The Federal Reserve’s largest interest rate hike in nearly three decades likely will place more hurdles on Greater Boston’s housing production, further constricting new supply and spelling increases in apartment rents and mortgage payments.
Developers will face higher borrowing costs and equity requirements, potentially weeding out less experienced and well-capitalized firms. Others may shift to non-residential projects, real estate executives predict.
“Once interest rates start going up, on the income side, the homeowners are challenged to make the numbers work, and the developer is challenged also,” said Kathy MacNeil, a partner at developer MP Boston. “The fact that we have inflation and construction costs at all-time highs, things are definitely tipped the wrong way.”
The central bank’s decision to increase the rate that banks charge each other for overnight borrowing by 0.75 percent this month comes after a recent spike in interest rates typically offered by banks for construction and permanent financing of multifamily projects.
“Rates have moved 1 percent [higher] in the last 60 days, so that’s having a tremendous effect on the market in both ground-up construction deals and sales of existing product,” said Kevin Benzinger, a director in Boston Realty Advisors’ capital markets group. “Construction costs have moved 30 percent in the last year, and people who have bought land with plans of building a multifamily development are figuring out what to do. Are the rents or prices there to make a project viable now?”
In the short term, the answer still appears to be yes, according to some developers who are active in the Boston-area multifamily market. Local banks are still aggressively seeking projects to finance, but are getting choosier and favoring developers that have been successful in similar projects.
“We’re seeing that many lenders are being more choosy and the deal has to be really good for someone to put money into it,” said Herby Duverné, CEO of Boston-based multifamily developer RISE Together. “In general, there is a need for stability and we’ve seen many of the large investors and lenders saying, ‘Give us a few months and see how things move along and how the market stabilizes.’”
Rent and Price Gains Offset Rate Shocks
In a Catch-22 for consumers, real estate industry executives say new multifamily construction will remain feasible as long as Greater Boston apartment rents and condominium prices continue to rise. Recent market data shows continued appreciation, although anticipated future mortgage rate increases will cut into buying power.
Massachusetts’ median condo sale price rose 7.1 percent in May on a year-over-year basis to $525,000, according to data compiled by The Warren Group, publisher of Banker & Tradesman. Worcester and Boston are the first- and third-most competitive housing markets in the nation respectively, Redfin reported, based upon the number of offers written by its buyer agents that met with competition.
Median apartment rents, meanwhile, rose 15.2 percent statewide between June 2021 and June 2022, according to Apartment List, and increased 14.4 percent in Greater Boston.
“The cost of money is high, but people still need a place to live and there’s a shortage of units,” Duverné said.
Lender Relationships Matter
Millennium Partners Boston faced a monumental challenge in 2020 as it sought construction financing for its $1.3 billion Winthrop Center skyscraper, which contains a mix of office space and 315 luxury condos, in the early stages of the pandemic. The firm obtained a $775 million construction loan in October 2020 from London-based Cale Street Partners.
In the inflationary environment that’s emerged in COVID’s wake, condo developers have to navigate a gantlet of financial challenges, MP Boston Partner MacNeil said.
“Today, I think people are going to have a hard time making their pro formas work with construction costs and interest rates and land costs. Everybody wants top dollar,” MacNeil said. “There’s only so much the marketplace can bear, and I think it’s going to be challenging to build in Boston.”
The Davis Cos. recently broke ground on 1515 Commonwealth Ave., a 254,000-square-foot project including 151 apartments and 102 condominiums in Brighton. The Boston-based developer is set to close on construction financing from a pair of regional and local banks, CEO Jonathan Davis said.
“We had really solid competition from banks and a lot of it had to do with having the right basis and a great site, and the power of the relationships that we have with the banks,” Davis said. “Between our chunk of equity and low carrying costs, we got favorable financing and we were able to make it make sense.”
Boston-based developer Cabot, Cabot & Forbes has built anticipated interest rate hikes into its pro formas on future projects, Director of Capital Market Dan Nagler said. The firm’s broke ground in May on a 435-unit rental complex on Kilmarnock Street in the Fenway.
“It’s a question of the capital markets adjusting to their new costs,” Nagler said. “From our standpoint, we can absorb the higher costs based upon the fact that rents and pricing for condos are all going up.”