ULI with Focus' Vicky Lee: Construction Financing Outlook

May 1, 2023 | Urban Land Institute

It’s no secret that construction starts are down in the current market, where higher interest rates are making new projects tough to pencil out. For some developers, though, the bigger problem these days is sourcing equity versus debt.

Developers are having to bring more equity to the table in a market where lenders, across the board, have pulled back on leverage. “The challenge, and maybe the reason that construction financing is down, is that institutional private equity has been sitting on the sidelines, for the most part, for the last 15 to 18 months,” says George Maravilla, a partner at Scottsdale, Arizona–based Tower Capital. If developers don’t have the equity, they don’t have a path to secure their debt financing, he adds.

“Deals are still getting done on the construction lending side. It’s the equity side that we’re having more trouble with, because these investment companies are saying, ‘Let’s hold [back] until we see what the Federal Reserve will do with interest rates’ before they make a move,” says Vicky Lee, senior vice president, development at Focus, a development and construction firm based in Chicago. In addition, because there haven’t been many investment sales that are not distressed, it’s difficult to determine exit values and cap rates, which makes it difficult for investors to underwrite new construction projects, she notes.

Focus has several projects in the pipeline, including one multifamily project in the Fulton Market submarket of Chicago that is shovel-ready. In that case, the firm is facing the added challenge of courting investors who appear to be wary of the Chicago market in general. Lee attributes that condition to some of the negative headlines related to such issues as property taxes and crime, which might be untrue or apply only to specific submarkets.

The firm also has a handful of apartment projects in South Florida that are in the early construction drawings stage, such as the 517-unit 128 Southwest 7th project in Miami. And even though that market remains hot, investors are more cautious now than they were in the past. “[Although] we are testing the waters on our Florida projects, a lot of equity partners and new construction lenders are not willing to step in early,” Lee says. That wariness represents a change from a couple of years ago, when Focus could market an early-stage development to investors who were eager to get involved during pre-development. Now the firm is finding that before investors commit capital, they want construction drawings done; the guaranteed maximum price in place; and even some of the pre-development steps, such as infrastructure and utilities, complete.

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