Impending Decline in Construction: What It Means for Real Estate Investors
As we enter the new year, key trends are set to reshape the investment real estate market. Leading the charge is a notable decline in new inventory, a shift that will impact all property types across the board. However, the effects of this trend will not be evenly distributed, as some markets are likely to feel the strain more acutely than others.
Understanding the reasons behind this trend, the driving factors, and its potential impact on their portfolios is crucial for real estate investors.
Decline of New Construction
The development of new properties is projected to decline across all property types heading into 2025. This downturn is expected to persist for several years, with ripple effects likely extending for more than five years. Multifamily and industrial sectors are anticipated to be the hardest hit, while new office and retail developments have already slowed significantly since 2022. This trend may also reflect a cyclical shift, as 2023 and 2024 saw a record influx of new units entering the market.
Factors at Work
The two factors that are slowing down new development projects are a declining workforce and the cost of construction.
Declining Workforce: The construction labor market is losing workers at a rate faster than it can replace them, a trend expected to worsen in the coming years. Large numbers of experienced professionals are retiring, while the pool of qualified replacements continues to shrink. Meanwhile, younger generations are increasingly prioritizing college education over trade school, further reducing the availability of skilled labor. Proposed immigration policies advocated by the incoming Trump Administration, could further impact the workforce by limiting the entry of skilled laborers into the country, exacerbating the industry's challenges.
Rising Construction Costs: The shortage of skilled workers is driving up labor costs as demand outpaces the available talent pool. Compounding this issue, new loans with interest rates exceeding 8% are increasing the financial burden on developers, limiting access to funding for future projects. Simultaneously, the cost of essential construction materials, such as lumber, steel, and cement, remains high. These prices could escalate further if new tariffs are imposed on imports under policies like those proposed by President Trump. Potential tariffs on materials like Canadian wood and Mexican steel would add to the financial strain on an already challenged industry.
What it Means for Investors
These challenges won’t impact all markets equally. While some areas may experience minimal disruption, others, like the Bay Area, could face significantly greater burdens. Labor shortages, rising material costs, and restrictive financing could exacerbate existing affordability and development constraints in such high-demand regions. In the Bay Area, where construction costs are already among the highest in the nation, these issues could intensify, potentially making the problem three times worse than in less affected regions.
For investors holding property in the Bay Area, these challenges could present a significant upside. Limited new supply is likely to drive up the value of existing inventory, enabling property owners to charge a premium for units or commercial spaces. This creates an opportunity to capitalize on increased demand and rising rents. Additionally, investors looking to exit the market can benefit from these favorable conditions. They could sell their assets at competitive market prices and leverage the gains to invest in more affordable markets through a 1031 exchange.
The Azucena Take provides an inside look into the investment real estate market using the research done by Marcus & Millichap.