Why Some Developers Are Breaking Ground On New Projects During A Pandemic
Some U.S. cities have halted construction activity during stay-at-home orders to slow the spread of the coronavirus. But in the D.C. area, not only have ongoing projects been allowed to continue, developers are breaking ground on several new projects, despite the pandemic and consequent economic collapse.
These groundbreakings will create hundreds of new apartments and retail space from Greenbelt to Northeast D.C. to Buzzard Point. Development timelines mean it will be about two years before the projects deliver, and developers believe that will be an advantageous time to bring apartments to the market.
"You can't time these cycles perfectly, but I do think for the stronger developers with better-placed product hitting the market, there will be less competition," Neighborhood Development Co. CEO Adrian Washington said. "And when we do recover these projects will do really well."
Permit data shows the pace of new groundbreakings is slowing, and some developers have publicly pulled back on projects they had planned to start this quarter. This drop in the overall pipeline means developers that are able to move projects forward will face less competition when they deliver, and some also expect the slowing activity to bring down construction costs.
Many of these projects are also being financed through the opportunity zone program, with funds looking to deploy capital quickly to meet timelines that allow them to realize the program's tax benefits.
Even with these advantages, developers say it has been harder to close deals during the pandemic, and it took extra effort to make their financial partners and contractors feel comfortable with the prospect of starting a new construction project during a health crisis and a period of economic uncertainty.
"There was an overall concern with getting the transaction closed because of what is going on all around us, but [our financial partners] are as committed as we are to our mission to provide workforce housing," CityInterests Managing Partner Peter Farrell said.
CityInterests broke ground Monday on a 191-unit apartment building at its Parkside development near the Minnesota Avenue Metro station in Northeast D.C. The project used opportunity zone financing, and Farrell said the program helped the developer secure investment.
Last week, Washington Property Co. broke ground on a 26-story, 403-unit apartment tower in Silver Spring. It also used opportunity zone financing through its partner, the Cresset-Diversified QOZ Fund.
At the Parks at Walter Reed development in Northwest D.C., Hines, Urban Atlantic and Triden Development Group closed the financing last month — including opportunity zone equity from a Bridge Investment Group fund — and plan to break ground this month on a 323-unit building anchored by Whole Foods.
MRP Realty is preparing to break ground within two months on a 344-unit project with retail on Buzzard Point, for which it closed on the land buy last week. It has yet to close the financing package, but one of its partners is planning to use opportunity zone equity.
Timing The Price Drop
Despite these projects moving forward, data shows the overall development pipeline is slowing, potentially creating advantages for the developers that have been able to break ground.
Construction starts in the D.C. area were already down 47% during the first two months of the year, according to Dodge Data & Analytics. That was before the coronavirus became an economic crisis, and groundbreakings are continuing to slow.
D.C. issued 18 new building permits in March and 14 in April, Department of Consumer and Regulatory Affairs data shows. By comparison, it issued 27 new building permits in February, 27 in January, 36 in December, 26 in November and 33 in October.
"There will be fewer projects built," Washington said. "Financial partners will be more skeptical about financing projects and developers' attention will be more focused on solving problems in their existing portfolios."
A slowdown in development could make projects cheaper to build, as construction costs had been rising in part because of the development boom creating high demand for materials and labor.
Washington said he has had exploratory conversations with subcontractors that said bids for materials are coming in 10% to 15% below the expected cost, and he believes costs will fall further as the year goes on. In addition to the Eastern Avenue project, NDC also broke ground on a Benning Road project in February and has a project in Southeast D.C.'s Hillcrest neighborhood scheduled for a July construction start.
"In the summer and fall, when subcontractors start to see pipelines are reducing, they'll start taking their bids down accordingly," Washington said. "Material inputs like the cost of fuel going down translates into things like plastics and metals. Worldwide demand will go down so those components of the construction process will go down."
Farrell and MRP Realty principal John Begert also said they are seeing construction costs begin to fall, and that makes it more attractive for a developer to break ground now.
"We're seeing material costs go down," Begert said. "We're seeing projects dry up that are in the pipeline, we're definitely seeing some things get pushed, and that creates more urgency with some of our subcontractors."
JBG Smith CEO Matt Kelly, in a quarterly letter to investors released Tuesday, said he is expecting to see a drop in construction costs and is planning the groundbreaking of its 1900 Crystal Drive apartment project in Crystal City accordingly.
"While we are committed to building this asset as part of our National Landing repositioning, we intend to time our construction commencement to capture the benefit of an expected decline in construction costs," Kelly said. "Earlier this year, we started demolition and enabling work at 1900 Crystal Drive to ensure that we are ready for construction [to] start when market conditions and construction pricing warrant."
