the higher costs of materials, and environmental regulations from the state, getting to phase 1 of new construction requires heavy capital, leading to more interest in existing buildings.

Stump said that investment in construction in the restaurant industry has changed in the last 20 years, with fewer sit-down restaurants being built and more construction for fast food type restaurants that have a drive-thru lane.

Investors do prefer to have a corporate lease over a franchise chain lease, Stumpf said.

Banks and lenders are going to make sure they get returns on their investments, Stumpf said, so they will be a bit pickier with their lending.

“A bank is going to want to protect their interest. They don’t want to take back the properties, they just want to loan money,” Stumpf said. “They’re not going to give loans to everyone that wants to build something, they’ll have to have a tenant that wants the space. You can’t do speculative like it used to be.”

Brad Huxley, owner of Fresno Construction, said that when the interest rates changed, banks were dragging out the loan process and the firm did see a change in approval times and in how long it took to receive financing.

Huxley’s clients doing larger projects such as apartment complexes and hotels saw financing for those projects dry up earlier in the year, and instead did self-financing and cut the banks out entirely.

“Banks came up with different terms that were not favorable anymore, so for their asset acquisition they brought on more partners for self-financing,” Huxley said.

Huxley said that banks are not approving larger deals for new construction like before, but there is still a lot of activity for residential remodeling.

Construction companies are plenty busy, he said, but the trouble comes on the lending side. With the change in temperature for lending, Huxley said, its affecting how people operate when they are acquiring assets and how many they are acquiring.

Companies are still ambitious and moving forward, Huxley said, and if they can’t get into new facilities, they will just rehab their existing spaces, whether it be a home, a commercial space, or an industrial facility.

In his talks with underwriters, this current trajectory in the market is expected to carry on into next year.

With real estate being a lagging indicator to the stock market, there will be a dip in the real estate market.

The question is whether it will be just a dip or a fall.