RCA Insights

Is the Urban Apartment Development Game Over?

By on August 4th, 2016

Development site sales are a precursor to construction and they plummeted into H1’16. Real Capital Analytics (RCA) calculates that sales were down 36% YOY in Q2’16. Some have suggested that slowing apartment rent growth limits the incentives developers have to move forward. Opportunities for development are still in place, however, and this slowdown may be more of a function of changing debt market conditions.

Real estate development is often driven by gut instinct rather than data suggesting that the market cycle is mature. Developers are risk takers and if there is a good story behind an underutilized site and a vision for a project, they will try to move forward.

The New York metro area and the Brooklyn market in particular have been receiving a lot of attention given the supply that has – and continues – to enter the market. Since 2015, analysts have been talking about a wave of new supply hitting this market, yet development continued.


Tracking development site sales in NYC across market cycles, in fact, RCA sees that whereas an average of only 13% of all development site transactions happened in Brooklyn in the last cycle, 19% of total were seen in the recent construction boom. Knowing that there is competition coming may not deter developers when there is a good story on an area that is underutilized.

I have had a unique opportunity to see the how much of Brooklyn still remains underutilized. I moved to Brooklyn last year with my dog Sasha and we have covered a lot of ground. (If you want some walking exercise, Pokémon Go has nothing on walking an 85 lb German Shepherd). We explored the Brooklyn Bridge, Gowanus, Crown Heights, Bed-Stuy and all points in between, and visited about all the development sites where new towers are planned or underway.

These areas of Brooklyn have a number of one-to-three story brick buildings, many of which have suffered from deferred maintenance over the decades. My dog’s excitement over the wonderful smells of these buildings is matched by the enthusiasm of developers in Brooklyn, and other urban areas of the U.S., as they bring these underutilized locations back into the productive economy.

All this new construction is not coming in just to compete with existing assets – in part, it is a story of the ongoing trend of rediscovery of urban locations that started in the 1980s. Of course, developers cannot come in and build new assets simply because existing ones are underutilizing a location. There needs to be a profit opportunity. This said, even though rents are under pressure and may not grow as quickly moving forward, they are still at an elevated level that developers can convince themselves will work.

It may be almost impossible for a developer to get the market cycle right and deliver an asset in an urban area at just the right point in time. There are complications from site aggregation, obtaining entitlements, addressing the concerns of locals and working with other service partners like architects and contractors that can delay or hold up a project. Perhaps more important than any these is working with the financier who will provide the construction debt.

Without that first draw from a construction loan, there is not much that can happen with a new development project. Data from the Federal Reserve suggests that a changing lender appetite for risk is now limiting construction lending across the U.S.

In the Quarterly Senior Loan Officer Survey, just under 25% of respondents noted that they had tightened standards on construction loans into Q2’16. This figure is up dramatically from 2014 when most were easing up on underwriting for construction loans. With new regulatory oversight on so-called HVCRE loans, concerns over asset valuations at record highs, and uncertainty over proformas on income growth with new competition, it is these financers who are putting on the brakes.

If you give developers money, they will build. Overall rent growth may be under pressure, but these people are optimists who see opportunities and try to make them work. Though make no mistake, there are still tremendous opportunities to bring underutilized areas of urban America back into the productive economy after decades of neglect.

Construction is pulling back, however, as financiers get jittery. This case of nerves may not be a bad thing at the moment. Even though there is ongoing job growth, not every new apartment tower would be able to fill up quickly, had supply continued to come in quickly. Plummeting development site sales into H1’16 may in the end help to continue to preserve asset valuations at record highs by preventing some new competitors from entering the market.

Jim Costello

Jim Costello

Senior Vice President

Jim Costello has worked in the CRE space on issues of urban economics since 1990, including a 20-year stint at Torto Wheaton Research. Jim expanded the reach of the Torto Wheaton Research team developing forecasts of global market fundamentals. He also developed approaches to pair the forecast results with frameworks to answer investor questions on asset values and relative investment opportunities.

In the aftermath of the Global Financial Crisis, Jim provided advice to the Treasury Department and helped educate these professionals on commercial real estate performance. Jim is a member of the Commercial Board of Governors of the Mortgage Bankers Administration, where he helps policy makers understand the commercial real estate industry.

Jim is expanding the capabilities of the Real Capital Analytics team on issues of real estate market dynamics. Jim has a master’s degree in economics and is a member of the Counselors of Real Estate.