In a consistently competitive commercial real estate market like New York City, proactive construction risk management (CRM) always plays a more critical role in project development and asset allocation. Lenders rightfully recognize that projects should be watched closely because construction risks are compounded. For example, competition for labor means developers pay more to get and keep quality labor, and the impact of delays or defaults is magnified. A thorough strategy to manage such construction risks includes overseeing construction project budgets and contractors, progress monitoring to ensure milestones and deadlines are on target, and evaluating cost to complete and documentation.
But NYC market is in a state of flux. Property as a whole is oversold, with rising vacancy rates. A flat 2017 for development deals brings forth a strong possibility of significant retraction in 2018. The factors contributing to a likely downturn include oversupply of certain markets (hotels, hospitality), heavy losses in the retail sector, a slowdown in typically reliable sectors (office space, multi-family developments), and stagnation in trading and foreign investment. Most owners and developers are now looking to refinance and trim portfolios in order to lock in on good interest rates rather than aggressively developing or renovating new acquisitions. New York City CRE is in a stale mate of sorts – prices have gone up high enough to make development purchasing cost-prohibitive, but there isn’t enough liquidity in the market to sell.
How does such a tenuous and rapidly changing CRE environment affect the need for a comprehensive construction risk management process? Believe it or not, it’s more important than ever! Below are some key considerations for lenders to traverse the current climate and prepare themselves for successful transactions in the future:
Budgeting and Cost Reviews More Critical Than Ever The New York City CRE market for new developments, particularly for large, audacious projects, is undoubtedly frosty. Fewer overall transactions and a slowdown in construction mean less cash flow and revenue and more belt tightening for loans and underwriting. Lenders are likely to become even more conservative. There is no margin for error with existing projects when it comes to money loss. You have to be smarter to make money: every dollar has to go farther, milestones must be met on time and on budget. As such, budgeting, document and cost reviews, along with funds control and disbursement are essential, indispensable CRM needs.
Vetting of Contractors Will Be Key Fewer overall new development projects will weed out C-tier subcontractors and developers. There will be high demand for quality labor, as lenders will want to ensure that the very best contractors and subcontractors are being used. Furthermore, with fewer projects and tighter margins, developers and lenders can’t afford delays or costly issues caused by subcontractors. To find the very best and most reliable professionals, they will need CRM consultants with established relationships and reliable contractor evaluations to make the best decisions in a stressful market.
Cost To Complete For Unfinished Projects In the late 2000s, the foreclosure and default crisis resulted in a slew of abandoned projects and unfinished developments, leaving lenders and buyers in the difficult position of assessing whether to sell, complete or delay completion. Cost to complete analysis is an essential asset for lenders to make informed risk-based decisions. And while the NY CRE market doesn’t anticipate anywhere near such a dire set of circumstances in the near future, foreclosures in and around New York are booming. A 2007 lending spree to jump start a sagging CRE market means a significant wave of commercial mortgage backed securities are set to mature this year. Many of them were handed out liberally, with a slew of leveraged assets. Cracks in the marketplace, in the form of defaults, foreclosures and an increase in auctions across the city portend caution for next year. Lenders would be wise to hire due diligence CRM consultants to help navigate unfinished projects or delayed developments.
CRM For Changing Trends Although the New York CRE market is undoubtedly headed for a downturn, not all segments have cooled down. In fact, mid-tier multi-family development and warehousing have shown tremendous promise for growth and demand over the coming years. Warehousing and industrial buildings, in particular, are proliferating at an exponential rate, with vacancies at an all-time low, as a direct result of e-commerce growth. But not all buildings and developments are the same. In fact, highly specialized warehouses, particularly refrigerated ones for grocery deliveries, will require expert knowledge, elite subcontractors and guidance about sector trends. What is normal for a deliverable milestone? How much money should construction and development cost? What are the due diligence considerations of these projects? Keeping abreast of market trends proactively is an important element of adequately managing construction risk throughout different states of the market.
Construction risk management is an essential component of maintaining budgets, monitoring construction progress and milestones, as well as evaluating subcontractors. The current uncertainty of the CRE climate in New York, however, with a strong possibility for retraction and far fewer overall developments in 2018, lends urgency to committing to a thorough construction risk management process.