Washington Property Co. Vice President of Development Janel Kausner said she expects the costs of some materials may rise because of global supply chain issues during the pandemic, but a slowdown in development could help balance that out.
"I do think there will be more contractors and subcontractors hungry for work," Kausner said. "Leading up to the pandemic, there was a lot of work around here and subcontractors had their choice of which project they wanted to work on, so this may change that dynamic a bit."
Another result of the development slowdown could be less competition in the apartment leasing market for projects that deliver in two years. The massive surge of supply in recent years had made it harder to increase rents, and a delivery slowdown could help developers achieve their desired lease-up pace and rents.
The NDC and CityInterests projects are largely affordable or workforce housing, a segment of the market developers expect will remain strong through the recession as people look to spend less on rent.
"Of all the asset classes, residential will be the one that's least affected," Washington said. "People still need a place to live. There will be slowing I'd think at the higher end, but for affordable housing projects, unfortunately, the demand for that type of product will increase, because we'll be going through a recession and people will have less income."
Darby said he is not expecting to see an overall slowdown in development, as he believes every developer that is able to obtain permits and financing will continue to move forward. But he said he is comfortable with the number of apartments that will be delivering in NoMa — one of the fastest-developing neighborhoods in recent years — around the time of 40 Patterson's delivery.
"We know there will be several other projects delivering, we've pro forma'd that accordingly, and we've seen that market stay strong with some of the best lease-up rates in Washington," Darby said. "We don't see it changing even with the pandemic because people have to live somewhere."
Putting The Money Together
The advantages of falling construction costs and reduced competition may make breaking ground on a new project today attractive, but doing so during a pandemic still comes with significant challenges.
Lenders have been more hesitant to underwrite new construction loans in this environment, Begert said, meaning developers with strong relationships with financial partners will have an easier time breaking ground. He said he is confident MRP will close its financing for ts 1800 Half St. SW project despite the lending slowdown.
"We've seen the debt guys completely back up," Begert said. "There are not really construction loans out there, so we feel like we have a great lender for 1800, and we need to strike."
Darby said he is still working to close the financing deal for Monument's 40 Patterson St. project, a $110M development that will use a roughly $75M construction loan.
"Everyone's being cautious because banks are going through interesting times," Darby said. "We want to make sure we're working hand in hand with lenders to make sure they're comfortable moving forward, and once we start, we go full bore and there's no slowing down."
Hines Managing Director Katie Wiacek said the financing partners for the latest Parks at Walter Reed building were already on board before the coronavirus and remain confident in the project, but there were some logistical issues.
"Getting to the closing certainly took greater effort without anyone able to work together or meet in person," Wiacek wrote in an emailed statement. "Just the logistics of obtaining original and notarized signature pages, for example, from all parties added time and complexity."
The opportunity zone program has provided a meaningful source of equity for developers looking to break ground at a time when other investors may be pulling back. Many opportunity zone funds have already pooled significant amounts of capital that they are looking to deploy, and the program has timelines that make it more advantageous the earlier you put money into projects.
"That has definitely added a boost because of the time frames that capital was looking to deploy," Washington said of the opportunity zone program. "The projects still have to make sense in and of itself, but it does give an extra added incentive to get financing for those projects."
Having its project in an opportunity zone and using the program also helped Washington Property Co. receive permits to allow construction to begin, Kausner said.
"For the county, as far as [the Department of Permitting Services] working with us, they're also very invested in seeing an opportunity zone project move forward," Kausner said. "They were very cognizant of the amount of jobs that will come from this job, so that was a factor in getting this done and knowing that it would be an economic boost for the county."
The safety of construction workers on-site is a concern developers must weigh when considering whether to break ground on a new project. Construction has been allowed to continue during stay-at-home orders in D.C., Maryland and Virginia, but some projects — including Marriott International's Bethesda headquarters — have been forced to temporarily stop after workers tested positive for COVID-19.
"We discussed at great length with our contractor the protocols that they would have in place for the workers on the site," Farrell said. "We became comfortable that they had thought it through carefully and appropriately and would put proper protocols into place."
CityInterests is working with Bozzuto Construction as the general contractor for its project. MRP has two ongoing projects under construction in Northeast D.C., and Begert said it has had discussions with its Moriarty, its GC for the Buzzard Point project, about safety protocols.
Begert said the construction team is projecting a 5% to 10% loss in productivity on the project because of social distancing measures, and it is factoring in the possibility of the pandemic continuing through the end of the year.
"They're definitely considering some of the impacts of this occurring again in the fall and winter and how to deal with that, so they're addressing that with the language in the agreements," Begert said of the contractors. "We're planning around it and we hope it doesn't happen, but we are taking additional measures ... They are comfortable working and moving forward."