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As New Projects Get Harder To Start, D.C. Developers Dust Off Their Recession Playbooks

For D.C. developer Richard Lake, this year is starting to feel reminiscent of 2009. 

The head of Roadside Development remembers how construction starts slowed dramatically during the Great Recession as it became nearly impossible to finance new deals, and he used that period to prepare for a major new mixed-use project that would break ground in 2011 in the emerging Shaw neighborhood.

"This feels to me a bit like what we went through before we started at City Market at O," Lake said. "There were very few products coming online. We used '09 and '10 to design for '11. That allowed us to really hit the market running, so when the markets did start to free up, we were already under construction."

Roadside Development's Richard Lake and Rand Construction's Bob Milkovich at Bisnow's D.C. Construction & Develoment event Oct. 19.

Lake, along with executives from Hines, Bozzuto and Akridge — speaking Wednesday at Bisnow's D.C. Construction & Development event at the Capital Hilton — said it is becoming harder to make the financial math for new development deals work as interest rates and construction costs rise, and as the economy potentially enters a recession. 

While these challenges will likely slow down new development in the near term, executives said it also brings opportunities to find deals at a discount and prepare new projects that can ride the recovery. 

The sharp rise in interest rates this year, with the Federal Reserve enacting three consecutive 75-basis-point hikes, has made it much more costly for developers to secure construction financing.

"All of a sudden, the economics of many deals don't work," Lake said. "I know a lot of projects that are not going to move forward. The numbers don't work any longer. ... Capital right now is frozen in a lot of places for new investments."

But this isn't stopping Lake from looking for new deals.

After delivering the huge Wegmans-anchored City Ridge mixed-use project this summer, Lake said he is working on early designs for another 1.5M SF of potential development.

"When the market is rocking like it has in the last decade, it’s very efficient; you’re really just riding the tide," Lake said. "But when the market’s a little choppy and there’s inefficiency, there’s opportunities. That's typically where we start to look at acquiring."

He said he is focusing his acquisition targets on emerging neighborhoods that haven't experienced the development boom of the last decade but that may be prime places for growth during the next economic expansion. 

"The key is to be targeted and to really think about markets that are underserved, locations that can get you ready for the next cycle," Lake said. 

NFP's Dustin Smith, Eastern Atlantic State Regional Council of Carpenters' Anthony Abrantes, Roadside's Richard Lake, Rand's Bob Milkovich and Hines' Andrew McGeorge.

Hines Senior Managing Director Andrew McGeorge said he thinks D.C. can handle a recession better than most cities because the federal government and its private sector contractors provide stability, but he still said it is hard to finance a new project in the District today. 

"All of our construction costs are up, all of our interest rates assumptions are up, our cap rates up, so it is tough to make the numbers work," McGeorge said at the event. "We’re really just trying hard to make sure the birds in hand that we have, if you will, become real projects. But it’s a challenging time in the near term."

McGeorge, who works on multifamily deals for Hines, didn't address the reports last month that the firm handed back the keys to a D.C. office building to its lenders, a move that has created concern in the office market. But he said Hines also sees opportunities to make acquisitions at a discount during a potential downturn. 

"At Hines, we have four large domestic discretionary funds we’ll use to take advantage of the distress," McGeorge said. "But we're definitely assuming more equity is going into the deal and a lot less leverage."

An economic downturn may lead investors in real estate funds to try to redeem their money, which McGeorge said could force fund managers to sell assets. 

"There are a lot of institutional investors here, so investors will just sit and wait, those that can, but a lot of redemptions will be occurring, and those funds will have to sell," McGeorge said. "They’re going to be selling at inopportune time, so we do believe there will be opportunities going forward."

Potomac Law Group's Tamara McNulty, MRP Realty's Andrew Foncannon, Davis' Dominic Argentieri, Akridge's David Toney, Bozzuto's Kelly Cantley, DPR's Matt O'Malley and EagleBank's Ryan Riel.

Akridge Senior Vice President of Development David Toney said supply chain issues are making construction costs rise and forcing the developer to source materials earlier, but the biggest challenge he sees in getting new projects off the ground is securing debt. 

"What keeps me up at night is what's going on with the capital markets. That drives what we're able to do," Toney said. "Most [lenders] are a little more frozen and stuck with what's going on with rates and not being able to refi deals and get taken out through reversions and sales of properties, so they're a little bit stuck."

Akridge was able to secure a $367M construction loan in April from Bank OZK for the first phase of its 2M SF project in D.C.'s Buzzard Point neighborhood, and it broke ground on the project in May with an expected delivery in 2025.

"The fundamentals of what we are investing in, I think, are sound," Toney said. "The projects I mentioned are not delivering for a couple years now, so maybe we're on the other side of something, and then we still have some more pipeline that we also feel good about how it's underwritten and the general fundamentals."

Bozzuto Construction Co. Senior Vice President Kelly Cantley said the development firm and the clients of its construction arm still have a "strong" pipeline, but she expects some projects will be delayed. 

"We are anticipating a slow-up," she said. "Probably some of the projects are going to slip anywhere from 30 to 60 days. We're already having clients say, 'Well, I think I'm going to push it a little bit more into the spring or summer.' In speaking with our clients, the concern is truly what’s happening with the capital markets and what’s going to happen later next year."