. . . . a tough question in light of today’s stubborn economic recovery. Even though we’ve spotted a few bright spots on the economic horizon (a shrinking foreclosure rate, a growing cash-investor class taking advantage of bargain distressed property prices, rising values of existing commercial properties), tepid job growth and an inventory of unsold REOs seem to negate any optimism. Arguably, the building industry has suffered as much as any other sector. Construction of new homes, one key indicator of economic health, posted its largest decline in the past few decades and finds itself struggling with rising material costs in an environment not conducive to raising prices to cover costs. While conventional wisdom suggests that investors should distance themselves from the building and construction industry, first impressions could be misleading. A strategic return to the sector could yield great returns for the smart investor. The secret lies in pinpointing specific demand and if enough demand exists to drive growth. UCLA’s Anderson School of Business’ recent findings echo findings from a number of other sources indicating a consumer “shift” is occurring to affordable rental units from the traditional single family home. Higher down payment requirements, tight credit and other factors make renting a more practical choice for current homeowners and the growing segment of “Echo Boomers” – defined as children of Baby Boomers born between 1975 and 2000. Fannie Mae estimates that the currently available 15.2 million rental units will not meet the growing demand for affordable housing for this group in the future. Similarly, on retail and office market fronts, analysts predict shortages in retail office spaces as businesses expand. While the fate of the traditional single-family home may be unclear at the present time, the need for affordable apartments and commercial square footage is increasing. Demand exists. The economic downturn crippled the construction industry. The credit vacuum created by the voluntary exit of lenders and the FDIC shutdown of banks with non-performing construction loans brought building to a virtual halt. New project starts diminished and ongoing developments that lost financing stalled. These factors combined to stymie the supply of units brought to market. Now that demand is showing signs of returning, some mothballed projects may begin to make sense at today’s prices. The initial infrastructure work leading up to construction (permits, environmental studies, plans, etc.) that comprise the up-front costs and take years to complete, new investors can now obtain for pennies on the dollar. Private equity funds and large banks are once again injecting new capital into projects. Activity is increasing at construction sites nationwide to meet projected demand, providing much-needed jobs to their immediate communities. We recently completed a development project that was able to sell at attractive current levels based on the fact that we saved on both the land cost as well as benefited from existing infrastructure. This in addition to the short time frame from investment to repayment, made the difference. The key factor is to begin in the areas that were located within good markets and avoid those areas that were on the outer rim of the growth pattern. If the project is well located it should achieve a fair return using very conservative projections. Is it time to build again? The answer depends on finding the right location at the right price at the right time when land is cheap and the up-front costs have already been absorbed by previous investors. The heavily discounted infrastructure and approvals, in my opinion, are the key elements.
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MICHAEL MCDEVITT 