Atlanta’s urban building boom could come to a screeching halt.
In another move to curb 40-year high inflation, the Federal Reserve last week raised interest rates by 0.75% for the third time in four months. This was the fifth hike this year alone, bringing the benchmark rate from nearly 0% up to 3%-3.25%. The Fed is forecasting more.
Some economists warn a recession is near — with stocks slumping as a result — while others argue otherwise.
“In terms of prognosis, it’s time to be real cautious,” said Henry Lorber, a longtime distressed real estate expert with Henry Lorber & Associates.
All office projects coming out of the ground in Atlanta are impacted in some way by the current economic climate. Around 4.9 million square feet of office space is currently under construction, according to a report from real estate services firm Colliers.
Equity is apprehensive
The amount of capital that private investment firms are ready to deploy is at an all-time high, according to multiple sources in Atlanta’s real estate community. Research from accounting firm PricewaterhouseCoopers reflects this.
But given the amount of uncertainty in the market, institutional equity partners are holding back. The returns on government-backed treasury bonds and Atlanta’s intown office buildings are not far from each other. Cap rates on office buildings in Atlanta averaged 7% in the second quarter of the year, according to Colliers. Sources in the market say this number is closer to 5%, particularly for Midtown. The U.S. 10-year Treasury yield most recently traded at 3.93% on Tuesday, according to the Wall Street Journal.
Debt is more expensive
An increase in the benchmark rate makes the cost of borrowing money much higher.
Construction financing is always floating rate debt, which is tied to the federal funds rate, Lorber said. When the cost of funds to a lender goes up, the cost of funds to a developer goes up. It may not even make sense to build the building until interest rates or rents balance out, Lorber said.
Loan volume has slowed as borrowers reassess expectations for “acquisitions and refinancings in a rapidly moving market,” according to a Q2 debt market report from commercial services firm Cushman & Wakefield. Lending standards are also tightening.
Building material prices are still volatile
When the cost of building materials goes up, so does the overall price of completing a project. And when they triple in a matter of months, developers that have underwritten buildings six or eight months before beginning construction will have to reprice them — while also trying to predict future fluctuations in cost. Rents could return higher than anticipated.
The most recent closing price of lumber is not what it was eight months ago. As of Sept. 29, lumber costs $429 per thousand board feet. In March, this number was $1,310.
This isn’t a sure sign that prices will stay down, however. After dipping to $498 in August 2021, lumber climbed steadily to its steep peak in March.
Along with lumber, the costs of steel and diesel fuel have been on a rollercoaster over the past few months, said Kenneth Simonson, the chief economist with the Associated General Contractors of America.
“It’s very much a mixed picture on costs right now,” Simonson said.
The cost of labor is up, too. Total compensation for hourly and salaried construction workers averaged $43.56 per hour in the second quarter of 2022, according to the U.S. Bureau of Labor Statistics. This is 12% higher than the average wage of all private sector employees in the same time period.
Contractors are having to raise wages to attract workers to positions, Simonson said. That adds on to the overall cost of building a project.
Companies are still unsure of their long term real estate needs
After a year and a half of steady leasing to new-to-market companies in Atlanta, the demand for office space isn’t as clear.
There are few, if any, companies seeking more than 50,000 square feet of office space, multiple sources in the market said. The average lease requirement is between 15,000 to 20,000 square feet.
The absence of big anchor tenants in the market is not a positive indicator for buildings that have just delivered or are under construction. It’s more difficult to convince a lender or equity partner to invest their capital in the project when a company of that size hasn’t pre-leased space.
Partly motivated by the economic headwinds, companies with existing footprints in buildings are increasingly subleasing their space, according to a report from Cushman & Wakefield. The amount of available sublease space in Buckhead, Midtown and Central Perimeter increased between the second quarter of this year and last, with Central Perimeter offering the greatest share out of all intown and suburban markets.
If companies aren’t subleasing, there’s a possibility they aren’t fully occupying their space. The average office occupancy among major office markets in the U.S. was 47% during the week of Sept. 26, according to Kastle Systems. Meta Platforms Inc. (Nasdaq: META), which leases 35,000 square feet at T3 West Midtown, only has around 20 to 30 employees in their office “on a good day,” Hines senior managing director John Heagy told Atlanta Business Chronicle earlier this month.
Though not immune, the outlook on Atlanta is positive
Atlanta’s real estate market will likely better weather the economic slowdown than other markets, Simonson said.
For one, population growth in Georgia is higher than the national average — 0.7% versus 0.1%, according to data provided by ACG.
Business activity should still gravitate toward markets in the Southeast for a few reasons, Simsonson said. They generally have lower taxes and regulation than Midwest or Northeast cities, for example, and warmer climates. The Port of Savannah is also a draw for companies.
“None of that says Atlanta is immune and that you won’t feel the slowdown,” Simonson said. “But Atlanta will do better than a lot of places.”
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