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Strategies for Developers Amid Inflation and Rising Interest Rates

Strategies for Developers Amid Inflation and Rising Interest Rates



As inflation and higher interest rates persist, it is easy to see the effects on the housing industry as a whole. These two areas are closely related, reshaping the landscape for developers and playing a large part in the feasibility of new projects.

Inflation's Effect on Costs

The COVID-19 pandemic has had a long-term effect on inflation, stemming from the significant economic stimulus that was injected into the economy to fend off a downturn. This has led to a surge in costs across the board, from materials to wages, as the workforce demands higher pay to meet living standards.

While inflation seems to have steadied at the moment, it continues to be a concern for developers and contractors. The climbing costs of goods and services have left developers with the difficult task of covering these high costs, creating a cash flow crunch that can impact a developer’s ability to manage operating projects effectively.

On the construction side, the costs of getting developments completed are astronomically higher than they were in pre-COVID times. While costs have stabilized some, and developers have a more realistic expectation, costs are still high, with supply chain issues exacerbating the problem. Wages and labor force issues also continue to challenge contractors and developers.

Interest Rate Woes

Adding to the inflation issue is the high interest rate environment. The Federal Reserve incrementally increased rates as a means to tame inflation through July of 2023 and has since held them steady, leading to higher borrowing costs for banks, who then pass the cost on to clients through higher interest rates. This can make securing new financing difficult for developers, as well as causing deals to no longer pencil out as their projects can no longer support the debt service with the higher rate.

This hesitation among developers is causing a noticeable dip in the future pipeline of construction projects. Contractors and subcontractors are facing reduced demand for their services, which could lead to a decrease in construction pricing. This is supply and demand at work. With fewer projects in the pipeline and less work available, providers are forced to lower prices as they compete for fewer available contracts.

Easing the Pain

What can developers do to mitigate these economic pressures? That’s the million-dollar question and unfortunately, there are no easy answers. However, there are some strategies that could help ease the pain.

Rent Management

Ensure that you are keeping up with the market when it comes to rent increases for comparable units. Keep in mind that tenants have been feeling the pinch of inflation over the past few years, possibly limiting how much can be passed through to them.

Energy Efficiency

Investing in energy-efficient technology and materials can provide long-term savings on operating costs and potentially you could be eligible for tax credits. There are up-front costs here, so it is important to make sure the return on investment is worth the original price tag.

Leverage Economies of Sale

Look at your current projects and determine if there is an opportunity for additional projects in the same area. This can reduce the per-unit cost of property management, maintenance, and even construction.

Value Engineering

Revisit your plans and look for ways to reduce costs without compromising quality. Choosing less expensive materials or designs that still meet the project’s needs and appeal to tenants can be a relatively easy way to bring material costs down.

Negotiate

You likely work with the same group of service providers on your projects year after year. Now is the time to shop around for the best price for the services you require (i.e., landscaping, trash removal, insurance, etc.). If you find a better price elsewhere, your existing providers may be willing to negotiate rates. This is also true for projects close together. For example, if you have multiple housing units in the same area, ask service providers if they can offer a proximity discount.

Budget Review

Reassess any non-essential expenses and determine if they can be lowered or removed completely without affecting core functionality or appeal.

Remain Flexible

With inflation somewhat stabilizing but still presenting a challenge, and interest rates posing a significant barrier to project viability, developers must remain flexible and instill strategic foresight and innovative thinking into their projects. Staying adaptable through these changing economic circumstances is of utmost importance.

Those who can creatively manage costs, explore new efficiencies, and adjust project scopes accordingly will be better positioned to emerge resilient.

You’re not alone in facing these challenges. Contact SVA today and let us help you navigate the options.

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Biz Tip Topic Expert: Chris Fearn, CPA

Chris Fearn, CPA

Chris is a Principal with SVA Certified Public Accountants with expertise in the real estate and nonprofit industries. In his role, he manages and performs audits for owners of affordable multifamily housing projects receiving Section 42 Low-Income Housing Tax Credits.

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