The Last Word: Wrenches In Construction

Posted by msmessenger on Dec 27, 2022 12:00:00 AM

If you are a business owner exhausted of renting commercial real estate and considering purchasing versus renewing your lease agreement that increased substantially, you’re in for a rude awakening. The commercial real estate market has been dominated by investment capital. A business owner is being priced out of the market; it’s nearly impossible to be the winning contract bid on a piece of commercial property. 

After months of searching and unsuccessful attempts at winning a contract bid, business owners are forced to consider taking on a construction project that will take a minimum of nine months to design and an additional 12 to 24 months to complete. Many business owners are entering an area that requires experts in their specific field. A business owner is focused on managing their day-to-day operations; they do not have the time for overseeing a construction project. They are investing company working capital or personal funds in a project and bear 100 percent of the risk through the due diligence process of land planning, zoning, building design, and permitting. 

All initial costs are paid by business owners; lenders are ready for construction financing once the project has final construction costs itemized and permits issued. A construction contract is required for appraisal purposes and loan commitment. The increase in construction costs have made it difficult to estimate a construction budget through the process of design. Contractors are unresponsive to new potential jobs, or they bid with higher projected costs that will not pencil out on paper and kill the deal. 

Lenders are scrutinizing construction loan requests; they are requiring financial statements from general contractors with resume, references, and underwriting both the borrower and contractor. Lenders control the construction draws and inspections and protect the project from any unnecessary subcontractor liens for payment owed on work completed. 

Contractors are dealing with supply chain issues on every level; something as simple as a window on backorder delays a project for final sign-off. Labor shortage is a problem all industries are experiencing, and the lack of a skilled labor force will need to be addressed somehow. Wages have increased to keep the qualified labor force in place, which works until someone else offers your labor force more money. 

The icing on this cake for business owners was the historic low interest rate period (3.0 percent +/-) that allowed them to leverage their capital and purchase a property that might have been at the top of their desired price range. The 25-year amortization allowed the loan payment to be reasonable versus their increased rent payment. That’s now over. Interest rates have increased over the last few months, and I’m expecting construction loan requests to slow or existing loans to reconsider moving forward with construction. 

The reality is that interest rates remain reasonably low and business owners will continue to consider the option to buy, build, or lease real estate. Will there be an adjustment in the market? Is this the new normal? Are construction costs going to continue increasing? Who knows?

It’s all about the choices, or lack of choice, available for business owners.