CBRE Flash Call: COVID-19 Impacts on Construction Activity and Lending

CBRE anticipates an economic recovery beginning in Q3, accelerating in Q4 and continuing into 2021. GDP in the United States is forecasted to fall by 5% in 2020 and rebound by 6% in 2021. While this essentially equates to two years with essentialy no economic growth, CBRE’s view is optimistic about a quick rebound because:

• There is a massive amount of unprecedented Federal stimulus coming into the economy.
• Asia is already rebounding with office and retail well on the road to recovery.
• Rent collections for office and multifamily properties exceeded dire forecasts.

• In many markets, construction has been deemed an essential business, which enabled activity to continue moving forward.
• Several major markets across the U.S. (New York, Boston, Philadelphia, Bay Area and others) had a more narrow definition of essential business, causing approximately 25% of projects to shut down, with nearly 50% of construction projects halting in New York City. Some major markets are beginning to resume construction.
• Health & Safety protocols are being implemented at construction sites based on CDC guidelines for construction workers including social distancing, wearing masks, temperature checks, additional hand washing and sanitizing stations and restricted use of shared tools or equipment.
• In some instances, additional personnel have been added on site to enforce guidelines and check in on the Health & Safety of the workers.
• The type of asset affects how the project is being impacted. For example, taller buildings in dense urban cores where it is challenging to implement certain guidelines, particularly vertical transportation, may experience greater delays.

• The construction lending market is experiencing a more significant slowdown than the overall financial markets due to larger perceived risks.
• Due to the pandemic and uncertainties around construction timelines, social distancing and contractor safety, lenders have been conservative in their underwriting and highly selective relative to their borrowers.
• Lenders are focused on borrowers with the experience and financial resources to address any short-term interruptions. Capital is limited and reserved for top clients, based on lender relationships.
• Regulators have implemented enhanced monitoring and focus on value impairment, providing lenders leeway and guidance to modify loan structure as deemed necessary by market conditions.
• Commercial mortgage spreads for construction are up dramatically (100-200 bps) over the last eight weeks because of perceived additional risks.
• Expect tightening of loan structures including lower loan-to-value (LTV) and loan-to-cost (LTC) ratios, increased pricing, unused fee and more critically stressing the borrower’s assumptions.
• Lenders are going to be more conservative, building in more interest carry, longer lease up periods, assuming higher vacancy, lack of rent growth and highly scrutinized rental rate projections.
• Speculative construction financing is extremely difficult to secure right now.
• There are very few nonrecourse construction lending options, debt funds are one of the few, but with 200-400 bps price increases.
• Construction lending may continue to be constrained through the end of the year.
• Markets best positioned for construction loans today are major markets – particularly in Texas and the Southeast – which are expected to bounce back quickly, with less density relative to urban cores.
• Multifamily and industrial are the most favorable product types.

• Currently, there has not been a significant reduction in construction costs.
• Any cost savings may be offset by additional costs for complying with certain guidelines.
• The potential to lose a construction crew due to contracting COVID-19 could impact the labor pool.
• We could potentially see a reduction in labor costs from subcontractors and contractors if more up and coming projects are paused and there is a decrease in backlog.
• There are going to be more opportunities for back-filling the construction pipeline.
• Impacts on construction schedules depend on the asset type. Many projects are continuing on schedule, but denser projects may experience a loss of productivity. A 10-15% extension on timeline may be necessary for some projects.
• Practices to accommodate social distancing may be implemented including staggering shifts, longer days, more workdays, etc.

• It’s still too early to tell if there will be any major structural changes to buildings in terms of Health & Wellness as a result of COVID-19. There may be some adjustments to layouts, amenities and a bigger focus on sustainability moving forward.